Let the IRS Pay for Day Care

By Markets Fool.com


Source: Wikimedia / Myles Grant.

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Parents who work know how expensive child care can be. With few employers offering on-site day care for their workers, most couples face a tough decision: should both parents work to maximize income, or should one parent stay home to save the family the cost of day care? The cost of having someone care for your child can easily eat up most or all of that second paycheck.

Yet those who choose to work and send their children to day care can get at least some relief from the IRS. With tax credits and deductions available for child care costs, many parents can save hundreds or even thousands of dollars on their tax bill to offset part of what they have to pay on day care.

Get credit for your child care expenses
One tax break that the IRS offers parents is the Child and Dependent Care Credit. This credit allows you to cut your taxes by a certain percentage of your child care expenses for qualifying children under the age of 13. The percentage depends on your gross income; those who earn $15,000 or less get 35% of their expenses back, while those with incomes above $43,000 have a limit of 20%. The credit gradually phases downward by single percentage points for every $2,000 of income between $15,000 and $43,000. The maximum amount of child care expenses you're allowed to use in calculating your credit is $3,000 for parents of a single child or $6,000 for those with two or more children.

The net impact of the child care credit can be huge. For a family of four making $50,000 and paying $5,000 for child care, a 20% credit would produce savings of $1,000. A family with one child making $25,000 and spending $2,000 on child care, on the other hand, would qualify for a higher-percentage credit of 30%, yielding $600 in tax savings.


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Stay flexible with your child care
The other big tax break that working parents can get comes through flexible spending accounts at work. In addition to the flex accounts for medical expenses that most people are familiar with, some employers also offer flexible spending arrangements for child care expenses. These accounts let you contribute pre-tax money that you can later use to pay for child care, essentially saving you the income taxes and payroll withholding taxes on every dollar you contribute. There's a $5,000 limit on contributions to child care flexible spending accounts.

Here, your tax savings depend on your tax bracket. If you earn enough to be in the 25% tax bracket and save the maximum $5,000 amount, your deduction will produce income tax savings of $1,250 plus another $382.50 in savings on Social Security and Medicare taxes. Lower-income families in the 10% bracket, however, would save only about $350 in income and payroll taxes from a $2,000 contribution to a child care FSA -- producing savings that represent a much smaller proportion of what they put into the account.

Photo: Peter Moons, Flickr.

Moreover, with flexible spending accounts, you have to be careful not to contribute more than you'll need. Even under new rules, flex accounts for child care expenses aren't eligible to carry over unused amounts, meaning that if you don't spend everything you save, you simply lose that money entirely.

Make the right choice
Finally, taxpayers need to understand that the IRS won't let you take advantage of both of these provisions with the same child care expenses. Therefore, most people will have to pick whichever one produces the larger tax savings. The usual rule of thumb is that high-income taxpayers benefit more from flex accounts, while low-income taxpayers get more from the credit.

Raising a child is expensive, but tax breaks from the IRS for child care expenses can help cut the net cost of day care. That's a big load off the backs of working parents everywhere.

The article Let the IRS Pay for Day Care originally appeared on Fool.com.

Dan Caplinger was never happier than the day his daughter left preschool to go off to publicly funded kindergarten. He has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.