The Child Care Tax Break Many Parents Overlook

Robyn Gearey
Updated

Like many people's, my biggest expense after my mortgage is child care for my two little demons, er, darlings. And just as with my mortgage, I've always made sure to take full advantage of the tax breaks available to offset these massive costs.

So imagine my chagrin when I realized I've missed out on $200 in tax savings each year for the past five years!

Yes, thanks to confusing and often misunderstood rules surrounding child-care tax breaks, I've overpaid Uncle Sam to the tune of $1,000. Read on to avoid my mistake -- unless you happen to enjoy filing mounds of amended returns.

2 Tax Breaks for Parents

If you have kids and need child care in order to work (this can include actively looking for work or attending school full-time), there are two potential tax breaks available to you:

  • The first is a tax credit that applies to up to $3,000 in expenses for one child or $6,000 for two or more children.

  • The second is the dependent care flexible spending account (FSA) -- offered as a benefit by some employers -- which allows you to set aside up to $5,000 a year tax-free for child-care expenses. This amount is fixed no matter how many children you have.

The "qualifying child," in tax-speak, must be 12 or younger and be claimed on your taxes as a dependent. (As with everything IRS-related, there are all sorts of qualifiers and exceptions, so if your situation is the least bit unusual, make sure you check with an accountant. There's also more information here on the IRS website.)

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What kind of care is eligible for these tax breaks? Daycare counts, as does preschool. A full-time nanny or au pair counts, too. For school-age children, before- and after-school expenses can be deducted, but not private school tuition for kindergarten or above (private preschool is fine).

Parents with kids in private school should make sure any before- or after-care costs are broken out separately on their statements. Day camp fees are deductible, but overnight camp costs are not. (Obviously the IRS has no idea how much more productive parents whose kids are gone for a week or two can be!)

Which Money-Saving Option Should You Take?

Now here's the tough part: Do you take the credit or fund the FSA? Of course, the answer is "it depends."

Generally speaking, if you make more than $43,000, you'll want to opt for the FSA. Above $43,000, the credit gives you 20% of the amount you spend up to the maximum (that is, a maximum of $600 for one child, $1,200 for two or more). With the FSA, as long as you're in the 15% tax bracket or higher, you'll save at least 22.65% of your care expenses (15% Federal taxes + 7.65% Social Security/Medicare taxes). Again, check with an accountant for specifics on your situation.

Can I Take Both? (What I Didn't Know)

Maybe, and here's the part I missed: If you have two or more qualifying children and your expenses are at least $6,000, you can actually benefit from both options. For instance, if you spend $6,000 on child care, you can use your FSA for $5,000, and apply the credit to the remaining $1,000 in expenses. Since the credit gives you back 20% of that $1,000, it means an additional $200 for those families.

Even more ways to save

  • Max out your expenses. If you have an au pair or live-in nanny, you can deduct any costs you incur from having that person live with you. Even with a live-out nanny, you can deduct the cost of any food, insurance, or transportation you provide. You can also deduct any taxes you pay on the caretaker's behalf.

  • Double up and get a discount. Many care providers, including day camps, offer sibling discounts. Take advantage of them whenever practical and save 10%-20%.

  • Share care and cut costs. Consider a nanny share. Popular in more expensive areas of the country, a nanny share -- where two families share one caregiver -- can actually be cheaper than daycare. The Nanny Network site offers more details.

What other ways do you save on child care? Share your money saving tips in the comments area below.

Motley Fool writer Robyn Gearey is not going to miss out on her $200 in child care savings ever again.

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