A dependent care assistance program (DCAP) is a separate, written plan of an employer for the exclusive benefit of employees to provide coverage for dependent care expenses. A dependent day care flexible spending account plan is a type of DCAP.
A dependent day care FSA allows employees to put aside money on a pre-tax basis for reimbursing eligible dependent day care expenses. Such expenses must allow the employee to work or look for work and include items such as babysitting, day care, preschool, and day camp.
Employees who are eligible for a dependent day care flexible spending account plan can participate in the plan or can claim a dependent care tax credit on their tax returns, but cannot do both. To make an appropriate choice, employees must understand the following rules:
- Flexible spending account rules,
- Dependent care tax credit rules,
- Rules governing the earned income credit,
- And rules relating to the child tax credit.
Dependent Care Tax Credit.
The Dependent Care Tax Credit is a credit against an individual’s income tax liability. The credit can be claimed if the taxpayer pays someone to care for a qualifying individual. A qualifying individual is a child under age 13 or a dependent age 13 or older who is physically or mentally incapable of self-care. The expenses must be incurred to allow the taxpayer and spouse to work or look for work.
Up to $3,000 of expenses for one qualifying individual, or up to $6,000 of expenses for two or more individuals, may be taken into account. The available tax credit ranges from 20% to 35% of eligible expenses, based on adjusted gross income.
Earned Income Credit.
The Earned Income Credit is a refundable tax credit available for certain low income taxpayers. A taxpayer is eligible for this credit if he or she pays for care for a qualifying child. A qualifying child is a child with whom the taxpayer shares the same abode for more than half the year. The child must be the taxpayer’s child, stepchild, eligible foster child, brother, sister, stepbrother, or stepsister, or the descendent of such person. Additionally, the child must be under age 19 (under age 24 if a full-time student, or any age if disabled) as well as younger than the taxpayer or disabled.
Nonrefundable Child Tax Credit.
The nonrefundable Child Tax Credit is a set amount per qualifying child. To be eligible to claim this credit, the taxpayer must have tax liability, and the availability of the credit phases out at certain income levels. The taxpayer and the child must share the same abode for more than half the year, and the child must be the taxpayer’s child, stepchild, eligible foster child, brother, sister, stepbrother, or stepsister, or descendant of such person. The child must be younger than age 17 and must not provide more than half of her own support. Finally, the child must be younger than the taxpayer or disabled.
Refundable Additional Child Tax Credit.
The refundable Additional Child Tax Credit is a refundable credit for certain taxpayers who cannot use the nonrefundable Child Tax Credit because their tax liability is too low.
DFSA or Tax Credit?
Each employee will have to make an individual determination as to whether he or she should participate in an employer-provided dependent care flexible spending account plan or take advantage of the various tax credits available to be applied on the income tax return. The appropriate determination will be based on many factors including tax filing status, income, and number of dependents. Employers may wish to advise employees to consult their individual tax advisors before participating in a DFSA.
