Dependent Care Pre-Tax Expense Account

Eligible Expenses

If you have a child, a disabled parent, or a spouse who needs daily care while you work, your expenses for that care may be paid with the pre-tax dollars you contribute to your dependent care pre-tax expense account. The primary eligibility requirement is that incurring the expense allows you to work. Moreover, if you are married, you may use the dependent care pre-tax expense account only if both you and your spouse are employed, or if your spouse is disabled or is a full-time student.

The maximum amount you may contribute to the account depends on how you file your federal income taxes, and on your own and your spouse’s gross income levels. For example:

If you are married and file a joint return, or if you are single and file as head of household, you may contribute up to $5,000 in a calendar year to this expense account.
If you are a highly compensated employee (salary of $110,000 or more), this limit is $1,800.
If you are married and file separate tax returns, the maximum amount you may contribute individually is $2,500.
If both you and your spouse participate in a pre-tax expense account plan, your combined contributions to both accounts cannot exceed $5,000.
Your contributions to the account cannot exceed your annual income or your spouse’s income, whichever is less.
If your spouse is disabled or enrolled as a full-time student, he or she probably has little or no income. In this case, the maximum contribution to the dependent care pre-tax expense account is $200 per month if you have one eligible dependent, or $400 per month if you have two or more dependents, for each month your spouse is enrolled or is incapable of self-care. This is the income level your spouse is “deemed” to have for purposes of determining how much you may set aside.

In addition to the rules governing the maximum amount you may claim in a dependent care pre-tax expense account, there are rules governing what constitutes eligible expenses:

The dependents who receive the care must be under age 13, or physically or mentally incapable of caring for themselves (a disabled parent or spouse, for example). They must depend on you for more than half of their support.
You may claim expenses for day care services outside your home. But if the persons receiving the care are age 13 or over and physically or mentally incapable of caring for themselves, the dependent(s) must spend at least eight hours a day in your home for the expenses to be eligible. Twenty-four-hour nursing home care expenses are not eligible.
You may claim expenses for services given in your home, as long as these services are not provided by someone you or your spouse also claims as a dependent on your tax return, or by another child of yours who is under age 19 (even if you no longer claim that child as a dependent).
Also, if you use the services of a day care center that provides care for more than six people (other than residents), the center must comply with state and local laws for the expenses to be eligible under the account.

Your eligible expenses may include:

The costs for dependent day care, at home or in a day care center.
Housekeeping expenses, but only that portion of these services directly related to caring for the dependent.
After-school care for children under age 13.

The IRS requires you, in most instances, to report the taxpayer identification numbers of dependent care providers you use. So if you are being reimbursed from your dependent care pre-tax expense account, you should ask each provider for its taxpayer identification number. This will be required on your income tax return. For an individual, the taxpayer identification number is the social security number.

Exclusions

According to the IRS, the following expenses are not eligible for reimbursement through the dependent care pre-tax expense account:

Expenses incurred for child care for a domestic partner’s dependent child(ren) unless such individual is the
employee’s tax dependent.
Non-employment related care, such as baby-sitting fees during nonworking hours.
Transportation expenses.
Convalescent or nursing home expenses for a parent or disabled spouse.
Overnight camp expenses.
Educational expenses for a child in kindergarten* or above.
Child care expenses that enable your spouse to do volunteer work.

* Certain kindergarten expenses may be eligible if an employee can demonstrate that all or a portion are primarily for the care of a child (and not educational in nature). Kindergarten expenses that are strictly educational in nature (and billed as tuition) are not eligible for reimbursement

Federal Tax Credit Compared to the Pre-Tax Expense Account

A federal tax credit is available for the same dependent care expenses that can be reimbursed through the Dependent Care Pre-Tax Expense Account. However, you cannot “double dip” — e.g., use both for the same expenses. You can only use one or the other. Or, you can apply the tax credit to some expenses and use the Dependent Care Pre-Tax Expense Account for others.

The tax credit allows you to subtract a part of your expenses from the federal income taxes you owe. The tax credit ranges for 20% to 30% of your eligible expenses, depending on your income. The higher your income, the lower the percentage you may use.

The Pre-Tax Expense Account, on the other hand, reduces your taxable income by the amount of your contributions — reducing the total taxes you owe. Your tax savings are determined by your marginal tax rate — the higher your tax rate, the greater your tax savings.

Generally, the Pre-Tax Expense Account is more advantageous if your household income is $24,000 a year or more. You should check with your personal tax advisor to determine the method that is best for you.