Any parent knows that the costs of raising children can really add up, and they always seem to be rising. Chief among these is the cost of child care, which can be especially steep for working parents. Thankfully, the tax code is set up to help parents by providing tax credits and pre-tax savings. There are some stipulations, however, so make sure you understand your options in order to maximize these benefits.
The Nanny Tax (Babysitter Tax)
Before taking into account tax savings, parents need to be aware of what is commonly referred to as the “nanny tax.” Not everyone is subject to the nanny tax, so the first thing to do is look at a few factors that impact whether or not you are. The nanny tax applies if your babysitter or nanny is considered a household employee by the Internal Revenue Service (IRS) and their annual pay is above a certain threshold.
To determine if this applies to your situation, consider these guidelines:
- Who is the employer? If your caregiver is self-employed or works through an agency that has control over how they conduct their work, they generally are not considered a household employee, and you are not responsible for employment taxes. However, if you use an agency simply to find a caregiver and you pay them directly, your caregiver may be considered a household employee. The idea of who has control over the caregiver’s work is key. As Care.com explains, they are considered an employee if they are “coming to your home on the schedule you dictate while following your rules.”
- What amount did you pay this caregiver over the course of a year? If you are considered a household employer and you paid a caregiver more than $2,100 in 2018, you are responsible for withholding Medicare and Social Security taxes. In 2018, these taxes combined add up to 15.3 percent of wages, and are split between yourself and the employee. You may also be required to pay federal and state unemployment taxes. The main thing to keep in mind is the “nanny tax” is based on the amount a caregiver earned and not the number of hours they worked.
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What this means overall is that if you only hire a babysitter for the occasional night out, you probably aren’t on the hook. However, if you hire someone for regular care, they may be considered a household employee, and you have a responsibility to withhold these taxes. The good news is that there are several tax breaks that help offset this expense.
Child care costs are not actually tax deductible, but you may be eligible for tax credits. The main difference is that a deduction reduces the amount of your income that is taxed, whereas a credit is applied to the amount you owe the IRS, which reduces the amount you owe and can even bring that amount to zero.
The Child and Dependent Care Tax Credit (CDTC)
The CDTC is the primary tax credit that is available for parents who have earned income and pay someone to care for their children so they can work. The amount you are eligible for varies based on income, but you may be able to get a credit of up to 35% of child care expenses, with a maximum of $3,000 for one dependent or $6,000 for a second dependent. This credit is non-refundable, so it may reduce your tax bill, but if it brings the amount you owe to zero, you won’t see the money in the form of a refund.
There are a few requirements that you must meet in order to be eligible:
- You must have income earned from a job (investment income does not qualify).
- Your child must be younger than 13 when the care is provided.
- If you are married, you must file your taxes jointly.
Along with these basic requirements, make sure you’re familiar with the types of care that count, as well as some exceptions.
- Most types of child care, including daycare, nannies and babysitters, count for the child and dependent care tax credit. Before- and after-school care and summer day camps also typically count, but overnight camps do not. You may also be able to count other expenses the caregiver provides, such as cooking and housekeeping.
- Your care provider may be a relative, but they cannot be your spouse, a parent of the child, your dependent, or your own child under the age of 19.
- You will need to provide some information, including the caregiver’s name and address, along with either their Social Security Number (SSN) or an Employer Identification Number (EIN).
Dependent Care Flexible Spending Accounts (DCFSA)
Instead of using the CDTC, some families pay for child care through a Dependent Care Flexible Spending Account. Similar to a healthcare FSA, these accounts allow you to set aside pre-tax income to cover child care costs. A DCFSA has to be offered as a benefit through your employer in order for you to be eligible. A married couple filing jointly can contribute a maximum of $5,000 per year, although you may choose to contribute less. One potential downside is that you lose any money that you don’t use, so be very careful about estimating expenses.
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The advantage of going this route is that it lowers your total taxable income by whatever amount you choose to deposit. What this means is that those with a higher income may see a greater tax savings using a DCFSA as opposed to claiming the CDTC. There isn’t a set income level where you are better off choosing one option over another, but a DCFSA calculator can help you decide.
The Child Tax Credit (CTC)
One last thing to keep in mind is that the Child Tax Credit is available to many families with dependents under the age of 17. It is a tax credit that varies based on your income and is available to joint filers with an income of up to $440,000 and single filers with an income of up to $240,000. The CTC is also refundable up to $1,400. While the CTC is a tax advantage families get independent of child care expenses, don’t overlook it as a resource that helps offset the cost of child care, as well as the “nanny tax.”
These are all general guidelines based on the most recent federal tax law, but it’s always a good idea to check in with your state’s tax laws as well. Parents already have plenty of worries to keep them up at night, and you don’t want child care costs to be added to that list. This is why it pays to explore all of your options and take advantage of the tax breaks that best fit your situation.