Federal employees who have a need for dependent care for a qualifying relative – a qualifying relative includes a child under the age of 13, a disabled spouse or a tax dependent parent – can benefit through participation in a dependent care flexible spending account (DCFSA).
The DCFSA is one of two flexible spending accounts offered to federal employees through the FSAFEDS program (www.fsafeds.com). A recent column discussed the health care flexible spending account (HCFSA) also available to federal employees through the FSAFEDS program.
This column discusses the DCFSA and how employees can benefit by utilizing the DCFSA when they have to pay for daycare expenses for qualifying relatives in order for employees (and their spouses, if married) to work.
Like contributing to an HCFSA, a federal employee contributes to a DCFSA via payroll deduction. Contributions are made with before-taxed salary; that is, before federal and state income taxes, and Social Security (FICA) and Medicare Part A (Hospital Insurance) payroll taxes are deducted from gross salary.
The DCFSA allows employees to be reimbursed on a before-tax basis for qualified child or adult dependent care expenses. An adult includes a parent, a grandparent or a disabled adult child that an employee can claim as a tax dependent. The employee must also provide more than half of the adult’s annual financial support.
The rules regarding which employees are eligible to contribute to a DCFSA and make withdrawals to pay for qualified daycare expenses are the same as the rules for employees who are eligible to take the child and dependent care tax credit (CDCTC) when they file their federal income tax return.
The CDCTC is discussed below. A comparison of the DCFSA and the CDCTC is also presented.
Earned Income Requirement
With married federal employees, both spouses must have earned income in order to utilize a DCFSA to pay for the qualified daycare expenses of a dependent child. The exception to the two earned income requirement for a married couple is when one spouse is a full-time student. Earned income includes wages (which the federal employee has) and a spouse’s earned income that includes wages from private industry employment or net income from self-employment.
Qualifying Persons for Which Tax-Free Reimbursements from the DCFSA Can be Made
The following individuals are qualifying individuals for the purpose of making tax-free withdrawals from a DCFSA to pay qualified dependent care expenses:
• A child under age 13 who may be claimed as a dependent of the federal employee
• A disabled spouse (mentally or physically) unable to care of himself or herself who lives with the employee more than 6 months of the year
• Any disabled person not able to care for him or herself whom the employee can claim as a tax dependent, or could claim as a dependent except that the person had gross income of $4,300 or more, or
• To be a qualifying person, the person must have lived in the same home as the federal employee during the year.
Qualifying Expenses for Which Tax-Free Withdrawals from the DCFSA Can Be Made
Qualifying expenses include amounts paid for household services and care of the qualifying person while the federal employee (and spouse, if married) is working. Household services are ordinary and usual services done in and around the employee’s that are necessary to run the employee’s home. They include the services of a housekeeper, maid or cook.
Included is the cost of care provided outside the home for any dependent under age 13 or any qualifying person who regularly spends at least eight hours a day in the employee’s home.
If the care was provided a a dependent care center, the center must meet all applicable state and local regulations. Note the following:
(1) A dependent care center is a place that provides care for more than six persons and receives a fee, payment, or grant for providing services for any of those persons even if the center is not run for profit;
(2) Nursery school and similar pre-school qualify as day care but kindergarten does not because it is considered primarily for education rather than employment related; and
(3) Specialty day camps (such as soccer, computers, literary) fees are qualified expenses (but not overnight camp).
How to Participate in the FSAFEDS DCFSA
Only permanent (full-time or part-time) federal employees may participate in a DCFSA offered through FSAFEDS. Federal retirees are not allowed to participate in a DCFSA.
Enrollment or renewing enrollment (enrollment must be renewed from one year to the next) in the DCFSA for 2023 is done through the FSAFEDS program during Open Season each year. The following are the specific steps to be taken in the DCFSA enrollment process:
Step 1. Determine One’s Annual Election
Assuming an employee is eligible to participate in the FSAFEDS program (https://www.fsafeds.com/support/faq/eligibility) the employee must decide how much to contribute to his or her DCFSA during calendar year 2023 based on how much the employee plans to spend in 2023 on child or adult day care expenses. An employee can contribute via payroll deduction (see below) from a minimum of $100 to a maximum of:
• $2,500 per year if the employee is married and filing federal income return as married filing separate, or
• $5,000 per year if the employee is married and filing a federal income tax return as married filing joint or if an employee is filing as single or head of household.
Note the following:
(1) if a federal employee is married and both the employee and his or her spouse are both eligible to contribute to a DCFSA through their respective employers, the federal employee and his or her spouse may not each contribute $5,000 to their DCFSAs. Each may contribute, but their total contributions to their respective DCFSAs cannot $5,000 for the plan year. Also, each spouse may not “double-dip” expenses. For example, expenses under the federal employee’s DCFSA may not reimbursed through the spouse’s DCFSA and vice-versa; and
(2) the amount that a federal employee contributes to his or her DCFSA must be used up within the plan year (January 1 through December 31, 2023) and the grace period of January 1 through March 15, 2024.. Any funds left in the DCFSA at the end of the grace period will be forfeited. If an employee plans to leave federal service or retire from federal service before December 31, 2023, then any balance in DCFSA must be used no later than employee’s departure date or retirement date.
Step 2. Enroll in the DCFSA to Start Saving
After deciding how much to contribute to one’s DCFSA for 2023, an employee needs to enroll by going to https://www.fsafeds.com and clicking on “ENROLL IN A PLAN” on the top of the screen. After the employee is enrolled, the employer’s funds are withdrawn from the employee’s gross salary (before any taxes are withheld, either federal and state income taxes, Social Security and Medicare Part A payroll taxes) starting with the first pay date in January 2023. An equal amount is withdrawn from the employee’s gross salary on an equal basis spread over 26 pay dates.
The following example illustrates:
Example 1. Jason is a federal employee, married and has two small children, ages two and four, who attend nursery school. Jason’s wife Alice also works but does not have access to a DCFSA. Jason elects to set aside the maximum $5,000 from his salary during 2023 to be contributed to his DCFSA. Starting with Jason’s first pay date during 2023, a total of $5,000/26 equals $192.31 will be subtracted from Jason’s gross salary.
Step 3. Pay for Dependent Care Expenses
As soon as an employee’s DCFSA account is funded, the employee can use the current balance in the account to pay eligible dependent care expenses. An employee enrolled in a DCFSA can only use the funds that are available in his or her account, not the entire election amount. Eligible dependent care expenses for which reimbursement from one’s DCFSA will be made, can be found here.
To be reimbursed from a DCFSA for dependent care expenses, the DCFSA owner must obtain from the daycare provides is or her Social Security number or tax identification number. If a daycare provider is a childcare center providing care for more than six children. The provider must be licensed by the state or local government.
DCFSA Versus Child and Dependent Care Tax Credit
Instead of contributing to a DCFSA a federal employee who is paying daycare expenses for qualifying dependents in order for the employee and spouse (if married) to work, the employee could instead use the daycare expenses as a basis for using the child and dependent care tax credit (CDCTC). The rules for who qualifies for the CDCTC are identical as the rules for who qualifies to contribute to and use an DCFSA, as discussed above.
An employee cannot use the same qualifying expenses for reimbursement from the DCFSA and subsequently use those expenses as a basis for reducing his or her tax liability by using the CDCTC. The question becomes which benefit is better; that is, which results in a lower annual liability for an employee with daycare expenses.
The child and dependent care tax credit is a percentage (based on an individual’s adjusted gross income (AGI)) of the work-related childcare expenses an individual pays during the year. When calculating the dependent care tax credit on individual may use up to $3,000 of qualifying dependent care expenses if the individual has one qualifying dependent and up to $6,000 if the individual has two or more qualifying dependents.
The credit can range from 20 percent to 35 percent of qualifying expenses paid during the year with the exact percentage based on one’s adjusted gross income during the year. Most individuals, including federal employees, will have a 20 percent credit. The following example illustrates:
Example 2. Jerry and Sharon are both federal employees and are the parents of two children, ages 2 and 4. They drop off their children to a daycare center each day before going to work. During 2021, they paid a total of $25,000 in qualifying day care expenses. They elected not to participate in a DCFSA. Instead, they will use the CDCTC when they file their federal income tax return. Jerry and Sharon are entitled to a $1,200 tax credit, computed as follows:
20% of qualifying daycare expenses (up to $6,000)
Equals 20% of $6,000 equals $1,200 CDCTC
Question: Which is better (results in more net cash after taxes): the DCFSA or the CDCTC?
The example illustrates:
2021 Example: DCFSA Versus CDCTC
Assumptions: Annual Income $100,000 married filing jointly, 2 children, $10,000 in qualifying day care expenses (limit of $5,000 for the DCFSA, $6,000 for the CDCTC), 30 percent combined federal and state income tax bracket.
In this example, participation in a DCFSA results in $1,632 in more net cash compared to use of the CDCTC. But the difference will depend on a number of variables including filing status, income levels, expense amounts, etc. As a general rule for 2022, if a married couple is within the 20 percent CDCTC credit range, contributing to a DCFSA results in more net cash compared to using the CDCTC.