Investments to Help Employees with the Availability and Affordability of Child Care
There are several tax provisions in the federal tax code designed to help expand the availability of child care and to help make child care more affordable for families.
Federal Tax Incentives for Business Investment in Child Care and Child Care Resource and Referral
Businesses can receive a tax credit equal to 25 percent of qualified expenses for employee child care plus 10 percent of qualified expenses for child care resource and referral services. The maximum total credit that can be claimed by a business cannot exceed $150,000 per taxable year. The credit is part of the general business credit and can be claimed any time within 3 years from the due date of the return. (IRS Form 8882)
To be eligible for the credit:
- The primary use of the program must be for child care and the program must meet all applicable state and local laws.
- The child care program must be open to enrollment to the employees of the business.
- Enrollment cannot discriminate in favor of highly compensated employees.
- At least 30 percent of the children enrolled in the program must be dependents of employees of the business.
Qualified child care expenses include costs paid to:
- Acquire, construct, rehabilitate or expand property that is to be used for the child care program;
- Operate the program, including the costs of training and compensation for employees of the child care program as well as scholarship programs;
- Support child care under a contract with a qualified program to provide child care to employees of the program.
Child Care Resource and Referral expenditures:
Qualified child care resource and referral expenses are amounts paid or incurred under a contract to provide child care resource and referral services to the employees of the business. Activities must be provided in a way that does not discriminate in favor of highly compensated individuals.
Employer Sponsored Dependent Care Assistance Plans for Child Care Expenses (DCAPs)
Under current federal tax law, employers can set up Dependent Care Assistance Plans, which are flexible spending accounts (Section 129 of the Internal Revenue Code). If employers choose to offer such plans, employees can set-aside up to $5,000 per year in pre-tax salary for dependent care expenses. Using pre-tax dollars means a tax savings to employees (potentially 20-40 percent of child care expenses depending upon the family’s tax bracket and expenses incurred for child care) as well as a tax savings for employers (funds set aside through a flexible spending account reduce employer payroll – for example, these funds aren’t subject to FICA or FUTA taxes). For many employees with young children, they may already be paying for child care, so the option for a flexible spending account reimburses them at a tax savings for money that would be spent anyway.
How do flexible spending plans work? An employer establishes a written plan (required by the IRS) and distributes a summary of the plan to all employees (required by the Department of Labor). Employees estimate how much they think they will spend on child care for the year. They can then choose to have up to $5,000 of their salary set aside tax-free into a flexible spending account through regular paychecks. As child care expenses are incurred, employees can submit for reimbursement from their flexible spending account (FSA). FSAs are capped at $5,000 per year. Expenses related to dependent children under age 13 or related to dependents who are mentally or physically incapable of caring for themselves (and who the employee claims as a dependent) are eligible for reimbursement through FSAs. Here’s a calculator to help employees figure out tax savings by utilizing DCAP benefits.
It’s always a good idea to consult with a tax professional, but conceptually, there are savings to be realized through the tax code for employers who wish to assist their employees with child care affordability.
You can read more about flexible spending accounts through the Idaho Office of Group Insurance web site.
Child and Dependent Care Tax Credit (CDCTC)
The Child and Dependent Care Tax Credit (DCTC) is an opportunity for families to take a tax credit for child care expenses related to dependent children under age 13 or expenses related to caring for individuals who are mentally or physically disabled (and who are claimed as a dependent). The amount of eligible expenses are capped and only a percentage of the allowable expenses are used to calculate the credit.
For example, the credit rate declines as income rises. Allowable child care expenses for a family with one child are limited to $3,000 per year. Families with two children are allowed $6,000 in expenses per year. Against the cap of allowable expenses is a percentage limitation that is applied against the cap, which declines as income rises. Therefore, the maximum credit is $1,050 for one child (35 percent of $3,000 in expenses) and $2,100 for two children (35 percent of $6,000). The 35 percent credit rate is reduced, but not below 20 percent, by one percentage point for each $2,000 of adjusted gross income above $15,000. Therefore, the credit rate for families with income over $43,000 is 20 percent. The following table shows the declining percentage of credit rates by income.
Idaho Tax Incentives to Promote Affordability for Families
Idaho Child Care Tax Deduction: In Idaho, families can deduct a modest amount of child care expenses from their income. Idaho uses the same criteria as the federal government to determine which expenses are eligible for the deduction. Filers can claim the deduction using the Idaho tax form 39R section B Line 6 (more information is available as part of the Idaho Individual income tax instructions and worksheet on page 22) and must submit a copy of their federal Form 2441 along with their Idaho tax return.