Dependent Care Assistance as an Employee Benefit

As the family needs of today's workforce change, many employers are providing their employees with some type of dependent care assistance. Dependent care assistance is a benefit whereby your employer pays for your work-related dependent care services. A service is work-related if it allows you to work and if the services are for a qualifying individual's care. A qualifying individual is a dependent under the age of 13, a dependent who is physically or mentally incapable of caring for him or herself, or a spouse, if he or she is physically or mentally incapable of caring for him or herself. The types of dependent care assistance that your employer can provide you with include dependent care assistance programs (DCAP), tax-exempt organizations, voluntary employees' beneficiary associations (VEBA), and dependent care flexible spending accounts (FSAs).

Dependent care assistance programs (DCAP)

A Dependent care assistance program provides you with dependent care services. If your employer offers a Dependent care assistance program, the IRS allows your employer to exclude up to $5,000 per year in dependent care assistance from your gross income. There are two types of DCAPs that your employer can offer: an employer-responsibility program or an employer-assistance program. An employer-responsibility program requires your employer to develop and maintain an on-site facility for your dependents (usually a day-care facility). An employer-assistance program is a program where your employer pays either for dependent care services that you incur when you place your dependent in an off-site facility, or for a counselor to aid you in selecting the appropriate off-site facility for your dependent.

Tax-exempt organization

Your employer can offer you a Dependent care assistance program by creating a tax-exempt organization that operates a day-care facility. While you are not eligible for a tax credit for the dependent care assistance that your employer provides through the tax-exempt organization, it enables you to provide your dependents with affordable day care.

Voluntary Employees' Beneficiary Association (VEBA)

A Voluntary Employees' Beneficiary Association provides for the payment of health insurance, life insurance, disability insurance, or other benefits to its members. If your employer provides you with dependent care assistance through aVoluntary Employees' Beneficiary Association, the monetary value of the services you receive is included in your gross income. However, the value of the benefits is not subject to taxation until you receive distributions from the Voluntary Employees' Beneficiary Association. Click here for more on Voluntary Employees' Beneficiary Associations

Example 1: Jack, who is not married and has no children, is entitled to the dependent care assistance benefits that his employer offers through a Voluntary Employees' Beneficiary Association. However, the value of the benefits is not taxable income to Jack unless he enrolls a child in the day-care facility.

Dependent care flexible spending account

A dependent care flexible spending account (FSA) allows you to contribute pretax dollars to an account that your employer can later use to reimburse you for qualified dependent care expenses. In order for your dependent care expenses to qualify for reimbursement under a flexible spending account, they must be necessary for employment and, if you are married, for employment of your spouse as well. The IRS allows your employer to exclude up to $5,000 per year from your gross income in order to fund the account. In addition, any contributions that you make to fund the account are tax exempt. In order to claim the exclusion for dependent care expense reimbursements, you must list on your federal income tax return the name, address, and taxpayer identification number of the person or party that provides dependent care to your dependents. For more on Flexible Spending Accounts click here

Dependent care tax credit

If your employer does not offer dependent care assistance, you may be eligible for an individual tax credit. The IRS allows you to claim a dependent care tax credit if you maintain a household for a qualifying individual and incur employment-related expenses. A qualifying individual is a dependent under the age of 13 or a dependent or spouse who is incapable of self-care. Employment-related expenses are expenses that you incur in order to enable you to be gainfully employed. The tax credit allowable ranges from 20 to 35 percent of qualifying expenses, depending upon your adjusted gross income (AGI). The qualifying expenses on which the tax credit is based are limited to $3,000 for one qualifying dependent and $4,800 for more than one qualifying dependent. If there is more than one qualifying dependent, the expenses that are taken into account for purposes of the $6,000 limit do not have to be attributable to more than one dependent.

Example 1: Diane, a single parent, has $30,500 of adjusted gross income and pays $5,500 per year to keep both of her children, ages two and five, in day care. Since both of her children are qualifying individuals, the higher tax credit limit ($6,000 in 2003) applies and all of her day-care expenses ($5,500) fall within her available tax credit. Assuming that Cindy's allowable tax credit is 20 percent, she can claim a $1,100 tax credit. If her employer reimburses her for $4,500 of the dependent care expenses. Only the remaining $1,000 ($5,500 - $4,500) would be eligible for the dependent care tax credit.

NOTE: Expenses that are eligible for the dependent care assistance tax credit must be offset by expenses that you exclude from your income under a dependent care assistance plan.

If you have child-care expenses that exceed the $6,000 limit and you are eligible to participate in a company-sponsored dependent care assistance plan, you may have to choose between the company plan and the dependent care assistance tax credit. Your choice will hinge upon a number of factors, including your tax rate, whether or not amounts that would otherwise be allocated to child care under the company plan can be allocated to other benefits, your filing status, and your adjusted gross income. For more information on the IRS dependent care tax credit, see Section 21 of the Internal Revenue Code.

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