I remember going to Capitol Hill for an Entrepreneurship Day several years ago. I told my story of starting a business to lawmakers, including the part about paying $ 2,100 a month in child care for three children and questioning the financial sense of starting a business. Whenever people asked me what entrepreneurs needed, I was a record broken: CHILD CARE.
The American Rescue Plan Act of 2021 hits the headlines as real money (which can be used) flows into people’s checking accounts, but parents of young children need to pay close attention to two improvements in the childcare for 2021 – childcare and dependents. Credit and Flexible Expense Account for Dependents (FSA).
The good news is that many more people will get much higher tax relief for 2021 on their child care expenses. Don’t hesitate to stop reading here and start dreaming about what you’ll do with all those Benjamins at tax time next year. Or, for those who are willing to fend for themselves a bit (under the supervision of their CPA), there might be choices to be made to optimize how you use credit and / or the flexible spending account.
Here are the details.
The American Rescue Plan Act expands the child and dependent care credit and increases the flexible expense account limit for dependents for 2021 only.
First, the child and dependent care credit, or “care credit”. The previous maximum applicable percentage used to calculate this credit was equal to 35% of the eligible child care expenses per eligible child up to a maximum of $ 3,000, or $ 6,000 for two or more children. Importantly, there has been a fairly small phase-out of a 1% reduction for every $ 2,000 of Adjusted Gross Income (AGI) over $ 15,000 until it stops at 20%. .
In the new law for 2021, the credit drops from 35% to 50% of qualifying expenses with a phase-out starting at a much higher AGI of $ 125,000, up from the previous AGI limit of $ 15,000, reduced by 1 % for every $ 2,000 above $ 125,000 AGI. The credit will not drop below 20% until the AGI of $ 400,000 is reached, at which point the credit will begin to gradually wane. Importantly, you can use up to $ 8,000 in eligible child care expenses for one child and up to $ 16,000 for two or more children, substantial increases over the 2020 limits. To be eligible, both spouses must work full time and children must be under 13 years of age.
The highest credit available for 2021 would be $ 4,000 for one child and $ 8,000 for multiple children. Oh, and unlike in years past, this is a refundable credit.
Then there is the FSA for dependents. The FSA contribution limit for employer-sponsored dependents more than doubled in 2021, from $ 5,000 to $ 10,500 for single taxpayers and married couples filing jointly. Parents of two children in full-time child care could easily maximize this limit.
These are the rules. Here is how to play.
First, you have to make a choice: the flexible expense account or the tax credit? Or the FSA and then the credit? Or a tax credit and then FSA? That is the question, or these are the questions, or let’s just take a nap and deal with that later.
No, let’s persevere.
It seems to me that the winners of the American Rescue Plan Act’s child care provisions are those who earn up to $ 125,000 in adjusted gross income, or a little more. This 50% care credit is incredible – so unbelievable that some people might want to ask their CPA if it makes sense to reconsider their choice of FSA made in the fall, before the law was passed, in favor the use of the care credit at tax time. . Why? Well, an FSA just lets you spend pre-tax money on child care expenses. At an AGI of $ 125,000 or less, even avoiding federal, state, and FICA taxes, it’s hard to beat the 50% care credit. If it makes sense to change your FSA contribution, you may want to try to do so as soon as possible.
For many high-income earners, the FSA for dependents could be particularly beneficial. Consider a couple who both work full time and earn $ 250,000 AGI. Between summer camp, daycare, and after-school care, they calculate child care at about $ 23,000. The wife’s employer has an FSA for dependents and the CPA finds that the FSA is more valuable than the tax credit. The ideal plan would be to increase the wife’s contribution to the FSA to the maximum of $ 10,500. Any remaining child care expenses paid out of pocket could then be eligible for the 20% child care credit.
It sounds simple, but it’s not. I called the human resources departments. Don’t forget that this law was just passed on March 11. The human resources folks are still grappling with the day to day issues of health insurance and, oh yes, the global pandemic. I don’t know how easy it could be in practice to increase or decrease an FSA contribution, but it is worth asking the question. Also, don’t be surprised if your company chooses not to allow employees to raise the FSA beyond the 2020 limits. They might be concerned about the discrimination tests they need to do to prevent higher employees. to take too many profits.
Second, if you go for the care credit, what more can you do to maximize it? Consider increasing your pre-tax contributions to your pension plan. So many people could hit the AGI $ 125,000 limit for the 50% maximum credit if they could think about trying to save more aggressively in their company’s 401 (k), 403 (b), or 457 (b) pre-tax. to lower their AGI.
Obviously, long after this credit is applied, I hope people find that they can live very well with this higher pension contribution. More likely, they could forget that they were saving so much until it was too late. They are starting to get closer to retirement and, to their dismay, find they have enough money to retire. Wouldn’t that money have been so much better spent on their youth? Well I guess we’ll have to take a bigger vacation and spoil the grandkids a little bit more with all that extra cash.
I digress. Consider a couple who saves 10% in their retirement account, but a little more than the AGI limit of $ 125,000 to get the maximum care credit of 50%. What if they increased their pre-tax retirement savings contribution rate further (perhaps to 14% -15%) to bring their AGIs in the range to qualify for full credit? What a win-win. They see their retirement savings increased and they get more money back for what they spent on child care.
Third, find out what qualifies for the care credit. I had mistakenly thought that this only applied to formal daycares or daycares. My husband and I will apply this credit to our summer day camps, which are eligible, and we save all of our online confirmations and print them for the 2021 tax file. Additionally, we have a nanny who works with us during the day. ‘summer and we can count what we pay him.
The biggest benefit is calling your CPA if you think this applies to you. Maria Bean, CPA, of Landmark CPA confirmed this point. “Now, more than ever, it’s critical to work with your CPA on how to best use some of these short-term tax benefits (under current legislation) to best help make the tax code work for you.” Bean said.
For 2021, a break in May to get the child care strategy for the summer and the rest of the year makes financial sense. The American Rescue Plan has plenty of flashy stimulus payments like the cool kids, but don’t overlook revenge from the tax nerds who get their money’s worth from the FSA for dependents and / or increases in the care credit. to children and dependents.
Sarah Catherine Gutierrez is Founder, Partner and CEO of Aptus Financial in Little Rock. She is also the author of the book “But First, Save 10: The One Simple Money Move That Will Change Your Life”, published by Et Alia Press. Contact her at [email protected]