THE FLEXIBLE SPENDING ACCOUNT WINDOW
A couple gave birth to a baby boy on July 3, 2011. In mid-July, they began searching for a nanny so the mom could go back to work after Labor Day. With about 2 weeks to spare, they found the perfect nanny.
When the mom went back to work, she learned that they had missed out on a major tax break.
Families with childcare expenses are entitled to tax breaks to help offset some of the costs of care. (There is no income restriction on the childcare tax breaks so everyone qualifies — as long as the children are under age 13 and both spouses are working, looking for work or full-time students).
The most lucrative childcare tax break is the Dependent Care Account (commonly called a “Flexible Spending Account” or “FSA”). FSAs are federal tax breaks offered through business employers as a benefit to their employees. If either one of the spouses has access to an FSA through their company, the family will be able to pay for up to $5,000 of childcare expenses using pre-tax dollars. That means the family has no taxes on that portion of their income, which will save them between $2,100 and $2,300 per year, depending on their marginal tax rate.
Enrollment in the FSA is limited to once a year (most companies offer open enrollment in the fall for the subsequent tax year). However, there is a 30-day window after a “life-changing event” (i.e. birth of a child) when the family can enroll immediately — allowing them to take advantage of this tax break during the current tax year.
When families don’t have access to a Flexible Spending Account (or miss the 30-day window enrollment opportunity), they can utilize the Child and Dependent Care Tax Credit when they file their federal income tax return. This tax credit allows families to itemize up to $3,000 per child per year (maximum of $6,000 per year). After the 20-35% tax credit is applied to those expenses, most families will save $600 per year if they have one child and $1,200 per year if they have 2 or more children.
• Because the family missed the 30-day window for life-changing events, they were not able to enroll in their FSA program for the 2011 tax year, and therefore, missed out on $2,300 in savings.
• Instead, they had to settle for the Child and Dependent Care Tax Credit using Form 2441 when they filed their federal income tax return. The tax credit saved them $600 in 2011.
• The difference between the two tax breaks for this family was $1,700 ($2,300 – $600). That $1,700 in extra tax breaks would have paid for a lot of diapers!
How It Could Have Been Avoided
Unfortunately, this story is extremely common. As first-time parents become first-time employers, there is a lot of new information to process. During this busy stage of life, families need expert guidance and support throughout the nanny search and hiring process. Without it, oversights, mistakes and missed opportunities happen regularly — especially in the tedious and complex world of household employment tax and labor law.
As a remedy, we offer a New Employer Orientation free of charge. This 10-minute no-pressure, no-obligation phone call allows a Breedlove household employment expert to assess the family’s unique situation and provide expert guidance on all the tax and labor law issues that will come into play for them. Whether they decide to use our “nanny tax” service or not, this guidance will likely save them thousands of dollars and dozens of hours.