Director HomePay
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Household Employment Tax Breaks Make In-Home Care More Affordable

Feb 24th 2016
Director HomePay
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An increasing number of families are looking at childcare and senior-care solutions that involve in-home caregivers. When budgeting for care, families typically struggle to calculate the extra employer costs (i.e., taxes and insurance), as well as the tax breaks that can help offset those costs. We run care budgets for families dozens of times each day, and we have found that most are pleasantly surprised at the overall cost – primarily because they didn’t factor in tax breaks.

There are two dependent care tax break options available to most families:

  • Dependent care account (a type of flexible spending account offered through an employer)
  • Child and Dependent Care Credit (Form 2441, Child and Dependent Care Expenses)

These tax breaks are not income-restricted, nor are they subject to the alternative minimum tax. However, they do require that both spouses must pass the “work-related expense test,” meaning they both need to be employed or be a full-time student.

Additionally, they require that the person receiving care pass the “qualifying person test.” (See IRS Publication 503.) A qualifying person is:

  • Your qualifying child who is your dependent and who was under age 13;
  • Your spouse who was not physically or mentally able to care for himself or herself and lived with you for more than half the year; or
  • A person who was not physically or mentally able to care for himself or herself, lived with you for more than half the year, and either was your dependent or would have been your dependent except that he or she received gross income of $4,000 or more, he or she filed a joint return, or you or your spouse, if filing jointly, could be claimed as a dependent on someone else’s return.

Let’s assume the family passes both of these tests and is eligible for dependent care tax breaks. The most significant savings the family can realize is through signing up for a dependent care account. This flexible spending account is available through most employers, although only one spouse can sign up for it.

Unlike medical flexible spending accounts, which have a $2,550 limit, families can set aside up to $5,000 in a dependent care account to pay for qualifying expenses with pre-tax dollars. The caregiver’s wages are generally what are applied to the flexible spending account, but employment taxes and any placement agency fees qualify, as well. The exact savings are tied to the family’s marginal tax rate, but a dependent care account typically saves around $2,000 per year.

Families can sign up for a dependent care account during their company’s open enrollment period, but certain life-changing events can provide another 30-day window of opportunity. These are commonly the birth of a child, a change in employment, or change in childcare/eldercare provider. Companies have some leeway in how they manage their flexible spending account program, so it’s important that families check with their human resources contact to get all the details. Additionally, to receive reimbursement, families will usually be required to prove the expenses were for dependent care needs. A copy of the caregiver’s pay stubs generally is acceptable.

If the family doesn’t have access to a flexible spending account or misses the open enrollment period, the Child and Dependent Care Credit can provide significant savings instead. Families can use IRS Form 2441 to take a tax break on up to $3,000 of care-related expenses if they have one dependent, or up to $6,000 if they have two or more dependents. Most families will save 20 percent on these expenses, meaning they’ll receive a tax break of up to $600 if they have one dependent and up to $1,200 for two or more dependents.

It is possible to combine both of these tax breaks if a family has two or more dependents and more than $5,000 in care-related expenses. The family can utilize the full $5,000 in their flexible spending account and apply up to an additional $1,000 to the Child and Dependent Care Credit. This generates an additional savings of up to $200 – on top of what they save from their flexible spending account.

Because most families have access to a flexible spending account (at least one of the two spouses) and many have two or more dependents, this dual utilization of tax breaks is quite common. In this situation, families frequently end up saving enough to offset most – sometimes all – of their employer tax liability. This is especially true when wages are relatively low, which is common in NannyShare/CareShare situations or part-time/short-term employment situations.

Here’s a payroll scenario that is fairly typical of what a family coming to HomePay may see: The family has two kids and is budgeting for about $32,000 per year for their caregiver. If they are unaware of their tax breaks, they can only offer around $575 per week to their caregiver so their taxes are able to be accounted for.

Items Per Pay Period Annualized
Gross pay $575 $29,900
Social Security tax $35.65 $1,853.79
Medicare tax $8.34 $433.54
Unemployment insurance tax $5.48 $285.02
Total employer cost $624.47 $32,472.35

However, if the family utilizes both of their tax breaks, they can save $2,400, which drops their annual cost to a little more than $30,000. This puts them roughly $2,000 under budget each month and almost completely offsets their employer tax liability.

Through this kind of comprehensive budgeting (all costs and all tax breaks), families can know with great certainty what their total cost of care will be – and what they can afford to offer a caregiver. That’s why it’s so important for families to go through this exercise early in the hiring process.

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