Dependent Care Benefits: Meaning, How it Works

Dependent care benefits are tax-advantaged employer-provided reimbursements for employees' out-of-pocket expenses for dependent care. The Internal Revenue Service (IRS) defines a dependent as a qualifying child or relative who is under age 19 (or under age 24 if a full-time student) or who is physically or mentally incapable of self-care.

Dependent care benefits can help employees cover the costs of child care, adult day care, or other care for a dependent who is not a spouse or a domestic partner. The amount of the benefit that an employee can receive is limited to the lesser of:

* The employee's earned income
* The amount of the employee's adjusted gross income (AGI) minus $2,500

Employers are not required to offer dependent care benefits, but they may do so if they wish. If an employer offers dependent care benefits, they must make them available to all employees on a nondiscriminatory basis.

Dependent care benefits are generally provided through a flexible spending account (FSA). An FSA is a pre-tax account that employees can use to pay for eligible dependent care expenses. FSAs are funded with pre-tax dollars from an employee's paycheck, and the money in an FSA is not subject to income tax, Social Security taxes, or Medicare taxes.

The amount of money that an employee can contribute to an FSA is limited to $5,000 per year. However, employees can carry over unused FSA funds from one year to the next, up to a maximum of $5,000.

Dependent care benefits can be a valuable tax break for employees who have out-of-pocket expenses for dependent care. However, it is important to understand the rules governing dependent care benefits before you use them.