Dependent Care Flexible Spending Account (FSA)

What Is a Dependent Care Flexible Spending Account (FSA)?

Dependent care flexible spending accounts (FSAs) let employees use tax-exempt funds to pay for childcare expenses they incur while at work. Employees can also use FSAs to cover care expenses for qualifying dependent adults who live in their homes, including spouses and parents. Parents and guardians can save a significant amount of money when they use an FSA, rather than after-tax dollars, to pay for dependent-care expenses.

Understanding a Dependent Care Flexible Spending Account (FSA)

The money used to fund your dependent care FSA is pretax — meaning it is taken from your paycheck before taxes are deducted. For whatever amount you contribute to a dependent care FSA, you'll save whatever percentage you would have paid on that money in federal taxes.

The 2021 dependent care FSA contribution limit was increased by the American Rescue Plan Act to $10,500 for single filers and couples filing jointly (up from the previous limit of $5,000) and $5,250 for married couples filing separately (up from the previous limit of $2,500).

You can use a dependent care FSA to cover daycare expenses for a child who’s age 12 or younger. The FSA can also cover preschool tuition and summer camps, although you can’t use the account to pay for kindergarten or school tuition for a child ages five and older. In addition, you cannot use the account to reimburse an older child who watches a younger sibling.

While many taxpayers use the accounts to pay for child-related daycare expenses, you also can use the account to cover adult daycare expenses for other qualifying dependents, including elderly family members who live with you. The coverage also applies to a spouse who is not able to be independent at home alone.

A dependent care FSA is designed to cover daycare expenses that employees incur because they are working, so a taxpayer must have earned income in order to have a dependent care FSA. If the taxpayer is married, the spouse must have an earned income, be actively looking for work, or be enrolled as a full-time student.

It’s also important to note that the $10,500 maximum contribution applies to single filers and married couples filing jointly. If both spouses work, couples can run all expenses through a single account or divide their FSA contributions between two accounts that total no more than $10,500. If you plan to file for the childcare tax credit, you must subtract any expenses you paid through an FSA.

Example of a Dependent Care Flexible Spending Account (FSA)

For example, assume your combined federal, state, and payroll taxes are 30%. If you contribute $5,000 to the FSA, that saves you $1,500 in taxes. Most employers require you to pay dependent-care expenses out-of-pocket and then file for reimbursement.

Carefully examine your expected daycare expenses before deciding how much to contribute to your dependent care FSA. If you fail to use the entire account by the end of the year, you will likely forfeit the remainder (although there are exceptions to this rule).

Some plans allow you to roll over some amount of unused funds at the end of the year. Employers may elect one of two ways for account holders to let unused funds rollover:

1. Account holders can carry over up to $550 from one plan year to the next. 
2. The grace period option, which allows unlimited funds to be carried over to be spent in the first 2.5 months of the next plan year. At the end of the 2.5 month period, all unspent carried-over funds are forfeited. 

For 2020 and 2021, though, special rules apply. Due to provisions of the Consolidated Appropriations Act, employers can allow all unused funds to be carried over from 2020 to 2021 and from 2021 to 2022. Or, employers can extend the grace period to 12 months, rather than 2.5 months. The effect of either decision is the same: all unused funds can be carried over and used throughout the entire year.