Childcare is a significant expense for working parents. As with many things, the better child care is often the more expensive child care, and parents struggle to get the best possible care that fits into their budget.
Employees who are worried about their children are not able to focus fully on their jobs. Therefore, helping employees with their child-care expenses can benefit the employer in terms of increased productivity.
Fortunately, the tax code offers assistance with the cost of child care to both employers and employees.
Tax credits provide a dollar-for-dollar reduction against income taxes. Currently, several federal and state tax credits are available to working parents, or those seeking work, and their employers that can help offset the burden of child and dependent care expenses.
The first is the widely known Child and Dependent Care Credit, which provides a credit of up to 35 percent of the amount paid for qualified care expenses. Qualified care expenses are limited to $3,000 for one qualifying dependent and a maximum of $6,000 for two or more dependents.
The second credit is the lesser known, but potentially more beneficial, Employer-provided Child Care Credit.
The Employer-provided Child Care Credit is made available to employers who pay a qualified child care facility to provide child care services to employees. For expenditures to qualify, payments must be made to a child-care facility with which they have a contractual arrangement.
Amounts paid to employees as a reimbursement for child-care expenses cannot be included in the credit. Amounts included as a credit also cannot be deducted as an expense.
The credit amount related to the Employer-provided Child Care Credit is equal to 25 percent of child-care expenditures made by the employer, with a potential federal tax credit of up to $150,000 each year.
Furthermore, employers with operations in Georgia currently have the opportunity to claim a Georgia tax credit of 75 percent of child-care expenditures. The credit is limited to 50 percent of the employer’s income tax liability for the taxable year, but any unused credit is carried forward for up to five years until the credit is utilized.
If carried out effectively, an employer can use 100 percent of child-care expenses against both its federal and Georgia tax liability.
Employees have the potential to derive a greater benefit from the Employer-provided Child Care Tax Credit than from the Child and Dependent Care Tax Credit they could claim on their own return.
For example, if an employee pays $3,000 for child or dependent care, the maximum credit they will receive is $1,050 ($3,000 X 35%). With the credit taken into consideration, the employee will effectively pay $1,950 for dependent care services ($3,000 - $1,050 = $1,950).
However, if the employer pays the $3,000 to a child-care facility for the employee’s dependent, the employee saves the $1,950 and the employer now has a $750 federal tax credit and a Georgia credit of $2,250.
When calculating the credit, it is important to note that the $3,000 limitation for one dependent increases to a total of $5,000 for the Employer-provided Child Care Tax Credit, regardless of the number of dependents.
To keep with the theme of dependent care and potential tax savings available, it is important to shed light on the potential benefit derived from dependent care flexible spending accounts.
Also referred to as cafeteria plans or Section 125 plans, these plans provide tax savings to employees by allowing them to pay for various out-of-pocket dependent care expenses with pre-tax dollars, saving not only income tax but also FICA and Medicare taxes.
Employers also benefit from establishing a plan because they save the employer portion of the payroll tax. Currently, the pre-tax exclusion limit for a family filing a married filing joint tax return is $5,000. According to the National Association for Child Care Research and Referral Agencies, average annual fees paid for full-time care for a 4-year-old in Georgia during 2012 was $6,026.
As families with several children requiring care are well aware, dependent care can easily surpass $10,000, which is why is it paramount to have an understanding of these tax saving vehicles and how to develop a tax strategy that provides you with the greatest benefit.
The Employer-provided Child Care Tax Credit and Section 125 Plans create a benefit to all parties involved. Employees benefit by saving money on out-of-pocket child care, while employers are able to use qualifying child-care expenditures as a credit toward their federal and state tax liability. Additionally, long-term benefits that are not as easy to quantify financially include the ability to attract quality employees, increase employee productivity and decrease employee turnover.
Robby Skibicki is in the tax department at Hancock Askew & Co. He can be reached at 912-527-3317 or rskibicki@hancockaskew.com.