3.5 Dependent Care Assistance

The value of qualifying day-care services provided by your employer under a written, nondiscriminatory plan is generally not taxable up to a limit of $5,000, or $2,500 if you are filing separately. The same tax-free limits apply if you make pre-tax salary deferrals to a flexible spending account for reimbursing dependent care expenses (3.15). However, you may not exclude from income more than your earned income. If you are married and your spouse earns less than you do, your tax-free benefit is limited to his or her earned income. If your spouse does not work, all of your benefits are taxable unless he or she is a full-time student or is disabled. If a full-time student or disabled, your spouse is treated as earning $250 a month if your dependent care expenses are for one dependent, or $500 a month if the expenses are for two or more dependents.

Caution

Tax-Free Exclusion for Employer-Provided Dependent Care

You cannot assume that your employer-provided dependent care benefit is completely tax free merely because your employer has not included any part of it in Box 1 of Form W-2 as taxable wages. Although up to $5,000 of benefits are generally tax free, the tax-free amount is reduced where you or your spouse earn less than $5,000 or where you file separately from your spouse. You must show the amount of your qualifying dependent care expenses and figure the tax-free exclusion on Form 2441.

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Expenses are excludable from income only if they would qualify for the dependent care credit; see Chapter 25. If you are being reimbursed by your employer, the exclusion is not allowed if dependent care is provided by a relative who is your dependent (or your spouse’s dependent) or by your child under the age of 19. You must give your employer a record of the care provider’s name, address, and tax identification number. The identifying information also must be listed on your return.

Reporting employer benefits on your return.

Your employer will show the total amount of your dependent care benefits in Box 10 of your Form W-2. Any benefits over $5,000 will also be included as taxable wages in Box 1 of Form W-2 and as Social Security wages (Box 3) and Medicare wages (Box 5).

You must report the benefits on Part III of Form 2441, where you determine both the tax-free and taxable (if any) portions of the employer-provided benefits. If any part is taxable, that amount must be included on Line 7 of your return as wages and labeled “DCB.”

Follow IRS instructions for identifying the care provider (employer, babysitter, etc.) on Part I of Form 2441.

The tax-free portion of employer benefits reduces eligibility for the dependent care credit (Chapter 25).