How Does Child Care Reimbursement From an Employer Work?
Learn how employer child care reimbursements can lower your costs. This guide explains the financial structure and the process for accessing this valuable benefit.
Employer-provided child care reimbursement is a benefit that helps working parents cover the costs of care for their dependents. This financial assistance can make a difference for families managing the high price of daycare, after-school programs, and other related services.
Types of Employer Child Care Plans
Employers offer child care assistance through two primary structures: a Dependent Care Flexible Spending Account (DCFSA) or a direct employer-funded reimbursement program. A DCFSA is a pre-tax benefit account that allows an employee to contribute a portion of their salary before taxes are calculated. The funds in this account can then be used to pay for qualified dependent care services, lowering the employee’s taxable income.
The second approach is a direct employer-funded program, where the company pays for or reimburses child care costs. Unlike a DCFSA, where the employee uses their own pre-tax money, this model involves the employer providing funds directly as a subsidy or stipend. This can be structured as a reimbursement, where the employee pays upfront and submits receipts for repayment, or as a direct payment from the employer to the care provider.
These employer-funded programs have different tax implications than a DCFSA. While a DCFSA is a pre-tax benefit up to a federally defined limit, direct reimbursements or stipends may be treated as taxable income to the employee unless they are part of a formal Dependent Care Assistance Program (DCAP).
Tax Treatment of Reimbursements
Under federal law, an employee can exclude a certain amount of child care benefits from their gross income each year. The annual exclusion limit set by the IRS is $5,000 for individuals who are single or married and filing a joint tax return. For those who are married but file separately, the limit is $2,500 per person.
This exclusion means that reimbursement up to these limits is not subject to federal income taxes or FICA taxes, which include Social Security and Medicare taxes. For example, an employee in a 22% federal tax bracket receiving the full $5,000 benefit saves $1,100 in federal income taxes, plus additional savings from FICA taxes.
Any amount an employee receives from their employer for dependent care that exceeds the annual limit is considered taxable income and must be reported as wages. The tax-free portion of the benefit is reported by the employer in Box 10 of the employee’s annual Form W-2, Wage and Tax Statement.
Eligibility Requirements for Tax-Free Benefits
For child care reimbursements to be tax-free, the employee and the care arrangement must meet specific criteria established by the IRS. The primary rule is the work-related requirement, which mandates that the care expenses must be incurred to allow the employee and their spouse to work or actively look for work. If the employee is married, this rule applies to both spouses, with an exception if one spouse was a full-time student for at least five calendar months during the year or was physically or mentally incapable of self-care.
Another condition is the qualifying person test, which defines who can receive the care. A qualifying person is the employee’s dependent child who is under the age of 13 when the care is provided. The test also includes a spouse or any other dependent who is physically or mentally unable to care for themselves and lives with the employee for more than half the year.
Finally, the expenses themselves must be for qualifying care. Eligible expenses include:
- Payments for services at a daycare facility, a nanny, or an au pair
- Costs for preschool and nursery school
- Before- and after-school programs
- Summer day camps
However, certain expenses are excluded, such as tuition for kindergarten or higher grades, the cost of overnight camps, and any payments made for care provided by the employee’s spouse, the child’s parent, or a child of the employee under the age of 19.
How to Claim Your Reimbursement
The IRS requires that the employee report the provider’s name, address, and Taxpayer Identification Number (TIN) on their tax return. The TIN is the provider’s Social Security Number (SSN) if they are an individual or an Employer Identification Number (EIN) if they are a business.
The next step is to collect detailed documentation of the expenses incurred. This proof takes the form of itemized receipts or detailed statements from the provider, which must clearly show the dates the care was provided, the name of the child who received the care, and the specific amounts that were paid for the services.
Most employers or their third-party benefits administrators have a formal process for submitting reimbursement requests. This involves completing a specific claim form, which can be a paper document or an online form available through a benefits portal. The employee attaches the required receipts and provider information to this form and submits the entire package for review and payment.