How to simplify child-care tax benefits

Congress could simplify child-care tax benefits by harmonizing the maximum allowable expenses for both benefits, or eliminating one of the benefits altogether, Maag writes.

Every year at tax time I am reminded of two tax benefits that subsidize my children’s child care – the employer-provided child care exclusion and the Child and Dependent Care Tax Credit (CDCTC). Families with sufficient expenses can benefit from both provisions. Congress could simplify these child care benefits by harmonizing the maximum allowable expenses for both benefits, or eliminating one of the benefits altogether.

Here’s how the child care exclusion and CDCTC work. The exclusion allows me to set aside up to $5,000 from my salary to pay for child care expenses (regardless of the number of children I have) and exclude that from taxable income. However, I can only take the exclusion if my employer offers this benefit.

The credit applies to as much as $3,000 of child care expenses per child, to a maximum of $6,000. Unlike the Child Tax Credit (CTC) – which is refundable, the CDCTC is nonrefundable. It only benefits families with child care expenses who owe federal income taxes. The actual amount of the CDCTC depends on my adjusted gross income (AGI), and ranges from 35 percent of expenses for parents with AGI up to $15,000 down to 20 percent for those with AGI over $43,000.

Higher income parents tend to benefit more from the exclusion while middle-income parents are the primary beneficiaries of the credit. Because the credit only goes to families who owe taxes, very low-income families benefit more from the exclusion (because they don’t owe payroll taxes on the excluded income). However, relatively few of these workers  have access to the exclusion because their employers are less likely to let them put aside pre-tax child care dollars. 

I can receive benefits from both provisions. However, I must count different expenses for both s and when I calculate my child care credit, I must subtract the expenses already excluded from my income from my maximum allowable child care credit expenses. In my case, I exclude the maximum $5,000 of child care expenses from my taxable wages and claim the credit on $1,000 of expenses.

Sound confusing? It is. But it doesn’t have to be. Congress could set the same maximum allowable expenses for both benefits and limit parents to using only one. Congress could simplify more by eliminating the exclusion that provided $1.5 billion in tax benefits in FY2012 and keep the credit that provided $3.4 billion in tax benefits in FY2012. People currently using the exclusion would likely shift to the credit. .

On one hand, the exclusion makes sense if one considers child care a cost of earning income. But in practice, the credit is more popular, the plans allowing the exclusion are offered to less than one-third of employees, and eliminating the exclusion would simplify child care tax benefits for both parents and employee benefits’ offices. My own tax liability would increase.

Making expense limits uniform or getting rid of at least one provision It would be a good way to declutter the tax code, even if we can’t get broad tax reform.