Raising dependent care FSA limits would help manage child care costs

It may take a village to raise a child, but what does it take to pay for one? 

While there are many opinions, most agree that the figure is substantial. Just how large of a sum, what constitutes the highest percentages and why that is the case could fill a mountain of books and articles. One area worth focusing on is the cost of child care and how employers can help with this expense.

Child care costs have been exponentially increasing. A 2023 report released by the Women's Bureau at the U.S. Department of Labor suggesting a substantive variation on pricing across the country that is "untenable for families even in lower-priced areas." Based on data from the National Database of Child care Prices (NDCP), the most comprehensive federal source of child care prices at the county level, families are being charged anywhere from $5,357 to $17,171 (adjusted for 2022 dollars) with the lower range for school-age, home-based care in small counties and higher range for infant center-based care in very large counties. 

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For a shocking example, the median yearly child care price for just one child in center-based infant care ranged from $8,310 to $17,171 in 2022 dollars. These prices represent between 8% and 19.3% of median family income per child. "Reducing out-of-pocket child care expenses for families can help support employment, especially for mothers," the report concluded. 

The Internal Revenue Code includes tax breaks that help pay for the expenses of caring for children and other dependents. To leverage this benefit for employees, employers can choose to offer dependent care flexible spending account (FSA) plans to their employees. With a dependent care FSA, an employee saves money by not paying taxes on dependent care expenses that he or she incurred. 

Here's how it works: employees are allowed to elect to take a portion of their pay and credit it to a dependent care FSA, which reduces their tax liability because the amount of pay credited to the account is not taxed. Amounts credited to the employee's dependent care FSA account are then used to pay for or reimburse expenses the employee incurred for caring for an eligible dependent. The employee does not pay income or payroll taxes on those amounts.  

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All of this sounds helpful so far, right? Now comes the rub: There is an annual limit of $5,000 on the amount that can be credited to an employee's dependent care FSA. That means any child care costs exceeding $5,000 do not receive any tax benefits. The American Rescue Act temporarily increased the dependent care FSA contribution limit to $10,500 during the pandemic, but the limit is back to only $5,000, or $2,500 if married, filing separately. While a dependent care FSA is a genuinely beneficial offering, data above from the U.S. Department of Labor shows that $5,000 does not even cover the average price of one child in center-based infant care. The reality is that aside from the temporary change during the pandemic, the amount of money that is capped has not changed in decades, making it less useful than it could be for employees. 

Our member-led organization, along with numerous other parties, has been advocating for years to increase the contribution limit for dependent care FSAs. We need a better tax break for setting aside money for child care and other dependent care expenses. An adjustment to $10,000 or $20,000, would cover a much larger percentage of child care costs, but even that would not be enough for multiple children. 

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There is widespread agreement that it is expensive to raise a family. Anyone with children could tell you that child care costs far exceed $5,000 a year per child. With an updated limit on the dependent care FSA, more families could benefit from a tax advantage to help lessen the financial burden of child care costs. Providing some financial relief to families would be a worthy endeavor, and one we hope to see come to light sooner than later.