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Dependent Care Flexible Spending Account

A plan that enhances your benefits:
If you're one of the many people who spends money on the care of dependents, a dependent care flexible spending account can make these expenses more affordable. This valuable option is available through your employer's flexible benefits plan and is a qualified benefit under Code Section 125 of the IRS. Code Section 125 was created by the United States Congress to make benefits more affordable for you.

How it works:
If you participate, you will elect to have a specified amount of pretaxed money deducted from your paycheck each pay period. These dollars are set aside in a flexible spending account and subtracted from your gross earnings before any taxes are taken out. After you submit a receipt for a qualifying dependent care expense, you will be reimbursed from this account.

How it benefits you:
The advantage of participating is that when you contribute pretax dollars to a reimbursement account, you lower your taxable income; therefore, you pay less in taxes and increase your spendable income!

For example…
Mary has one child. She pays $216 per month ($50 per week) for day care. Here's how a dependent care plan can help her

Dependent Care FSA illustration:

Mary's Status:

Married, three fed/state exemptions, Weekly salary: $500
Eligible expenses: dependent care FSA/ $50

	Before Dep. FSA reim.	After Dep. Care FSA reim.
Gross Pay	$500.00	$500.00
Pretax dep. Care reduction	-0.00	-50.00
Taxable Gross	500.00	450.00
FICA, Fed/State taxes	-85.99	-71.52
Net Pay	414.01	378.48
Dep. Care cost	-50.00	+50.00
Spendable Income	$364.01	$428.48

Mary chooses to have $50 each pay period deducted from her gross salary.
When she incurs qualifying dependent care expenses, she simply files a claim and is reimbursed from the account. Because her taxable income is now lower, her taxes are less.
After Mary is reimbursed from her account, her total spendable income increases by $64.47 each week!

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How much can I contribute?

The U.S. Congress has set these maximum allowable contributions for a dependent care flexible spending account:

• $5,000 for a married couple filing jointly
• $5,000 for a single parent
• $2,500 for a married person filing separately

Eligible Expenses

You may use the plan for expenses that meet the following qualifications:

• The dependent care must enable you and your spouse to be employed.
• The amount to be reimbursed must not be greater than your spouse's income or one-half of your income, whichever is less.
• The child must be under 13 years old and must be your dependent under federal tax rules. Note: If your child turns 13 during the plan year, reimbursements must stop. Your contributions, however, must continue throughout the plan year, so plan carefully.
• The services may be provided in your home or another location but not by someone who is your minor child or dependent for income tax purposes (for example, an older child).
• If the services are provided by a day care facility that cares for six or more children at the same time, the facility must comply with state and local day care regulations.
• Services must be for the physical care of the child, not for education, meals, etc

Qualified dependent care expenses also include costs for the care of a spouse or dependent who is incapable of self-care and regularly spends at least eight hours per day in your home (i.e. invalid parent). The same rules that apply for child care apply to the care of other dependents, except that the dependent need not be under age 13.

Tax credits vs. dependent care FSA's

If you participate in the plan, you cannot claim credits on your income tax return for the same expenses. Also, amounts reimbursed under this plan will reduce the amount of other dependent care expenses that you can claim for purposes of tax credits. Before you sign up, evaluate whether or not taking federal income tax credit will save you more money than a dependent care FSA. The worksheet included in this booklet will help you decide.

The "Use it or lose it" rule

If you contribute dollars to a flexible spending account and do not use all of the monies you deposit, you will lose any remaining balance in the account at the end of the plan year.
A very important thing to remember…the rule exists because the IRS has established strict guidelines on plans with tax advantages. Estimate carefully the amount you want to contribute, and only contribute dollars that you're confident will be used before the end of the plan year.

What do I need to know when I file my taxes?

You must report on your tax return the correct name, address, and taxpayer identification number (TIN) of your dependent care provider to claim exclusion for employer-provided dependent care assistance benefits or the dependent care credit.

If your dependent care provider is exempt from federal income taxation, you are not required to report the TIN on your tax return. However, you must report the correct name and address of the exempt provider and you must write "tax-exempt" in the space provided for reporting the TIN.

If you fail to report the correct name, address and TIN of your dependent care provider and cannot establish upon request by the IRS that you exercised due diligence in attempting to provide that information, you are not entitled to either the Section 21 credit nor the Section 129 exclusion.

Due diligence can be proven by having obtained and retained a copy of the Social Security card (or driver's license) of your dependent care provider, or by having obtained the required information from a recently printed letterhead or printed invoice from the dependent care provider.

What if I want to make a change in my election?

The latest set of cafeteria plan regulations develops a process for determining if a participant is allowed to make a change in election during the plan year. The two-step process is:

1. A change in status must have occurred. A change in status has occurred if the event falls into one of the categories below:
• Legal marital status
• Number of dependents
• Employment status
• Dependent satisfies (or ceases to satisfy) eligibility requirements
• Change of residence
2. The participant's election change must be consistent with the status change event. In order to be consistent, a requested change must be on account of and correspond with a change in status that affects eligibility for coverage under an employer-sponsored plan.

What if the tax laws change?

Tax advantages currently available are based on the law as it stands today. If a change in the law takes place, you will be notified.

Will pretaxing have an impact on Social Security benefits?

Any reduction in your taxable pay may also lead to a reduction in your Social Security benefits; however, for most employees, the reduction in Social Security benefits is insignificant compared to the value of paying lower taxes today.

Understand your choices

With this program, you have benefit choices and opportunities you've never had before, and it's important to understand everything completely. Reading this booklet is the first step. The next step is to attend a planning session. At the session, your Colonial representative will answer questions and estimate your tax savings, based on the amount you plan to contribute.

Let's take another look at Mary's situation. If Mary chooses to deduct $10.60 per week in qualified premiums from her gross pay, along with her $50 dependent care deduction, here's how it would affect her paycheck:

Dependent care FSA and pretax premiums illustration

Mary's status:

Married, three federal/state exemptions, Weekly salary: $500
Eligible expenses: Dependent care FSA /$50
Colonial coverage's/ $10.60

	w/Dep. Care FSA & After-tax Premium	w/Dep. Care FSA & Pretax Premium
Gross Pay	$500.00	$500.00
Pretax dep. Care reduction	-50.00	-60.60
Taxable Gross	450.00	439.40
FICA, Fed/State taxes	-71.52	-68.44
Insurance	-10.60	-0.00
Net Pay	367.88	370.96
Dep. Care Reim.	+50.00	+50.00
Spendable Income	$417.88	$420.96

Mary's taxes are again lowered-$68.44 versus $71.52. She has paid $10.60 in premiums for qualified benefits, but her spendable income is only $3.08 lower.
You, too, can tailor your benefits package by choosing products you want and need, while reducing your tax burden.

Dependent Care Reimbursement Plan Worksheet

	LAST YEAR	THIS YEAR
Day Care	$________	$________
Nursery Schools	$________	$________
Other Eligible Care	$________	$________
Total Dependent Care	$________	$________

Reimbursement vs. Tax Credit

Dependent care expenses eligible for reimbursement from your account are also eligible for a federal income tax credit. You can apply one or the other of these two tax advantages, but not both for the same expense. If your family income is less than $24,000, known as your "cross-over income", it will usually be more advantageous to use the tax credit. This assumption is based on 2002 federal income tax tables and the 2002 Social Security rate. State income tax may impact this result. Your Colonial Representative will help explain this program to you.

How Does the Tax Credit Work?

The tax credit applies to a maximum of the first $2,400 of expenses if you have one eligible dependent. The credit applies to the first $4,800 of expenses with two or more eligible dependents. Depending on your adjusted gross income, a certain percentage of those expenses may be taken as credit.

Maximum Annual Contributions to Dependent Care Reimbursement Account

Maximum $5,000 - Single-parent household, or married, filing jointly.
Maximum $2,500 - Married, filing separately.
Note: Dependent care expenses shall not include any amount paid for services outside the taxpayer's household at a camp where the qualified individual stays overnight.

Tax Credit

Complete the following to determine the maximum tax credit for your dependent care expenses.