Sun Tzu told us in “The Art of War” to know yourself and to know the IRS.

The IRS allows income deductions or tax credits associated with dependent care expenses because it is considered a work-related cost. By paying someone else to “care” for the dependents, parents or guardians can work and pay taxes. This is why the IRS disqualifies expenses that are purely for education; sending your dependents to various educational activities often takes time away from work, which is the opposite of what the IRS wants you to do. This is also why the IRS does not allow the deduction or credit if one of the parents is not working, is not looking for a job, or is not preparing themselves to work by enrolling in school as a full-time student.

By understanding these distinctions between care and education, taxpayers can better navigate the tax benefits available for dependent care expenses and ensure they are not mistakenly claiming non-deductible educational costs. The key is to focus on expenses that are primarily for the care and protection of the dependent while enabling the taxpayer to work or seek employment.

Qualified persons

To qualify for the dependent care tax deduction, the expenses must primarily be for the well-being and protection of a qualifying person. According to IRS guidelines, a qualifying person can be:

  • A dependent under the age of 13.
  • A spouse who is physically or mentally unable to care for themselves.
  • Another dependent who is physically or mentally unable to care for themselves and who lives with you for more than half the year.

Qualified expenses

The deductible expenses include the costs of care provided to a qualifying person. This care can be provided both inside and outside the home, provided that the main purpose of the expense is for the person’s well-being and protection. For instance:

  • Daycare Centers: If the care is provided by a daycare center, the center must comply with all applicable state and local regulations.
  • Day Camps: Costs for day camps, even those that focus on specific activities like soccer or computers, are deductible.

Exclusions from the Deduction

The IRS explicitly states that the dependent care tax deduction does not cover expenses primarily for education, food, lodging, clothing, or entertainment. This means:

  • Educational Expenses: Costs associated with education, especially for children in kindergarten or higher, are not deductible. This includes tuition for private schools, summer schools, or tutoring programs.
  • Overnight Camps: Expenses for overnight camps are not deductible under this provision because parents do not normally work at night.

Incidental Expenses

There are circumstances where educational or other expenses might be included as deductible if they are incidental to the care provided and cannot be separated from the total cost. For example:

  • If a daycare center provides both care and meals, the cost of the meals may be included if it is inseparable from the cost of care.
  • Day camps that offer educational activities as part of their program can have those costs included, provided the primary purpose is still care.

Deduction versus credit

You can set aside certain amount of money in flexible spending account for the purpose of dependent care expense. This amount is pre-taxed, meaning it is excluded from taxable income (as well as social security and medicare incomes). If the amount set aside is below the IRS allowed limit ($3,000 for one dependent and $6,000 for 2 or more dependent, you can still claim tax credit for the difference.

Generally the income deduction is better for high income taxpayers for the following reasons:

  • It reduces your tax by marginal rate, while the tax credit is 20% of the expense if your income is over $43,000 (Year 2020 amount).
  • It has a higher limit of $5,000 even for 1 dependent.
  • It reduces not only income tax, but social security and medicare texes as well.

References