Most people assume that paying their caregiver “on the books” will significantly increase their cost of care. Good news: they’re wrong!  The truth is, for most employers, dependent care tax breaks offset most – if not all – of the employer payroll taxes. And the American Rescue Plan Act has greatly expanded those tax breaks. A typical family will see their savings from tax breaks at least double and some will see their savings even triple!

For most families, the tax savings will cover all the employer-related costs (including taxes, insurance, and payroll service) and some of the nanny’s wages. That’s right, most employers come out ahead by paying their household employees legally!

The 2021 Childcare Tax Breaks are Better Than Ever

If you employ someone in your home whose services are at least partly for the well-being and protection of a child (under age 13), and your household meets the work-related test — which means the care is needed because both parents work, are looking for work or are full-time students – the expenses qualify for one or both of the following tax breaks:

  • Dependent Care Account. Also called a “Flexible Spending Account” (FSA), this tax break allows you to pay for childcare expenses using pre-tax dollars. The limit for 2021 is $10,500 per family per year. Depending on your marginal tax rate, utilizing your FSA can put as much as $4,800 per year in your pocket. While the rules are set by the IRS, families access this tax break through a participating employer. For enrollment details, check with your HR or Accounting Department.


  • Child or Dependent Care Tax Credit (CDCTC). Families can receive a tax credit on care-related expenses through their federal income tax return using IRS Form 2441. The expense limit is $8,000 for one dependent or $16,000 for 2 or more dependents. Your credit percentage will depend on your Adjusted Gross Income (AGI), but most will get a credit between 20% and 50%, which will yield an annual savings between $1,600 and $4,000 for families with one child and between $3,200 and $8,000 for families with 2 or more children. Note: This break phases out for AGI >$440,000.

Maximizing Your Tax Breaks

Eligible expenses include the employee’s wages, employer taxes on those wages and any fees paid to a staffing agency. If your household AGI (adjusted gross income) is less than $125,000, the CDCTC will result in the most savings. If your AGI exceeds $125,000, you’ll likely get the most savings through an FSA.

SPECIAL SAVINGS NOTE: If you have access to an FSA, more than one dependent, and AGI between $125,000 – $440,000, you can maximize your savings by using both tax breaks. You’ll utilize your FSA for the full $10,500 and save up to $4,800 per year. If your dependent care expenses are greater than your FSA contribution, you will have “excess expenses” of up to $5,500 ($16,000 – $10,500 = $5,500). The excess expenses can be applied to the Tax Credit on Form 2441, which will save you an additional $1,100-$2,750 per year.

Thank you to our friends at HomePay for providing all of this great information. For an estimate of your tax costs and tax breaks, visit our website.