Usually, child-care in the US (or on the US system when assigned to Germany) is not free and contributing towards a Dependent Care Flexible Spending Account (DCFSA) can be a great way to save towards funding care while reducing your US tax liability.
To understand though how a DCFSA factors in on the German side it is important to first understand the basics of how it works on the US end.
When enrolled in a DCFSA you can contribute towards it from your payroll, then use funds in the account to pay eligible childcare expenses. This means you have used a pre-tax account to pay for dependent care. Money contributed to DCFSA is not subject to federal income tax, state income tax, or Social Security and Medicare taxes. Obviously, this can result in more take-home pay while also helping with the budget for childcare.
And while there other caveats attached to this concept pertaining to enrolment, dependants, qualifying expenses…. a DCFSA can get tax-tricky when working in Germany. How is that? Well, mostly under the following circumstances:
- Under NATO-SOFA: You or your spouse (also) command non-SOFA income and you take the Foreign Earned Income Exclusion (FEIE).
- No NATO-SOFA: You come to Germany and decide to cash-out to the maximum extent possible or to (partly) quit contributing. Now you have decent sized one-off cash-influx or a chunk of cash just sitting in an account potentially earning interest.
In case 1 taking the FEIE may reduce the eligible earned income on the US side.
In case 2 you want to show that the funds you received are essentially a return of capital. This means you may need to be able to show the entire contribution history (to include the contributions that forfeited). If you do not cash out you want to be able to show that the account either does not generate income, or, if it does, the exact amount.
For German purposes the following key-takeaways are essential:
- There is no DCFSA equivalent on the German end. The account will be viewed as a regular savings/investment account and treated as such. Hence
- you will not receive a tax cut for your contributions
- being able to show contributions, distributions and earnings per year matters.
- As child care expenses are tax deductible in Germany as well, you may use your DCFSA funds for those as well. When doing so make sure that the expense is a qualifying one as well – ideally under both US and German tax law.
If you have questions as to how child care expenses can be considered on your German tax return, please see this article.
