Using Dependent Care FSA to Pay Grandparents for Childcare - Tax Rules

Thanks for the info! Quick question - does the grandparent need any kind of license or certification to qualify for the FSA reimbursement? My mom watches my kids too and I've heard mixed things about this. Also, would this count as self-employment income for the grandparent, meaning they'd need to pay self-employment tax on it?

No, grandparents don't need any special license or certification to qualify for DCFSA reimbursement when providing care in your home. They're treated as household employees or independent caregivers depending on the arrangement. Regarding taxes, yes, this would generally be considered self-employment income for the grandparent if they're not your employee. They would need to report it on Schedule C and pay self-employment tax if their net earnings from self-employment exceed $400 for the year. However, if you structure the arrangement as household employment (with specific hours and supervision), different rules might apply - though that's more complicated for a family arrangement like this.

Was it difficult to get your FSA administrator to accept the grandparent payment receipts? Mine is being really strict and I'm worried they'll reject it even with documentation.

How does this service handle the relationship documentation? My parents watch my kids sometimes but I'm not sure how to prove they're actually providing care versus just normal grandparent time. Does the IRS actually check this stuff?

No, it wasn't difficult at all once I had the proper documentation. The key was having a formal childcare agreement that clearly stated the arrangement was for work-related childcare, along with detailed invoices showing dates and times of care. My FSA administrator accepted everything without questions. The service helps create documentation that distinguishes between paid childcare and regular grandparent time by establishing a formal arrangement with specific hours tied to your work schedule. The IRS doesn't typically audit these claims unless there are red flags, but having proper documentation is crucial if they do. The system creates a paper trail showing this was legitimate work-related childcare, not just family visits.

How exactly does this service work? Do they just wait on hold for you or something? I've been trying to call the IRS for days about my FSA situation.

This sounds like a scam honestly. You're telling me you pay some company to call the IRS for you? Why would they have any better luck getting through than I would? And even if you do get through, would a random IRS agent's word override your FSA administrator's policies?

The service basically holds your place in the IRS phone queue and calls you when they reach a real person. They don't just wait on hold - they use technology to navigate the phone tree and monitor hold times. When they connect with an agent, they conference you in so you speak directly to the IRS yourself. It's definitely not a scam. The power comes from getting an official response from the IRS itself. My FSA administrator was interpreting the rules incorrectly, and once I had documentation of the IRS's position on qualifying dependent care expenses paid to grandparents, they had to accept it. The agent even emailed me the relevant IRS publication sections which I forwarded to my FSA administrator. Remember that FSA administrators have to follow IRS rules - they can't make up their own restrictions beyond what tax law states.

Thanks for bringing that up! My mom doesn't live with us, she comes to our house during the day while we're at work. And yes, we're well under the $5,000 limit - we put in about $4,800 for the year and had the $1,300 leftover after daycare expenses. Does it matter if my mom is retired and collecting Social Security? Would this additional income affect her benefits?

Good to hear your mom doesn't live with you - that definitely makes things cleaner for FSA purposes. The additional income could potentially affect your mom's Social Security benefits, depending on her age and how much she receives. If she's at full retirement age (currently 66-67 depending on birth year), there's no limit on how much she can earn without affecting benefits. However, if she's younger than full retirement age, earning over certain thresholds can temporarily reduce her benefits. For 2024, that threshold is $22,320 if she's under full retirement age. Social Security would withhold $1 in benefits for every $2 earned above that limit. Once she reaches full retirement age, the reduction no longer applies.

Do you think Venmo or PayPal would work as payment proof? I've been paying my mother-in-law through Venmo for watching my kids and wondering if that's enough documentation.

Venmo or PayPal should work fine as payment proof since they create a digital record of the transaction. The key is that you have a clear paper trail showing the payment was made for childcare services. Just make sure to include a note in the payment description like "childcare services" or reference the invoice number so it's obvious what the payment was for. I'd also recommend keeping screenshots of the payments in case you need them later. Some FSA administrators are pickier than others about electronic payments, so you might want to check with yours first. But from a tax perspective, electronic payments are generally accepted as valid proof of payment as long as they clearly show the amount, date, and purpose.

This is really helpful, Bruno! I'm curious about the Tax ID requirement you mentioned. My FSA administrator hasn't said anything about needing one yet, but I want to be prepared. Would my mom need to get an EIN specifically for this, or would her SSN work? And if she does need an EIN, is that something she'd have to apply for through the IRS? Also, when you mention keeping it under $400 to avoid self-employment tax - does that mean if she makes exactly $400 or more from childcare, she'd suddenly owe a lot more in taxes? Just trying to figure out if there's a sweet spot amount-wise.

Great questions, Sofia! Your mom's SSN would work fine for FSA purposes - she doesn't need to get an EIN unless she wants to keep her personal and business tax matters separate. Most FSA administrators will accept either an SSN or EIN as the Tax ID. Regarding the $400 threshold - it's not as dramatic as it might sound. If she earns $400 or more from self-employment (like providing childcare), she'd owe self-employment tax on that income, which is about 15.3%. So on $400, that would be roughly $61 in self-employment tax, plus whatever regular income tax applies based on her tax bracket. The key thing to remember is that this $400 threshold is specifically for self-employment income, not total income. So if your mom has other income sources (like Social Security or retirement), this childcare income would be separate for self-employment tax purposes. There's no real "sweet spot" to game the system - it's better to focus on legitimate arrangements and proper documentation rather than trying to hit specific dollar amounts. The tax implications are pretty straightforward once you know the rules!

This is such an important point that Jessica brings up! I made this exact mistake when I first started using my DCFSA for family care. I was so focused on not losing the money that I almost created a situation where I was paying more for "childcare" than I actually needed. The key thing to remember is that the FSA funds can only reimburse you for actual expenses you incur for qualifying childcare. So if your mom is going to start providing care going forward, you need to establish a reasonable rate based on actual hours of care provided. You can't just create a $1,300 invoice to use up your remaining FSA balance. I'd recommend figuring out what you would have paid for daycare for the remaining months of the year, then set up a legitimate arrangement with your mom at a comparable rate. This way you're paying for actual childcare services you need, not just trying to drain your FSA account. The documentation will be much stronger if it shows ongoing, regular childcare rather than a one-time lump sum payment.

This is exactly the approach I wish I had taken from the beginning! I made the mistake of trying to rush into a lump sum arrangement just to use up my FSA funds, and it created unnecessary complications with my administrator. Clay's point about establishing a reasonable hourly rate is crucial. I found that researching what babysitters or nannies charge in my area helped me set a fair rate that looked legitimate. In my case, I ended up paying my father-in-law $15/hour for about 25 hours per week, which was comparable to what we were paying for daycare but slightly less since he was coming to our home. One thing I'd add - consider having a brief conversation with your mom about the tax implications before you start. When I first talked to my father-in-law about this arrangement, he was surprised to learn he'd need to report it as income. Having that discussion upfront helped us both understand what we were getting into and avoided any awkwardness later when tax season came around. Also, don't stress too much about making it perfect - as long as you're genuinely paying for childcare that enables you to work and you have reasonable documentation, you should be fine!

Thanks for the comprehensive advice, Nia! This really helps clarify things. I'm feeling much more confident about setting up a proper arrangement now. Just to make sure I understand correctly - when you mention calculating what I'd "realistically need to pay for childcare for the remaining months," should I base this on what I was paying the daycare previously, or what current market rates are for in-home care? I was paying about $200/week for daycare, but I'm not sure if that's a fair comparison since my mom would be providing one-on-one care at our house. Also, you mentioned checking with my FSA administrator about documentation requirements - is there a specific way I should phrase this question to them? I don't want to raise any red flags by asking about paying family members, but I also want to make sure I have everything they need before submitting. I'm planning to start this arrangement next week and do monthly invoicing going forward, so I want to make sure I get the foundation right from the beginning!

Great questions, Freya! For the rate calculation, I'd suggest looking at current market rates for in-home childcare or nannies in your area rather than using your daycare rate. In-home care is typically more expensive than daycare since it's one-on-one attention. You can check sites like Care.com or Sittercity.com to see what caregivers charge per hour in your zip code. This will help you establish a rate that looks reasonable and market-appropriate. For talking to your FSA administrator, you can simply ask something like "What documentation do you require for dependent care FSA reimbursements from individual childcare providers?" or "Can you send me your requirements for childcare provider invoices and tax ID information?" You don't need to mention it's a family member - just treat it like you're hiring any other childcare provider, because that's essentially what you're doing. Starting next week with monthly invoicing is a smart approach! Just make sure your mom tracks her hours each day and includes that detail in her monthly invoices. Having that level of documentation will make everything much smoother if your FSA administrator has any questions.