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Flexible Spending Account vs. Dependent-Care Credit
A couple of tax breaks are available for working parents who pay for child care, but you'll have to choose one or the other.
By Kimberly Lankford, Contributing Editor, Kiplinger's Personal Finance
September 24, 2009
Is it better to pay for child-care expenses using a flexible spending account or to claim the dependent-care credit on my tax return?
SEE ALSO: Make the Most of Your Flex Account in 2012
Many people will have that question over the next few months, as they make decisions about their employee benefits for 2010. You may be allowed to set aside up to $5,000 in pretax money for the year in a flexible spending account for dependent-care expenses. Or you could claim those expenses for the dependent-care credit when you file your 2010 tax return. But you can't use the same expenses for both tax breaks.
Most families who have access to a dependent-care flexible spending account at work would be better off running their child-care expenses through the FSA.Money you set aside in a flexible spending account is not only subtracted from your paycheck before income taxes are calculated, but it also avoids the 7.65% Social Security and Medicare tax. So if you're in the 15% income-tax bracket, you won't have to pay the 15% federal tax or the 7.65% Social Security tax, which means that you'll avoid paying a total of 22.65% in taxes on that money. In that case, contributing the maximum $5,000 to your dependent-care flex plan cuts your tax bill by $1,133. The benefits get even better as your tax bracket rises. If you're in the 25% bracket, for example, you'll end up saving 32.65% in taxes on the money you contribute to the FSA -- and lowering your tax bill by $1,633. You'll save even more if your FSA contribution escapes state income taxes.
See our How Much Should I Put in My Flexible Spending Account? calculator to help figure out how much your contributions will lower your tax bill. (You can also use this calculator to figure out how much money to set aside in your FSA for medical expenses, which have separate contribution limits.)
Also keep in mind that you generally must use the money in the flexible spending account by December 31 (or in some cases by March 15 of the following year) or else you will lose it.
The dependent-care credit, however, can help lower your tax bill if you don't have a flexible spending account at work, and it's most valuable for people with very low incomes.
To qualify for the dependent-care credit, you must pay someone to watch your child, who has to be younger than 13, while you work or look for work. Both spouses must have earnings from a job or self-employment, unless one is a full-time student. You can take a 20% to 35% credit for up to $3,000 in child-care expenses for one child (the higher your income, the lower the percentage) or up to $6,000 in child-care expenses for two or more children. That means the credit ranges from $600 to $1,050 if you have one child, or $1,200 to $2,100 if you have two or more children. And remember that a tax credit lowers your tax liability dollar for dollar.
But you'll qualify for that maximum credit only if you have a very low income - currently less than $15,000. If your income is more than $43,000, you'll qualify for the 20% break, which means that if you have $5,000 in child-care expenses, you'd get a tax break of only $1,000.
See A Tax Break for Sending the Kids to Camp and Five Things to Know About the Child-Care Tax Credit for more information.
If you have two or more children and child-care expenses exceeding $5,000, you might be able to benefit from both the FSA and the dependent-care credit. You can set aside up to $5,000 in pretax money in your FSA, and claim the dependent-care credit for up to $1,000 in additional expenses.
You can sign up for the FSA during open-enrollment season, then keep track of your child-care expenses throughout the year and possibly qualify for the credit on the extra $1,000 in expenses when you file your 2010 tax return. If you qualify for the 20% credit on that $1,000, you'll save an extra $200 on your taxes.
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Reader Comments (17)
Posted by: Andy at 10/18/2009 03:25:21 PM
Great Article...clearly and concisely answered that exact question for me. Thanks!
Posted by: Mike Kelly at 10/27/2009 06:31:16 PM
If you had only one dependent and would be eligible for a maximum $3,000 credit, can you still have $5,000 deducted from your paycheck? I believe in this situation, I'd have to at least pay income taxes on the extra $2,000.
Posted by: Kelly at 11/02/2009 07:55:31 PM
Thank you for the clear article on the subject. Too bad it wasn't #1 in the Google rankings, it would have saved me some time reading through a half dozen other vague articles on the subject. Nice job.
Posted by: Brill at 11/16/2009 05:31:30 PM
If I set aside $2000 for FSA but spent $4500 for after school care in 2010 (like YMCA) then can I claim dependent-care credit for remaining $2500 ( $ 4500 - $ 2000 = $ 2500 ) when I file 2010 tax ? Thanks.
Posted by: jamie at 11/18/2009 03:20:27 PM
Question on the second-to-last paragraph. What if you have one child and your child-care expenses exceed $5,000? Can you benefit from both the FSA and dependent-care credit? Perhaps the same $1,000 in additional expenses as if you have two or more children?
Posted by: Steve at 12/11/2009 03:15:08 PM
@MikeKelly - the $5k flex account limit is regardless of how many dependents you have. @Brill - the FSA reduces the amount subject to the credit dollar-for-dollar. So you could get a credit based on $3000 minus $2000 = $1000 if you have one kid. If you have two or more dependents it's the lesser of expenses or $6000, so in that case it would be $2500 like you say. @Kelly - no kidding - not only vague, but there are some out dated and just incorrect articles in the top 10 hits.
Posted by: Rob at 12/31/2009 01:08:25 AM
This is the first article even remotely helpful and hoping that someone help me clarify my situation...Spent ~9k in eligible dep care in 2009, 5k in FSA through work. Is the remaining 4k eligible for the dep care credit?
Posted by: TJ at 01/15/2010 01:34:15 PM
@Rob - if you had two or more qualified dependents, then you would claim the credit on $1000. If you max out on the FSA at $5K, the most you can ever claim on the credit is $1K ($6K-$5K= $1K). If you maxed out on the FSA and have just one qualified dependent, you could not claim the credit ($3K-$5K = negative). Your FSA benefit takes away from your credit dollar for dollar.
Posted by: John at 01/25/2010 03:16:47 PM
As a teacher my FSA deduction will run from August 2009 - August 2010. My total withholding for my FSA during 2009 was 1666.00. I noticed that your article stated the cut-off as March 15th? Am I out of lucK? Since only the 1666.00 was taken, can I still take some of the Child Depedent Care Credit? Thanks!
Posted by: Greg at 01/26/2010 09:07:12 AM
Forgive me if this is covered, I cannot find the answer in the article or the comments. My question is, must I take out equal amounts over an entire year, or can I put in money at the rate I actually pay for child care, hitting the $5000 limit by mid-year, in my case?
Posted by: Jerry at 01/29/2010 04:47:03 PM
Nice article...I have question though...Can an individual open a Dependent care FSA account ask the employer to deposit pre-tax contributions into that account? Should DCFSA be opened only by employer? Once again....Thanks for the great article.
Posted by: Brent at 02/14/2010 01:02:57 AM
We are going to be having someone outside of the home watch our kids (2). I want to use my FSA now that I have access to one, but what about the person providing the daycare... Do they need to claim the income (always been cash before since we got cheaper day care it was mutually beneficial)? If so, how much tax does that person pay? Is it just their marginal rate as figured on their tax return, or is their marginal rate plus FICA (and potentially both sides even)?
Posted by: Jordan James at 02/14/2010 10:35:17 PM
I have a son who is in 4k Montessori School. I paid $1000 in tuition for him last year. Is this tax deductible and fall under child care.
Posted by: Vishal at 04/11/2010 06:07:51 PM
Your calculator does not take into account earned income requirements for both parents which sets the limits for dependent care fsa. For eg. if my spouse is unemployed, her earned income is 0, which sets the limits for the pre-tax amount.
Posted by: Ben at 04/22/2010 12:19:06 AM
Me and my wife both work and we have 2 kids (dependents) under 18. My employer provides $5000 maximum Flexible Spending Account for Health, my wife's employer provides $2500 maximum FSA for health. I received $5000 already (othodontia) from FSA health for this year (2010). Could my wife also contribute up to $2500 in FSA health for 2010 and we would be eligible to avoid $7,500 in income taxes at the end of the year? So basically, does IRS put a maximum that can be contributed from a household to FSA health? Her employer is currently in open enrollment during April. I apologize if this is not the right place for this question.
Posted by: Robert J. Ford at 05/24/2010 05:23:53 PM
I run a small business in California, and am looking into the possibility of setting up a Dependent Care Assistance FSA for my employees. Is this a federal or a state program. If it is a state program does California offer such a plan and how would I go about setting one up? If it is a Federal program, does it exempt the employee from state taxes, and again, how would I go about setting up such a plan? Any help would be appreciated
Posted by: Dave at 08/25/2010 03:43:17 PM
Thanks for the article. I wasted a couple hours reading the other articles from my Google search as well as the IRS publications. In one page this article was able to clarify the relationship between the FSA vs Dependent Care credit. Great Job!!