The Best Way to Get a Tax Break for Child Care Costs

A flexible spending account escapes federal income taxes as well as payroll taxes.

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My employer is offering a dependent-care flexible spending account during open enrollment for 2016, and I’m wondering if it’s better to sign up for this FSA or to take the child-care tax credit. Or can I do both?

If you have the choice, you’ll generally come out ahead with the dependent-care FSA rather than the child-care tax credit. But you may be able to use both if your child-care expenses top $5,000.

The dependent-care FSA lets you set aside up to $5,000 in pretax money for child-care expenses, including the cost of a nanny, day care, a babysitter, preschool, before- or after-school programs, and even summer day camp, for children younger than 13 while you and your spouse work (one spouse can be a full-time student). The FSA escapes federal income taxes as well as the 7.65% in Social Security and Medicare taxes. The higher your income (and higher your tax bracket), the bigger the benefit you’ll get. If you’re in the 25% federal tax bracket, for example, you’ll save 32.65% in taxes on the money you contribute to the FSA, and setting aside $5,000 in the dependent-care account can reduce your tax liability by $1,632.50. You’ll save even more if your contributions reduce your state income taxes, too.

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The dependent-care credit, on the other hand, counts up to $3,000 in child-care expenses if you have one child or $6,000 if you have two or more children. The credit is worth from 20% to 35% of those expenses, depending on the size of your income. If your income is more than $43,000, for example, the credit is worth 20% of your eligible expenses. (It’s worth more for lower incomes.) Because it’s a tax credit, it lowers your tax liability dollar for dollar, so if you have $5,000 in child-care expenses for two or more children, your credit would be worth $1,000.

You can’t double dip tax breaks and use the same money for both the dependent-care FSA and the tax credit. However, if you have two or more kids and sock $5,000 in an FSA, you can count up to $1,000 in child-care expenses toward the dependent-care credit, too. If your income is $43,000 or higher, claiming $1,000 of the credit will be worth $200, even if you’ve maxed out the dependent-care FSA.

For more information, see IRS Publication 503 (opens in new tab), Child and Dependent Care Expenses.

Kimberly Lankford
Contributing Editor, Kiplinger's Personal Finance

As the "Ask Kim" columnist for Kiplinger's Personal Finance, Lankford receives hundreds of personal finance questions from readers every month. She is the author of Rescue Your Financial Life (McGraw-Hill, 2003), The Insurance Maze: How You Can Save Money on Insurance -- and Still Get the Coverage You Need (Kaplan, 2006), Kiplinger's Ask Kim for Money Smart Solutions (Kaplan, 2007) and The Kiplinger/BBB Personal Finance Guide for Military Families. She is frequently featured as a financial expert on television and radio, including NBC's Today Show, CNN, CNBC and National Public Radio.