FSA or Child-Care Credit?

I have to make choices about my employee benefits during this year’s open-enrollment season. Is it better to pay for child-care expenses from a flexible spending account or to take the child-care tax credit?

If your employer offers a dependent-care flex plan, that’s usually a better deal than taking the child-care tax credit. Money you set aside in a flexible spending account is not only deducted from your gross salary before income taxes are calculated but also avoids the 7.65% Social Security and Medicare tax. So if you’re in the 15% income-tax bracket, contributing $5,000 to your flex plan (the maximum for most employers’ plans) would cut your federal income-tax bill by $1,133 next year. The benefits get better as your tax bracket rises, and you’ll save even more if your FSA contribution escapes state income taxes, too.

The dependent-care tax credit can help if you don’t have an FSA at work. It’s most valuable for people with very low incomes. To qualify, you must pay someone to watch a child who is younger than 13 so that you can 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 tax credit worth 20% to 35% of the cost of care, up to $3,000 for one child or up to $6,000 for two or more children. The higher your income, the lower the credit, bottoming out at 20% for those who earn $43,000 or more. The 20% credit would cut your tax bill by $1,000 if you pay $5,000 in child-care expenses for two kids.

But there is a way to benefit from both options: If you have two or more children and your child-care expenses exceed $5,000 per year, you can set aside up to $5,000 in pretax money in your FSA, then claim the dependent-care credit for up to $1,000 in additional expenses.

For more information about the child-care tax credit, see FAQs on the Child Care Tax Credit.