Dependent Day Care FSA vs. Child Care Tax Credits
- A dependent care FSA allows a parent to take money directly out of a paycheck and move it to an account specifically set aside for paying the cost of child care. You may set aside up to $5,000 for two or more children, or $2,500 for one child. The account is used to reimburse parents for payments made to baby-sitters or daycare centers for child care provided so the parents could work. The money is taken out of the parent's paycheck pre-tax. This means that the parent does not have to pay federal taxes on this amount. In addition, this money is not subject to the 7.5 percent Medicare tax. The higher the parent's tax bracket, the more tax savings this option will reap. In the 25 percent tax bracket, for example, the savings would actually be 32.5 percent of up to $5,000, or a maximum tax savings of $1,625.
- While the FSA option lowers taxable income, the Child Care Tax Credit lowers the actual tax liability. For this credit, a family with one child can report up to $3,000 of child care expenses, and a family with two or more children can report up to $6,000. However, the tax savings is limited by the amount of money made. A person who makes less than $15,000 can take a tax credit of 35 percent of the reported expenses. This percentage is lowered as income goes up. A family earning more than $43,000 can only take 20 percent of the reported child care expenses, for a maximum tax savings of $1,200. In addition, this credit is non-refundable, which means that if the family's tax liability is only $300, the maximum tax savings is $300.
- Most people should choose the Flexible Savings Account if it is available through the employer. The tax savings is immediate, because less taxes will be withheld from the paycheck each week and the long-term tax savings will be more substantial in almost every situation. In fact, in some cases even if you use the Dependent Care FSA, you may still qualify to take the Child Care Tax Credit as well, which means even more savings. If an FSA is not available through your employer, take full advantage of the Child Care Tax Credit.
- In order to report the amount of money the employer withheld for the Dependent Care FSA or to take the Child Care Tax Credit, you must fill out Form 2441. Everyone must fill out Part I of the form, which provides information on which children received care and who provided the care. Part II covers the Child Care Tax Credit and Part III is intended for reporting the amount of money withheld from the paycheck for an FSA. The bottom part of Part III helps you figure out whether or not you can also take the tax credit.
- The FSA can only be used for sitters and daycare centers. If you pay for your child to be in preschool while you are at work, you can take the tax credit but you cannot use an FSA. Both options are only available for children until their 13th birthday. You can get credit for the amount paid in the year the child turns 13 up until the birthday, but not for any amounts paid after that day. If both parents in a two-parent family do not have earned income, you probably cannot use either option, since the other parent is available to take care of the children. If one parent is a student or disabled, special rules apply. Talk to your accountant for more information to make sure you are making the correct choices.