Deciding between the Dependent Care Flexible Spending Arrangement (DCFSA) and the Credit for Child and Dependent Care Expenses can be confusing. Let me break down the rules, so you don’t overpay for childcare.
You must work or actively look for work
Whether you are using the DCFSA or Credit for Child and Dependent Care Expenses, you and your spouse need to have jobs or actively looking for work. Although, there are exceptions for a student-spouse or spouse not able to care for self (see IRS Publication 503).
This is a great example of why the tax code is a book of incentives. Congress wants you to work. Therefore, if you are able to work, they will reward you with a tax deduction or tax credit.
Dependent Care Flexible Spending Arrangement Limits and Eligible Expenses
In 2017, the DCFSA contribution limit is $5,000. This is the same whether you are single or married, or have one or more children. If you are married filing separately, then it is $2,500.
Here are a few examples of eligible expenses:
- After school program
- Babysitting (work-related)
- Includes relative who is NOT a dependent
- Housekeeper or nanny who cares for your child
- Summer day camp
The important theme here is a reinforcement that the expenses must be in relation to allowing you to work.
When incurring expenses, you do not need to pay the provider directly from the funds of the DCFSA. You can pay with other funds, and reimburse yourself with the DCFSA funds later. No matter how you do it… KEEP YOUR RECEIPTS!
Dependent Care Flexible Spending Arrangement Tax Savings
When you deposit money into your DCFSA, you are doing it with 100% tax-free money. Tax-free means you receive a deduction for Social Security, Medicare, and income taxes.
Assume you deposit $5,000 into your DCFSA. Here is what happens if you are in the 25% bracket:
Not taken into account in the above calculation are state income taxes. If you live in the state of Wisconsin and fall in the 6.27% income tax bracket then, you can add another $313.50 in savings.
You can revise the calculation by switching the Ordinary Income Tax rate to match your tax rate.
Very important to know is that you need to use 100% of the funds you deposit into your DCFSA by March 15th of the subsequent year, or you lose it all. In other words, any money deposited by December 31, 2017, has to be spent by March 15, 2018.
Credit for Child and Dependent Care Expenses Limit and Eligible Expenses
The Credit for Child and Dependent Care Expenses is limited to the $3,000 of eligible expenses for one child or $6,000 for two or more children. If you have more than one child, then you do not have to split the expenses evenly. The total expense is what matters.
Fortunately, the eligible expenses are similar to the DCFSA above.
However, the calculation for the Credit for Child and Dependent Care Expenses is dependent upon your adjusted gross income (AGI). The higher your income, the lower the eligible percentage.
The credit ranges from 20% – 35% or $600 – $1,050 if you have one child. For two children, it is worth $1,200 – $2,100.
All of those ranges are your actual tax savings. Tax credits are a dollar-for-dollar reduction in your tax bill. If your tax credit exceeds to your tax liability, then you lose the credit because the Credit for Child and Dependent Care Expenses is a non-refundable credit.
Should I take the DCFSA or Credit for Child and Dependent Care Expenses?
Unfortunately, you are not able to take both the DCFSA or Credit for Child and Dependent Care Expenses in full in a given year. Just like sharing chips and dip with friends… there is no double dipping!
Although, there is one way to get the best of both worlds (partially).
If you have two or more children with at least $6,000 in eligible expenses, you can take a $5,000 DCFSA deduction and $1,000 towards the Credit for Child and Dependent Care Expenses calculation.
The first $5,000 of eligible Credit for Child and Dependent Care Expenses expenses are disallowed by using the DCFSA. Therefore, an extra $1,000 remains, which can be used in calculating the credit. Building off the two examples above, this means you could save the following:
Worth noting is the timing of your benefit. When contributing to your DCFSA, you have an immediate deduction from your paycheck. This means you have immediate tax savings. Your cash flow immediately increases. The Credit for Child and Dependent Care Expenses benefit will be received when you file your tax return.
Here are a few rules of thumb:
- Higher your income, the higher the probability a DCFSA is the right choice for you.
- Two or more kids, then a DCFSA and the Credit for Child and Dependent Care Expenses is there for you.
Ultimately, what’s best for your circumstances is based on your facts. Always consult with a qualified tax advisor to determine if your facts make you eligible, or how you can change your facts to become eligible.
** NOTE there is a lot of talk surrounding tax reform and the use of child and dependent care expense credits. The potential elimination of exemptions for your children might be met with an increase in deductions or credits for childcare.
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Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Nate Byers a Madison, WI CPA Financial Advisor, and all rights are reserved. Read the full Disclaimer in the footer below.