Dependent Care FSA vs. Tax Credit
My husband and I have an accepted division of labor on many household chores, and one of those is: he signs us up for benefits through his employer and I do our taxes. It leads us to have the same conversation every year during open enrollment over whether and how much to contribute to the Dependent Care FSA.
It’s not a straightforward question because there’s also the Child Care Tax Credit to consider. Both give you a tax break on childcare costs, but due to different eligibility requirements it isn’t clear which is better (or even possible) for a particular household. Here’s what my research showed me makes sense in 2022.
First, a bit of background. If you are a household with children and you pay for childcare, you might be eligible for programs that aim to defray that cost: The Dependent Care FSA and the Dependent Care Tax Credit.
If your employer offers the opportunity to sign up for a Dependent Care FSA, it allows you to set aside money from your paycheck (thus reducing your taxable income) that you can use to pay for childcare. When you sign up, you specify an amount that should be set aside from each paycheck (before tax) and put into the Dependent Care FSA. Throughout the year, you submit your receipts for qualifying childcare costs and get reimbursed for them from that set aside money. You can read more about it here.
The Child Care Tax Credit is a credit you receive when you do your tax return for the prior year. If you qualify for the credit, it can reduce your tax bill by a portion of your previous year’s childcare costs.
But you can’t always take both…so which is better? You can’t double dip, which means that if you get reimbursed for childcare costs through the FSA then those costs are no longer qualified to claim the tax credit. To know which is best for you I would need to know more about your household income, tax bracket, number of children, and how much you pay in childcare costs…because each program has different rules and maximums at play. So, I boiled it down to one situation (married filing jointly tax status, with 2 kids) to outline the circumstances when that household could take advantage of both programs and when one is better than the other.
In the scenario where your tax filing status if Married Filing Jointly, and you have 2 kids younger than 13 that incur childcare costs...
If your household income is below $169,000:
If you pay more than $6,000 in childcare costs – don’t use the dependent care FSA, take the credit.
If you pay $6,000 - $11,000 in childcare costs – you could put the difference between what you expect to pay in childcare costs and $6,000 in a dependent care FSA. So, if you expect to pay $10,000 in childcare costs, you would put $4,000 in the FSA and get reimbursed up to that amount, then take the credit for the remaining $6,000 that wasn’t reimbursed.
If you pay more than $11,000 in childcare costs – Max out the FSA by contributing $5,000 to it, then claim the tax credit using the remaining $6,000 in costs that weren’t reimbursed from the FSA.
If your household income is above $169,000:
In this situation you’re better off to max out the FSA first so you get reimbursed for the first $5,000 of childcare costs from the FSA. If you have remaining childcare costs that weren’t reimbursed, you can use those to qualify for the tax credit as well.
If your household income is above $480,000:
At this level of income, you are no longer qualified to receive any tax credit, so your only option to get a tax break on your childcare costs is the Dependent Care FSA.
The only variable you can control here is whether you sign up for the Dependent Care FSA and if so, how much you contribute. This decision is worth thinking through because the FSA is a use-it-or-lose-it type of program. If you contribute more to the FSA than you will incur in childcare expenses, you forfeit the remainder. So, it’s important to accurately estimate how much you’ll spend on childcare in the coming year.
Also, saving and submitting receipts for reimbursement can be a pain, so consider whether you have the discipline to do that, otherwise you forfeit the money you contributed.
All written content is for information purposes only. It is not intended to provide any tax or legal advice or provide the basis for your specific financial decisions.