Preface: this entry is a bit long, but this question is asked all the time and this should help most people…
Child Care Tax Credit vs. Dependent Care Spending Account? The answer depends on who is asking the question. However, in almost all cases, you should contribute to a spending account if:
1) You have a household income greater than $25,000.
2) You live in a state with state income taxes.
3) You have a household income greater than $25,000 and live in a state with state income taxes.
Example: John and Jane Smith pay $400 per month or $4,800 per year to their daughter’s daycare provider. The Smith’s adjusted household gross income (AGI) is $45,000 per year.
Child-Care Tax Credit
• The Smith’s AGI of $45,000 per year puts them in a 20% bracket as it relates to the child-care tax credit.
• Only $3,000 of their $4,800 in child-care expenses is considered eligible.
• The maximum child-care tax credit for The Smith’s is $3,000 multiplied by 20% = $600. They also receive 43% of the $600 tax credit on their CA state return for an additional $258.
• Total tax savings = $858
Dependent Care Spending Account
• The Smith’s pay just over 28% of their income toward taxes (15% federal income tax, 8% CA state income tax and 5.65% FICA tax*).
• All $4,800 of their child-care expenses is considered eligible through flexible spending.
• By using a dependent care spending account, The Smith family saves 28% of $4,800.
• Total tax savings = $1,344.
Conclusion: The Smith’s make an additional $486 per year by using a dependent care spending account compared to the child care tax credit.
I have more thoughts about dependent care spending accounts, so hang tight for part 2 of this entry. In the meantime, if you want to talk about your FSA plan we’d love to hear from you… (877)506-1660.
* The employee matching portion of social security was temporarily reduced in 2011 from 6.2% to 4.2%. The standard 1.45% medicare and 6.2% social security should be reinstated in 2012 (4.2% + 1.45% = 5.65% employee FICA tax).