A mainstay of employer Benefits Communications is to preach the virtues of Flexible Spending Accounts. But is there perhaps a better tax opportunity out there for your dependent care related expenses?
Tax is an important area of focus when it comes to attaining a productive benefits education. Before digging into the details of this particular tax opportunity, it’s important that you understand the difference between a tax deduction and a tax credit. Tax deductions are taken “off the top” and ultimately reduce your taxable income, and, of course your taxable income is what ultimately drives the amount of taxes owed. A tax credit on the other hand, is a dollar-for-dollar reduction subtracted from your tax liability. If you had a $50 tax credit, it’s sort of like the government saying that they are giving you credit for having already paid them $50 in tax.
You may or may not be aware of the Child and Dependent Care Tax Credit available for work-related dependent care expenses. This tax credit is calculated by applying a percentage to your total work-related dependent care expenses. This percentage can be as high as 35% or as low as 20% depending on your adjusted gross income. Now, there are a couple of rules to be aware of:
- The work related dependent care expenses that are applied may not exceed $3,000 for one qualifying dependent and $6,000 for two or more
- AND importantly, you can’t claim expenses for the purposes of the Child and Dependent Care Tax Credit that you’ve directed into your dependent care FSA
This raises an important question to ask yourself. Should you apply eligible expenses towards the Dependent Care FSA or Dependent Care Tax Credit? Well, this of course, will depend on your personal situation.
A good first step is to review the worksheet that the IRS has put together on the Child and Dependent Care Tax Credit. You’ll want to understand eligibility requirements and the amount of the credit, based on your adjusted gross income. Now, apply that percentage to your projected work-related dependent care expenses for the year (keeping in mind the IRS limits) to come up with your potential tax credit. You’ll likely want to work with a tax advisor to compare this Tax Credit with what the tax benefits of the Dependent Care FSA Tax Deduction.
It may be the case that you have work related dependent care expenses that exceed the IRS limits for both the Child and Dependent Care Tax Credit and Dependent Care FSA. In this case, it may be possible to leverage both of these opportunities. Because tax laws are complex and evolving, it’s important that you consult your tax advisor to understand how these two opportunities apply to your particular situation.
