Credit or Debit – Your Dependent Care Costs

November 16, 2010

Paper or plastic?  Credit or debit?  Common questions you hear at the grocery store, but do you consider what is the best way, credit or debit, when it comes to paying for dependent care?  I don’t mean actually charging the cost to a credit card – what I am referring to is whether to take the tax credit at the end of the year on your tax return, or to have the funds withheld (debited) pre-tax from your payroll using the Dependent Care Expense Account.  The best answer to this is based on what your marginal federal tax bracket is.

For employees in either the 10% or 15% federal tax bracket, it may make more sense to take the credit at the end of the year and steer away from the payroll deduction.  You may actually qualify for up to a 35% tax credit of up to $3,000 per child (maximum of 2, or $6,000).  Here are some examples at various income limits:

AGI up to $15,000 = 35 % credit

AGI $33,000 to $35,000  = 25 % credit

AGI $23,000 to $25,000 = 30 % credit

AGI over $43,000 = 20 % credit

For employees in the 25% or higher federal tax bracket, it probably makes more sense for you to take advantage of the payroll deduction option.  As income increases, the federal tax credit phases down to only a 20% tax credit so your savings from avoiding paying tax altogether on the funds is higher than the credit you would have been eligible for.   This tax savings not only includes your federal and most state income taxes, but also the 7.65% FICA tax for Social Security and Medicare.  Plus, you can contribute as much as $5,000 to the Dependent Care Expense Account (DCEA), even if you only have 1 child.  Some employers even match funds going into the DCEA, so check with your HR Dept to see if this applies.