How Child And Dependent Care Tax Breaks Work

January 29, 2019

During tax time, do you ever get to the section about child care expenses for the year and get confused about what’s really allowed and if you made the right decision? If you have been contributing to a Dependent Care FSA, does that mean that you are NOT able to take advantage of the Dependent Care Tax Credit? Let’s review how it works.

What are the tax breaks exactly?

Dependent care flexible spending account

The Dependent Care FSA (DCFSA for short) is an account where you choose to automatically have money deducted from each of your paychecks BEFORE TAX is taken out, which you can then use to pay for child care expenses that year. The IRS allows you to set aside up to $5,000 each year, regardless of how many kids you have.

How it works

In other words, you use pre-tax money to pay for the eligible child and dependent care expenses, so that $5,000 is not included in your taxable income for the year.

Child and dependent care tax credit

The Child and Dependent Care tax credit is not tied to your work, but is something that allows you to claim a credit against your taxes for the year. The credit is equal to 20% up to a maximum of 35% of your total child care expenses, limited to $3,000 for one dependent OR $6,000 for two or more dependents. So for example, if you have one child and paid $5,000 in child care expenses for the year, the most you can claim toward your credit would be $3,000, and your credit would be a percentage of that amount (20% up to 35%, depending on your total income).

If you have more than one child, it doesn’t matter how your costs are divided between the dependents either. You can pay $1,000 for one dependent and $4,000 for the other dependents and it doesn’t matter since the credit is simply based on the total cost.

How it works

A tax credit essentially reduces your tax bill, dollar for dollar, rather that just reducing your taxable income like a tax deduction. So if you owe $2,000 in taxes and your credit is worth $1,000, you would only owe $1,000 in taxes. This credit is not considered “refundable” though. So if you owe $900 in taxes and the credit is worth $1,000, you simply won’t owe anything. You don’t get to pocket the extra $100.

Sounds like a no brainer to go with the credit, right?

It’s true that at first look, the credit seems to be the obvious choice because it goes dollar for dollar against your actual taxes and not just your taxable income. However, the more money you make, the lower the percentage of eligible expenses you can claim as a credit, so there becomes a certain point where the DCFSA (aka the deduction) makes more sense.

 1) Your income matters. Did you make $43,000 or less during the year?

  • YES – You’ll typically have a better tax savings if you claim the credit, REGARDLESS of how many dependents you pay child care expenses for.
  • NO, I make more than that – You’ll likely benefit more by contributing to the Dependent Care FSA

You can dig into the math on that here. 

2) Can you get the credit AND contribute to the Dependent Care FSA in the same year?

Per IRS, the maximum credit you can take for child care expenses is reduced by whatever amount you contribute to a Dependent Care FSA. Remember, if you answered YES to # 1 above, taking the max credit for eligible expenses (up to $3,000 for one dependent or $6,000 for two or more dependents) typically gives you a bigger tax break.

Benefiting from both usually works out when the below is true:

  1. Your income is higher than $43,000 AND
  2. You have child care expenses for two or more dependents AND
  3. The expenses exceed $5,000 (which is the maximum you can contribute to the Dependent Care FSA)

3) If you fit into 1, 2, and 3 above and want the benefit of both tax breaks, how do you do it?

  • 1st – Contribute $5,000 to a Dependent Care FSA
  • 2nd – Take the credit for any remaining expenses up to another $1,000

Child care can be expensive, but we can do our best to budget for it and take advantage of tax breaks like these to help shave off some of the cost and use that extra money towards other goals like traveling and saving for retirement.