Dependent Day Care FSA vs. Child Care Tax Credits

Young kids at daycare.
Image Credit: diego cervo/iStock/Getty Images

The tax code provides two separate tax breaks for people who pay someone to take care of their children while they work. The first is a dependent care flexible spending account, or FSA; the other is the child care tax credit. Which one will save you more money depends on your circumstances.

Dependent Care FSA

When you have a dependent care FSA, your employer takes money out of your paycheck and puts it in an account to be used for child care expenses. The employer may also contribute money to the account. The most that can be put into the account each year is $5,000, though for married people who file a separate tax return, the limit is $2,500. The money has to be used by year's end. You don't pay income taxes on money put into an FSA.

FSA Tax Savings

Because FSA contributions are untaxed, the general rule is that the higher your tax bracket, the more money you would save with an FSA. For example, say you max out your FSA, contributing $5,000. If you're in the 15 percent federal tax bracket, that would save you $750 in income taxes. If you're in the 33 percent bracket, by contrast, it would reduce your income taxes by $1,650.

Child Care Credit

The child and dependent care tax credit is available to people who pay for child care out of their own pocket, without assistance from an employer. This credit directly reduces your tax bill by a percentage of the money you spent for care. If you have one child, you can apply up to $3,000 worth of child care expenses toward the credit. If you have two or more children, you can apply up to $6,000 worth of expenses toward the credit.

Tax Credit Savings

Your income determines what percentage of your child care expenses you can claim as a tax credit. At the lowest income levels, your credit is 35 percent of your expenses. That percentage goes down as your income goes up. As of 2015, anyone with adjusted gross income over $43,000 got a credit of 20 percent of expenses. Unlike an FSA, which gives you bigger benefits as you make more money and enter higher tax brackets, the child care credit has its greatest impact at the lowest incomes. Taxpayers in the lowest income range who applied the maximum of $6,000 in expenses would save $2,100 in income taxes; those above $43,000 in income would save $1,200.

Making the Choice

Taxpayers who have a choice between the options should run the numbers to determine which would save them more money. Also keep in mind that if you have an FSA and your allowable expenses exceed your FSA contributions, you can claim a child care credit for the "extra." For example, say you had $6,000 worth of allowable expenses and $5,000 in an FSA. The $1,000 not covered by the FSA would be eligible for the child care credit, which would be $200 to $350, depending on your income.

Reporting Requirements

The standards for both tax breaks are the same: Expenses must be for the care of a child who is under age 13, or is 13 or older but cannot take care of himself. The care must be provided so that you — and your spouse, if you're married — can work, look for work or attend school as a full-time student. When you make use of a dependent care FSA, there is no special form to file with your tax return, as the taxable income reported by your employer on your W-2 will take your FSA into account. To claim the child care credit, however, you must file Form 2441 with your tax return.