Kids childcare expense credit

[psshah_9062]

Hello,

I work on a full time job on W2. We have 2 kids who attend the preschool. We pay for the preschool out of pocket currently.

My wife has recently started a small online business which has not generated any income. Prior to this wife was not working.

As I understand there are certain restrictions where we can't get the childcare expense credit when both parents are not working. 

Given the above situation, would you please help answer these questions:

• Do we get the childcare credit on the tax return for 2024 next year?
• Are we eligible to open the flexible spending account to pay for preschool fees?

Thank you!

[K M W]

If you paid someone to care for your child or other qualifying person so you (and your spouse if filing jointly) could work or look for work, you may be able to take the credit for child and dependent care expenses.

In your situation, you indicted that your spouse does not have earned income for the year, as such, you will not qualify for this credit. Even if your spouse had some W2 wage income, know that a net loss from self-employment reduces earned income.

There is a special rule for a taxpayer (or spouse) student or a taxpayer or spouse not able to care for themselves. If this situation applies, the person is treated as having earned income for any month that he or she is:
1. A full-time student, or
2. Physically or mentally not able to care for themselves.

Specific rules for these exceptions can be found in IRS Publication 503, starting on page 6, as found here:  IRS Publication 503 

So, if your spouse does not work at all (Form W2 wages or self-employment income) in 2024, is not a full -time student or is not able to care for themselves, then you will not be able to take this credit on your tax return.

Unfortunately, the same concept applies to Dependent care FSA accounts - the amount you put into the dependent care benefit account that is excluded from income is limited to the smallest of:

• The total amount of dependent care benefits you received during the year,
• The total amount of qualified expenses you incurred during the year,
• Your earned income,
• Your spouse's earned income, or
• The maximum amount allowed under your dependent care plan. For 2023, the maximum amount that can be excluded from an employee's income through a dependent care assistance program is $5,000 ($2,500 if married filing separately).

So, in your situation, if your spouse has no earned income, then any amounts you set aside in a dependent care account will still be taxable on your tax return.

[marctu]

So let's start here:  A Flexible Spending Account (FSA) is an employer-sponsored benefit that allows employees to set aside pre-tax money from their paycheck to pay for certain expenses, including dependent care and medical.   To be eligible for an FSA for dependent care these test must all be met:

1.  The employee's workplace must offer a DCFSA as part of its employee benefits package.

2.  The employee can sign up during open enrollment or after a qualifying life event (QLE).

3  The employee and their spouse (if applicable) must be employed, or the spouse must be a full-time  student or looking for work.

4.  The employee's dependents must live with them for more than half the year. 

So since your spouse is  is now self-employed you would be eligible for the FSA and/or the Dependent Care Credit.   An FSA can be used for the first $5,000 of expenses and the Dependent Care Credit can be used for up to $3,000 per eligible dependent.   You do not pay FICA taxes, income taxes and state taxes on the FSA, so often you come out ahead using an FSA.   

Thank you so much for your question  @psshah_9062 

Be well and safe!

Marc T.

Turbo Tax Expert

27 Years of Experience Helping Clients

[psshah_9062]

Thank you @marctu and @K M W  for your responses. Much appreciated.

It looks like what @K M W suggested that we are not eligible to get the childcare expense credit where as what @marctu mentioned in that we'll be eligible?

A few follow up questions please:

• Is there a limit on how much does the spouse online business has to earn in order to claim the child care expense credit? and depending on the income, does it affect the credit in any way?
• Assuming we are eligible to get the childcare expense credit, opening the Dependent Care Flexible Spending account make sense or should we claim the credit at the tax return time?

[K M W · Accepted solution]

Hi, psshas, let me clarify the difference between the two posts....both are technically correct, but the two posts made different assumptions about whether your spouse's online business generates an income or generates a loss for the year

In my post, I answered based on your statement that your spouse not working prior to starting the online business, and based on the statement that she has not generated any income in her online business.  If the business does not have net business income for the year, (i.e. no income at all, or has a net loss, where expenses exceed income) then you do not qualify for this benefit, as your spouse has no earned income.

However, Marctu's response would be correct if your spouse has earned income for the year - in that situation then you would be able to take advantage of this tax credit, or take advantage of using a flexible spending account for childcare.

So, the difference between our two posts is related to whether or not your spouse has earned income for the year. To get a credit for dependent care expenses, the credit is limited to the lower of your or your spouse's earned income. The amount you put into a flexible spending account that you can exclude from income is limited to the lower of your or your spouse's income.

So, if in 2024 your spouse's business does not generate a net profit (and she does not have a W2 job), then you are not eligible for either of these tax benefits. If, however, your spouse DOES have earned income (either from a W2 job, or her business has net income for the year), then you will be eligible - but remember the amount of the tax benefit can still be limited.  Let's say, for example, that her business generates net self-employment income of $1,500, but you put $5,000 into a dependent care flexible savings account. Only $1,500 of the contributions will be tax free.

I hope that clarifies the responses for you - feel free to post again if you have any other questions!

[psshah_9062]

Thank you much @K M W  for the awesome explanation. Greatly appreciated.

Best