@Michael129 wrote:
Whether you contribute to the FSA is not the determinitive question. You can still deduct those dependent care expenses for which you have not been reimbursed from your FSA (or paid out of directly). In other words, this is a matter of careful accounting. If you want to take full advantage of the increased tax credit, make sure you spend only after-tax dollars on the first $8000 of dependent care expenses. Any dependent care expenses in excess of $8000 can be spent from your FSA again.
No. Under current regulations, the maximum FSA is $5000 and the maximum child care credit is $6000, but the $5000 FSA exclusion counts against the $6000 limit. In other words, if you have a $5000 FSA and provide care for two or more children, and spend $5000 from the FSA and $5000 out of pocket, your maximum eligible expense for the credit is $1000. The FSA is always accounted for first.
The American Rescue Plan Act has 2 relevant provisions.
§9631 increases the eligible expense limit for the dependent care credit from $3000 for one child and $6000 for two children, to $8000 for one child and $16,000 for two or more children. The maximum credit is raised from 35% to 50%, and the phaseout begins at $125,000, not $15,000. There is a second phaseout beginning at incomes over $400,000, so that very high income taxpayers will eventually become ineligible, whereas under pre-2021 law, the bottom percentage remained at 20% for everyone.
§9632 increases the amount of income that can be excluded from income tax using an FSA from $5000 to $10,500. This change is retroactive to FSA plans that start their plan year after Dec 31, 2020, and employers can allow employees who have plans in place to modify the amount they want to contribute. If you have a plan that starts in mid-year, you can't change your current plan but the new limit will apply when your plan re-starts in mid-year.
The sections that coordinate the FSA benefit and the child care credit are not changed, so whatever you spend on childcare, the FSA money comes first, and anything you pay out of pocket after the FSA is used up, your child care credit limit is reduced by the FSA amount.
All these changes are for 2021 only and revert back to the old rules on January 1, 2022.
Now, for some unofficial tax advice.
Since the child and dependent care credit has been increased to a maximum of 50% of eligible expenses, and the income phaseout does not start until you get to an AGI of $125,000, the credit is unarguably a better deal for 2021. If you are already enrolled in an FSA (maximum $5000 under the old rules), I don't see anything in the law that will allow you to back out of it. However, if your expenses are more than $5000, you will have up to $3000 additional eligibility if you pay for care for one qualifying persona and $11,000 of additional eligibility if you pay for care for two qualifying persons, and those amounts would be credited at 50%, as long as your income is less than $125,000.
If you did not enroll in an FSA yet because your plan starts mid-year, you probably will be better off skipping it this year and using the tax credit only.
If your plan allows you to change your FSA contributions, you should take the opportunity to stop your FSA contributions and rely on the credit instead, unless your income is more than $125,000. (I don't think this will be allowed, but I am not a lawyer, and there might be something in the law I have misunderstood. You will have to wait and see what your employer says.)
If your income is more than $125,000, there will be a break point somewhere, where the FSA becomes better than the credit, but I am not going to try and calculate it now.
