Married filing jointly - spouse full-time student and has small business income, contributed $5000 to DCAP through employer and some is reported taxable income on 2441?

[nikhila-miriyala]

After entering spouse income (less that mine), still there is some amount as taxable income. $5K is just half (even less) of a year's childcare expense as we all know and the overage paid is post tax money. Why is there still amount shown as taxable income on 1040 taken from 2441 line 26?

[BillM223]

If your spouse if a full-time student, then for purposes of the calculations on the 2441, your spouse is credited with $250/month of earned income (or $3k/year). 

So, on line 20, the choice is made to select the smallest of 17, 18, and 19. The $3k is one of those lines, so the amount of your expenses applied to this process is only $3k.

Therefore, since you could not show that all $5k was used for justified child care expenses, the part that was not justified was added to taxable income.

Next year, if your spouse's business makes more money than $3k, then do not report your spouse as a full-time student, but let the spouse's earned income be used instead.

[Opus 17]

The amount eligible for exclusion under an FSA is $5000 per year, or the earned income (income earned from working, does not count investments etc.) of the lower earning spouse.  In the case of a spouse who is a full time student, they are "imputed" an income of $250 for each month they are a student.

If your spouse's earned income from working is less than $5000, then part of your exclusion will be added back to your taxable income.  The credit was created to support child care while you and your spouse work.  Therefore, the eligible expenses can't be more than the lower spouse's income.

If you think the credit should be administered differently, you will need to talk to Congress.