Can I use my dependent care FSA on one child and claim the dependent care tax credit on child #2?

[lochnersm]

I'm trying to (legally) minimize my tax hit through dependent care benefits.  Am I allowed to claim the $5000 dependent care FSA on 1 child and use the tax credit on my second child?  I am in the 12% tax bracket, so if I can't then it doesn't seem to make sense to use the FSA at all.  It would seem that if I only had 1 child, then I would be able to use the full $5000 on one child making the FSA the better choice.  I currently receive $1200 in tax credit.  

Thank you for quick response.  It's my understanding that NJ does not allow me to reduce my taxable income by my dependent care FSA contributions, therefore making the max amount of tax reduction 19.65%, but the tax credit would be 20%.  Sound about right?

[Opus 17 · Accepted solution]

You can use both but they don't stack.  With 2 children you can have a maximum of $6000 of qualified expenses.  If you apply $6000 to the credit, then you can't have an FSA at all.  If you take a $5000 FSA, then you can apply $1000 to the credit.  Or $3500 FSA, then $2500 toward credit, etc.

Remember the FSA saves you federal income tax (12%, 22% or more) plus social security and medicare tax (7.65%) plus state income tax (if you have any).

For most people, maximizing the FSA first saves more money.  In your case it may be a close call and will depend on your state income tax.  

[lochnersm]

Thank you for your fast response.  I live in NJ and I don't believe NJ allows me to deduct FSA contributions, thereby maximizing my tax deduction at 19.65% on the first $5k and 20% on the last $1k, whereas the tax credit would allow me to obtain 20% on the full $6k.  

[Opus 17]

The FSA comes out of your W-2 box 1 wages before New Jersey even gets to see it. The only way New Jersey could tax it is if there was a special add back procedure on the New Jersey tax return.

 Alternatively, some states have a dependent care credit that is a percentage of the federal credit. You might not get the state credit if you use an FSA but you might get the state credit if you also clean the federal credit.

Someone knowledgeable in New Jersey tax law would  have to offer some additional information here.

[SweetieJean]

Look at Box 16 of your W-2.  It is gross of FSA, since NJ does not permit this deduction. Nor does it have a state Child Care deduction or credit. Thus it is moot for state tax purposes.

[rjs]

@Opus 17 - The add-back is right on the W-2. Box 16 is higher than box 1 by the amount of the FSA and other things that New Jersey doesn't allow to be deducted. So NJ sees it in box 16. The box 16 amount is entered as income on the NJ return.

[Opus 17]

I thought NY was greedy!

[SweetieJean]

Unlike some other states, NJ does not "start" with Federal info when completing the NJ return.  Everything is NJ-specific.

[SweetieJean]

@Opus 17  Ah, but the floor for medical deductions is only 2% of AGI.
On the other hand, Trad IRA contributions are not deductible in NJ.

[rjs]

On the other hand, when you take withdrawals from the IRA the portion of the withdrawal that is a return of previously taxed contributions is not taxable. Of course, to take advantage of that you have to have kept track of your contributions over the years.

NJ also has a very generous exclusion for retirement income, including IRA withdrawals, if your total income is under $100,000. For 2017 it's $30,000 for single, $40,000 for MFJ, and going up more over the next few years.

[lochnersm]

@SweetieJean thank you for help in clarifying this matter. It is what I suspected. It doesn't make sense for me to sign up with my employers FSA for child care since I get a bigger credit when filing taxes, and I don't have to go through the hassle of requesting reimbursements. Thanks to all who helped!

[Opus 17]

You can use both but they don't stack.  With 2 children you can have a maximum of $6000 of qualified expenses.  If you apply $6000 to the credit, then you can't have an FSA at all.  If you take a $5000 FSA, then you can apply $1000 to the credit.  Or $3500 FSA, then $2500 toward credit, etc.

Remember the FSA saves you federal income tax (12%) plus social security and medicare tax (7.65%) plus state income tax (if you have any).

For most people, maximizing the FSA first saves more money.  In your case it may be a close call and will depend on your state income tax.  

[Critter]

No you cannot do what you are thinking .... the $5000 is used on the form 2441 no matter how many children is listed on that form.  You cannot use it on only one ... not how the form works.   So you will not pay federal, SS & medicare taxes on the $5000 and you will get a credit on the other $1000 allowed on the form 2441.  

So you will save 12% + 7.65% + any state savings on the $5000  plus the credit on the $1000.  You will need to do the math to see which is better. 

[lochnersm]

Thank you for fast response.  I believe NJ doesn't allow me to deduct FSA contributions from taxable income.  So it seems just taking the tax credit is the best choice since I would get 20% of the full $6k vs 19.65% on the first $5k and 20% on the last $1k.

[Critter]

so in your case it turns out to be about the same either way