Dependent Care FSA / Dependent Care Credit and Foreign Income

[djtsukasa]

Good morning experts, I am running into a conundrum I'm hoping to have answered.

It is my understanding that claiming the dependent care credit and/or utilizing a dependent care FSA requires income from both parties of a married couple. It is also my understanding that if one of the income streams are from a foreign entity, that is OK; however, it will not qualify as income if said income is excluded using the foreign income exclusion.

So, my conundrum: I am a government employee stationed overseas, my wife is working for a foreign company, making non-US income. If I exclude her income using the FIE, I am basically removing her income from the equation for dependent care credit/FSA eligibility purposes, correct? Thus, utilizing the FIE renders us ineligible for the credit and/or the FSA?

Am I basically being forced to choose between being eligible for the credit/FSA, or my wife taxed from both host nation and the USA? It seems like we can either not exclude her income, which would mean paying taxes to both host nation and the USA, or excluding her income for US tax purposes but not being eligible for any of these credits.

It's strange to me that just because one of our incomes are from a foreign company, we cannot claim these tax breaks even if both of us are working and require childcare. Am I interpreting this correctly, and if so, is there a workaround that I am not seeing/understanding?

[Bsch4477]

Unfortunately both parents must have taxable earned income for those tax breaks. 

[djtsukasa]

Thanks for the reply. 

So, what happens if we don't exclude all of my wife's income? Exclude up to a minimal amount, so she at least has some income on the books? 

Lets say I make more than 7500 a year (the contribution limit), and she makes 1000 after exclusions.. will that still allow us to contribute the full 7500 into the FSA?

[Bsch4477 · Accepted solution]

Starting in 2026, married couples filing jointly can contribute up to $7,500 total per year to a dependent care FSA.
• You cannot contribute more than the earned income of the lower-earning spouse. For example if one spouse earns $6,000 and the other $70,000, the maximum is $6,000 for the couple—regardless of the IRS contribution cap. 

[djtsukasa]

Exactly what I was looking for. Thank you!