How do I get my pre-tax FSA payroll contribution to not be added back to my wages on 1040 line 1?

[pa74]

Turbo tax adds my pre-tax child care FSA payroll deduction ($2500 for 2018) to my wages on the 1040 line 1. My wife and I both have earned income. My wife's earned income (schedule C line 1 is positive) has expenses that offset it so she shows $0 for net profit for her independent consulting business (schedule C line 31). I believe as a result turbotax does not even ask us to input our child care expenses and automatically adds the FSA payroll deduction to my wages. Form 2441 line 16 is 0 (no child care expenses). Form 2441 line 19 is also 0. When I look at the instructions for form 2441, the IRS clearly states that I should be using my wife's earned income from schedule C line 1 here and not from schedule C line 31. I believe this is a bug in turbo tax. The only way it seems I can fix this is to manually override the numbers on form 2441 to include a positive number on line 16 and 19. Am I correct?

[JohnW15 · Accepted solution]

You may be misinterpreting the Form 2441 instructions relating to Schedule C income.

Your wife's entry on line 4 or 5 of Form 21 would be line 1 of Schedule C, if she's a statutory employee.  A statutory employee would have the "Statutory employee" box checked in box 13. 

If that box is checked on her W-2, and she's actually a statutory employee, make sure the box is checked on the W-2 that you've entered in TurboTax.  The computation should be fine then.

If she's not a statutory employee, then her earned income, based on what you're saying, would actually be zero, and you wouldn't be eligible for the credit.

Just as an FYI, please see the IRS' Statutory Employees page to see what qualifies as a statutory employee.

[pa74]

Thanks for the response. Doesn't seem like she is a statutory employee according to the IRS link. How is earned income then defined? Is it line 1 (gross receipts) of schedule C or line 31 (net profit)? I've been using line 1 but according to what you say it should be line 31. This strikes me as odd since in the early days of a business where net profit is 0 or even negative, a couple would not be able to use a child care FSA.

[JohnW15]

The earned income on Schedule C would be line 31.  If it's negative, you can still use an FSA... but if both spouses don't have positive earned income, they can't take the credit.

[pa74]

Thanks. I have positive earned income, my wife’s sched c line 31 is 0. As a result my FSA payroll contribution pre-tax is being added back to my income (1040 line 1). In effect, the FSA is not longer tax advantaged so there is no value to doing it. Does this sound right? Everything I read about FSA eligibility is that both spouses must work or be looking for work.

When you say credit above you’re referring to a child care tax credit which is not at play for my particular situation.

[pa74]

Thanks. I have positive earned income, my wife’s sched c line 31 is 0. As a result my FSA payroll contribution pre-tax is being added back to my income (1040 line 1). In effect, the FSA is not longer tax advantaged so there is no value to doing it. Does this sound right? Everything I read about FSA eligibility is that both spouses must work or be looking for work.

When you say credit above you’re referring to a child care tax credit which is not at play for my particular situation.

[JohnW15]

Exactly right on your first question... on the comment, that's right, I was just trying to explain the ramifications on the credit.