child and dependent care credit

[turbfiler123]

I have a question regarding the expanded child and dependent care credit.

As an example, if my gross salary as a day care teacher is $35000 and regular tuition for a toddler at this day care is $14000, can I claim that child care expense if my employer gives me a gross salary of $25000 for working there and allowing my toddler to enroll at a "discounted" rate? 

[Critter-3]

Child and dependent care credit

The act makes various changes to the Sec. 21 child and dependent care credit, effective for 2021 only, including making it refundable. The credit will be worth 50% of eligible expenses, up to a limit based on income, making the credit worth up to $4,000 for one qualifying individual and up to $8,000 for two or more. Credit reduction will start at household income levels over $125,000. For households with income over $400,000, the credit can be reduced below 20%.

The act also increases the exclusion for employer-provided dependent care assistance to $10,500 for 2021.

[Opus 17 · Accepted solution]

No.  You would have to have a receipt with the providers tax number. 

Your employer can provide a “day care” benefit as a cafeteria plan.  You would have a gross salary of $35,000 and a dependent care benefit of $10,000 in box 10 of your W-2, and a net taxable salary in box 1 of your W-2 of $25,000.  However, cafeteria plans have certain rules that your employer might not want to follow, especially as it pertains to a requirement to offer the same option to other employees.   

Or, your employer can pay you $35,000 and you pay the employer $10,000 and get a receipt.  You would be able to claim a tax credit that is larger than the tax you would pay on the higher income.  

Your employer can’t pay you $25,000 and also give you a discount and not have it be taxable.  Everything your employer gives you in return for your service is taxable income unless it falls under one of the employee fringe benefit rules.  It sounds like your employer needs to review the fringe benefit rules with their accountant.  Day care can be a fringe benefit but certain rules must be followed.  

[turbfiler123]

Thanks for the reply!

I guess my question is basically do I get more benefit taking the $25000 salary or $35000? I have to factor in the child/dependent care credit, taxes, etc. And I'm not good with numbers so I can't easily tell which one would give me more savings. 

[turbfiler123]

Is the credit of 50% of eligible expenses separate from those $250/$300 per child checks we're getting each month?

[Opus 17]

@turbfiler123 

The child tax credit and the child and dependent care credit are two separate things.

The child tax credit is $3000 for 2021, or $3600 if the child is under age 6. If you receive advance payments, they will count against the $3000 or $3600 when you file your tax return.  The advance payments don’t change the amount of the child tax credit, only when you receive it. For 2022, the child tax credit reverts back to $2000, unless Congress manages to pass an extension.

The child and dependent care credit is a separate item.  For 2021 only, this will provide a  tax credit or tax rebate of 50% of care costs for lower income taxpayers.  The credit goes back to the old rules on January 1, 2022, unless Congress passes an extension. Under the old rules, the credit was between 20% and 35% of $3000 of eligible expenses.

That makes figuring out your situation complicated, partly because you don’t mention when you would be starting your employment.

For 2021, you would receive a larger credit by taking the higher salary and paying the tuition.  Roughly speaking, we are talking about $3000 per month of gross salary and $900 per month of expenses. If your employment and child care both start August 1, you would receive $15,000 of salary and pay $4500 of care expenses by the end of the year.  The credit on the care expense would be $2250, while the combined income tax, Social Security, and Medicare tax on the extra $900 per month of income would be about $1125.  To say it another way, if you took the salary reduction and free tuition, you would save $1125 in taxes and you could not claim any amount of credit.

If Congress does not extend the enhanced dependent care credit, then you would be better off switching to the lower salary with free childcare starting January 1, 2022.  The lower salary would save you about $2500 in income tax over the course of the year, but taking the higher salary and claiming the credit for paying out of pocket (after taxes) would only result in a $900 credit.

Please take note, this is my best estimate based on current facts, but I do not have a complete understanding of your income and tax situation, and I do not know whether the laws will be changed again. Please have your situation reviewed by a professional advisor who knows all your full details.

[turbfiler123]

Thank you for the rough calculations and explanations. To kind of round out things, my spouse has a salary of about $90000 with $5000 in dependent care FSA, my other child also has day care at $8000 per year. Yes, the additional salary and child care costs would start with the new school year in September (if I go back to work).

[Opus 17]

You have added some additional significant factors.  

First, child care credit expenses are only eligible to be paid from an FSA or for the credit if you and your spouse are both working. Any expenses you’re currently paying for your older child are not eligible for FSA reimbursement or the credit if you are not working.  As a practical matter, form 2441 only limits your credit by the amount of your income earned from working.  For 2021, the amount of expenses eligible for the child and dependent care credit is a maximum of $16,000 for two or more children.  As long as your taxable income is more than $16,000, the form will not reject a maximum credit. However, in the unlikely event you are audited, any expenses that were incurred while you were off work will be deemed in eligible for either the credit or the FSA.

Second, the FSA reduces the amount of expenses eligible for the credit. If you have a $5000 FSA, and you provide care for two or more children, your maximum credit would be based on $11,000 of eligible expenses.  It sounds like you would have $8000 of expenses for your older child and about $1000 per month of expenses for your younger child, or $13,000. With $5000 reimbursed from the FSA, that would leave $8000 to be applied against the child and dependent care credit, which would result in a tax credit of $4000.  That credit is still more lucrative than the income tax you would save taking a reduced salary, so for 2021, I believe you should take your full salary and take the largest credit you can calculate. However, for 2022, you have already maxed out the child and dependent care credit with your first child and will not receive any tax credits or tax benefits for paying out-of-pocket for the second child, and so you probably want to use the salary reduction starting in January, 2022.

[turbfiler123]

Is the expanded $10500 amount for FSA for 2021 per household or per child? So between my two kids it will be a maximum of $10500 towards childcare FSA? Or is it twice that amount?

[Critter-3]

It is not doubled.