Child Care Tax Credit vs FSA for 2023

[jamijam]

My company is offering a a FSA account to which I could contribute up to 5,000$ and I am evaluating if I should open one or not based on how advantageous (or not) it would be for my taxes in 2023.

I have two children and will be able to claim around 35,500$ of child care expenses. I am wondering how can I determine if it is better to open the FSA account for next year taxes or will I be loosing in terms of Child Care Tax Credit? 

Can someone break down the calculations?

Thank you!

[Opus 17]

For 2023, unless Congress passes new tax law changes (which seems unlikely), the FSA and child care credit rules are going back to their pre-COVID amounts.  In that situation, the two plans are almost identical in benefits for adjusted gross income less than $125,000.  Above $125,000, the FSA is better.    However, this also depends on filing status.  

For the credit only, you would report up to $6000 of expenses and get a 20% credit, or $1200.

For the FSA, you would exclude income tax on $5000 of income, and claim a 20% credit on $1000 of expenses. 

There is where things get complicated.  Suppose you earn $80,000 and are married filing jointly.  You are in the 12% bracket, so the $5000 exclusion saves you $600, plus the income is excluded from social security and Medicare, which saves $382, plus the $200 credit on the top $1000 ox expenses, totals $1182.  But, suppose you are MFJ and you earn $150,000.  You are in the 22% bracket so you save $1100 in income tax, but you only save $72 in medicare tax since you are over the social security maximum wage base so an income exclusion doesn't reduce your SS tax, plus the $200 top credit totals $1372.  

If you can afford to pay $35K in child care expenses you are probably at an income level where the FSA is more beneficial.

[Opus 17]

I forgot to mention the effects of state income taxes.  As far as I know, every state will respect the exclusion of the FSA as taxable income, so the FSA should save you 3%-13% state income tax, depending on your income and state.  Some states also have a child and dependent care credit, and we would have to know the rules for your state to evaluate the impact.  For example, New York has an extremely generous credit for lower income filers.  At income levels above $65K, the credit is 60% of the federal credit (or a net of 12% of the expense), and at incomes above $150K, the state credit is 20% of the federal credit (or a net of 4% of the expense), while the state income tax rate is 7-9%.  So the NY state credit makes taking the federal credit much more attractive at incomes less than $150,000.

It depends on your own state of course.