What's my daycare tax benefit when we don't have FSA?

[winvivi]

We have a joint-income of over $50,000. We don't have FSA, and we had a daycare expense of $10,000. What would be my tax benefits related to the daycare expense? Are the $10,000 outside the standard deduction limit? We've done quite a bit of research but unfortunately still couldn't fully understand the publications. Thank you!

[MinhT1 · Accepted solution]

Your daycare expenses would qualify as expenses for the Child and Dependent care credit.

Please read this TurboTax Help topic on the Child and Dependent care credit.

[winvivi]

Great! It appears we can get 20%-35% * $3000 for one dependent or * $6000 for two dependent, depending on our MAGI. Correct? 

So, if we put $5000 into the FSA, we should be able to save around $5000 * (7.65% + fed + state + local tax rates). Correct? I also see something like "effective tax rate" on turbotax filing report, if the effective tax rate says 10%, does that mean we can use the 10% to calculate above tax savings for the fed level? 

[BillM223]

"Great! It appears we can get 20%-35% * $3000 for one dependent or * $6000 for two dependent, depending on our MAGI. Correct? "

Correct. Note that this is a credit, not a deduction (which is often better, but it depends on a lot of factors).

"So, if we put $5000 into the FSA, we should be able to save around $5000 * (7.65% + fed + state + local tax rates). Correct? "

Correct, if I understand you. Amounts that appear in an employer-sponsored FSA appear in box 10. This same amount - if you document that you spent it all on qualifying dependent care - is removed from boxes 1, 3, and 5. Since boxes 3 + 5 are generally 7.65% of your income, then, yes, that amount is saved.

Furthermore, you are saved the margin tax rate time the box 10 amount off your federal income taxes. I said. "marginal tax rate", not "effective tax rate".

The marginal tax rate is the amount of tax you pay on the next dollar earned. This normally is the tax bracket you are in. So if you are in the 12% tax bracket, then the amount in box 10 times 12% would be the amount that you would save, other things being equal (like the reduction in income doesn't drop you into another tax bracket).

It is difficult to compare credits and deductions, because they work differently. I suggest that you create a dummy account if you are Online and enter your data with and without $5,000 in box 10 to see if the credit or the deduction works better for you. Note, on the return that has $5,000 in box 10, you will need to remove $5,000 from boxes 1, 3, and 5 on your W-2. 

[winvivi]

We're now thinking about putting money into our dependent care FSA. If we put $2500 into the account, which is tax-free, can we still claim upto $2500 for the credit, because we didn't put the the entire allowable $5000 to the account?

[BillM223]

"can we still claim upto $2500 for the credit"

The way it works is this:

The amount in box 10 on your W-2 is removed from Wages, assuming that you otherwise qualify and assuming you used this money to pay for child care.

The maximum amount of child and dependent care expenses you can factor into the calculation is $3,000 if you have one child and $6,000 is you have two or more.

From this $3,000 or $6,000, the $2,500 must be subtracted. This leaves ether $500 or $3,500. The credit percentage is then applied to this amount, from 20% to 35%. Multiplying the maximum percentage against the higher number gives you $1,225 ( .35 * $3,500).as the largest possible credit. 

The credit you will actually get depends on a number of factors such as your Adjusted Gross Income (AGI), how much you spent on child and dependent care over and above the box 10 amount, and the number of children.

Please do not confuse "credit" with "deduction" - they have two different meanings. You don't get a "credit" for that second $2,500, if it used to calculate the credit. The $2,500 in box 10 is the deduction.