Question about dependent care FSA and the dependent care credit

[avanelzen1]

I am trying to understand the dependent care FSA. I put $5000 in a dependent care FSA through my employer. When i am completing my 2021 taxes, it looks like i am being taxed for that money, because my refund amount goes down. When i enter the $5000 in the dependent care area of the income section, my return goes down by$2500. Just to see what would happen, I removed the $5000 dependent care amount, and my refund increased by $2500, and the dependent care credit went up by $2500. With the $5000 FSA amount, my dependent care credit is $4904, but without the FSA amount listed it is showing as $7404.

Even if I add the $5000 to my gross income, and remove it form the dependent care like, that increased my refund by $1772. It is like I am being penalized for having a dependent care FSA, and using it to pay for daycare.

Can someone explain why it is doing this? The money i put in the dependent FSA is still my money i took out of my payroll, and i then used this to pay daycare. So i still paid $14500 in daycare costs for 2 kids in 2021. Why is my refund being decreased because I used an FSA account? I just don’t get it. Any guidance would be appreciated 😊

[ColeenD3]

No, you are not being taxed on your FSA. Your FSA paid your child care, not you so you should not be putting any figure in as if you paid the provider. You are not entitled to any sort of credit if the FSA pays. You are getting the tax break of paying with pretax dollars. Of course, you would get a bigger refund if you claim that you paid the money yourself.

You have a choice to either pay yourself and get a credit or pay with pretax dollars through the FSA.

[avanelzen1]

Thank you! I didn't realize that i couldn't use flexed money towards a credit. 

Do you know why then, when i change it and add the $5000 to box 1, and remove the $5000 from box 10, my refund goes up by $1772. In my mind, if i am adding the $5000 to my income(which it would have been had i not flexed it) it should decrease my refund by the amount of tax i saved by flexing it. Why would it be giving me an additional $1772 back?  Any thoughts on this? Im just really confused by this and dont understand why my refund is going down this much when adding the flex money. 

[RaifH]

In 2021, they greatly enhanced the Child and Dependent Care Credit as part of the American Rescue Plan Act. These provisions only apply to 2021.

Normally the credit is a maximum of $1,050 for one child or $2,100 for two or more eligible children, depending on household income. For 2021, that has been greatly increased to a maximum of $4,000 for one child or $8,000 for two or more.

Everyone's tax situation is a little different, but whereas for most people it is beneficial to use pre-tax dollars for child care every other year, in 2021 it might have been beneficial to instead get the Child and Dependent Care credit on their tax return. Moving the $5,000 on your W-2 from dependent care benefits to your income caused you to be taxed on $5,000 more of income but also gave you more of the Child and Dependent Care Credit. 

It depends on your gross income how much extra tax would have resulted from $5,000 of additional income and how much more Child and Dependent Care credit you would have gotten from $5,000 worth of eligible expenses paid for out-of-pocket. However, due to the enhanced tax credit this year, $1,772 additional refund sounds reasonable.