Dependent Care Reimb. vs. Dependent Care Tax Credit

[Guest Sheryl Kopsing]

Does anyone have or know where I might find any information on the comparison of tax savings between a dependent care plan vs. useing the child care tax credit? Any help in this area is appreciated. Thanks.

[Dave Baker]

Here's a document I put together in 1995 - it hasn't been updated to reflect the new tax rate breakpoints, of course, but might provide you with some helpful language and analysis. If anybody would like to bring this up to date, please do!

Explanation of the Child Care Tax Credit

Who needs to read this explanation?

This explanation provides important information if you pay child care or other dependent care expenses.

I have heard that I can take a "tax credit" for my child care (or other dependent care) expenses. If I receive reimbursements under the Cafeteria Plan, can I still do that?

Generally, no. To the extent your child care (or other dependent care) expenses are reimbursed to you from the Cafeteria Plan, you are not allowed to take a tax credit for those expenses on your Federal income tax return. In many cases you would save more money by receiving reimbursements, however, so you would not want to take the tax credit anyway.

Before you file your Benefits Election for the Cafeteria Plan, you should determine for yourself which method saves more money: paying your own expenses and taking a tax credit on your tax return, or taking tax-free reimbursements from the Cafeteria Plan (but losing the ability to take the tax credit).

The following information is designed to help you make that decision. If you need additional information or assistance, please see your tax attorney, accountant or other personal tax advisor.

• If your adjusted gross income for 1995 (including that of your spouse, if any) is expected to be more than $24,000 --

  it is better for you to receive reimbursements under the Cafeteria Plan.

• If your adjusted gross income for 1995 (including that of your spouse, if any) is expected to be less than $24,000 --

  usually is better for you to take the tax credit instead of reimbursements under the Cafeteria Plan;

• but if you are paying child care expenses for only one child that are expected to total more than $2,400, or if you are paying child care expenses for two or more children that are expected to total more than $4,800, it would be better for you to receive reimbursements under the Cafeteria Plan, even if your adjusted gross income is expected to be less than $24,000.

What is my "adjusted gross income"?

Adjusted gross income means all of your income from hourly wages, salaried paychecks and other sources (except tax-exempt income) minus your deductions (if any) for IRA contributions, deductible alimony payments, and certain other non-itemized expenses. In calculating your adjusted gross income, itemized deductions, if any (such as interest on your home mortgage) are not subtracted. Also, you do not subtract your "standard deduction" or the exemptions for yourself, your spouse or your dependents.

Example

. Chuck earned $28,000 in salary from his employer during 1994. He had no other income. He contributed $2,000 to an IRA for 1994, which was fully deductible. Chuck's adjusted gross income was $26,000 ($28,000 minus $2,000). In computing his adjusted gross income, Chuck would not subtract his itemized deductions, his standard deduction or the exemptions for himself, his spouse or his dependents.

If you are married, "adjusted gross income" means the combined adjusted gross income of you and your spouse, because you must file a joint tax return with your spouse in order to claim the tax credit. You will not be considered married (that is, you can file a separate tax return and still take the credit, without having to include your spouse's income in computing your adjusted gross income) if: (1) you file a separate return, (2) your home was the home of the dependent for whom the expenses were paid, (3) you paid more than half the cost of keeping up your home for the year, and (4) your spouse did not live in your home for the last 6 months of the year.

Here is another way of determining adjusted gross income: if you file Form 1040 or Form 1040A, "adjusted gross income" will be the figure that appears at the bottom of the first page of your tax return.

When am I in the 15% tax bracket?

In 1994, you were in the 15% tax bracket if your "taxable income" was less than the following amounts, depending upon your filing status:

TABLE I
15% Tax Bracket
Filing Status	Taxable Income
Single	Less than $22,750
Head of Household	Less than $30,500
Married filing jointly, or Qualifying widow(er)	Less than $38,000
Married filing separately	Less than $19,000

Example

. Jane is an unmarried taxpayer who had $22,000 in taxable income in 1994. She had one child living at home with her and she met the requirements for filing as "head of household." She was in the 15% tax bracket.

"Taxable income" above these levels generally was taxed at a 28% rate. These levels will rise in 1995, due to an automatic adjustment for increases in the cost of living.

Example

. Frank was an unmarried taxpayer having $32,000 in taxable income in 1994. He has one child living at home with him and he met the requirements for filing as "head of household." He was in the 28% tax bracket. (His first $30,500 was taxed at a 15% rate but the remaining $1,500 was taxed at a 28% rate.)

Your "taxable income" is the amount of income upon which you actually pay taxes. For example, if you use the tax tables printed in the instructions to your Federal income tax return, your taxable income is the amount you look up in the tables in order to determine the taxes you owe.

Taxable income means your income from wages, salaries and other sources (except tax-exempt income) minus all of your deductions (such as IRA contributions, itemized deductions, your "standard deduction," and the personal exemptions for you, for your spouse and for each of your dependents). Hence, your taxable income will be considerably less than the total earnings from your employer.

The amount of each personal exemption in 1994 was $2,450. (This amount will rise in 1995, due to an automatic adjustment for increases in the cost of living.)

Example

. Jean is unmarried with one dependent and uses the "head of household" filing status. Her only income for 1994 was her salary of $20,000. She did not contribute to an IRA for 1994 or have any itemized or non-itemized deductions. Her taxable income therefore was $10,150 ($20,000 minus her 1994 personal exemption of $2,450, a $2,450 personal exemption for her dependent, and her "standard deduction" of $5,600).

Note that the amount of your standard deduction will depend upon your filing status. In 1994, the standard deductions for persons who were not over age 65 or blind were:

TABLE II
Standard Deduction Amount
Filing status	Standard deduction
Single	$3,800
Head of Household	5,600
Married filing separately	3,175
Married filing jointly, or Qualifying widow(er)	6,350

These figures will rise in 1995, due to an automatic adjustment for increases in the cost of living.

What are the rules for taking the tax credit?

The following is a brief description of how the tax credit works. For additional details, see the latest edition of IRS Publication 503 ("Child and Dependent Care Credit").

A tax credit is an amount that reduces your taxes, dollar for dollar. For example, if your taxes for 1995 (before considering the tax credit) a

[Guest Sheryl Kopsing]

Dave, thank you very much for your quick reply!

[GBurns]

Thanks Dave, this is very helpful. I had been thinking of doing this for some agents but yours looks better.

[Guest msearle]

Good Job Dave.

[Guest laura2]

Does anyone know what the $24,000 breakpoint referenced in Dave's Q&A is for 1999? This is the threshold under which it is to the employee's benefit to claim a tax credit.

Any help is appreciated...

[Dawn Hafner]

Does anyone have an updated worksheet on this topic? I am looking for a worksheet that employees could complete to calculate whether the credit or the cafeteria plan is better for their situation.

Thanks.

[Guest dustd]

My spouse has a new job that offer the cafeteria plan for dependent care expense. I will be able to take advantage of this for the remaining of 2000 (and it would be advantageous over the tax credit). My question is whether I can use the daycare expenses up till now as qualifying expenses for the child care credit. Essentially I would use the child care credit for the expenses paid before we entered the cafeteria plan. I obviously wouldn't include any child care expenses that went through the cafeteria plan for calculating the child care credit. Can a person do both in one year if they separate the 2? Thanks!

[Mary C]

For Dustd - go to http://www.irs.gov/plain/forms_pubs/pubs/p50301.htm to download IRS publication 503 - Child and Dependent Care Expenses. It will tell you what you can and cannot claim for dependent care expenses on your tax form whether you participate in a dependent care reimbursement plan or not.