Daycare FSA?

[Telephus44]

I was just wondering if anyone had any experience with this. We're expecting in October (duh - see ticker below!) and I plan on going back to work in Jan. We will be putting our child in daycare.

My company offers the option of a Daycare FSA - I can put in $5,000 per year. The money comes out pre-tax, and will be taken out of each check equally (I get paid monthly, so if I put in the max I will have $417.00 taken out of each check). However, if I choose to go this route then: 1. I can't claim the dependent care credit and 2. If I don't use all $5,000 then it doesn't roll over and I'm out the money. I estimated online that by going with the FSA route, I'll save $1,700 in taxes (although the dependenat care credit is $3,000). Another plus for the FSA is that since it comes straight out of my check, its one less bill I have to worry about actually paying (my FSA has an arrangement to pay my provider directly, rather than having me pay and be re-imbursed).

I don't have an exact number yet, but around here daycare runs between $7,000-$9,000 per year. My co-worker (who has a 10 month old) pays $400 per month for a 3 day-per-week daycare arrangement.

I'm just trying to get a jumpstart on some of the tax issues - actually doing some planning this year! - and just wondering if you'd go with the FSA or not. I don't know anyone that has actually used the daycare one. I do currently use the Healthcare FSA my employer offers, and I really like it, but it has different tax implications that made choosing to sign up an easy choice.

[littlemotherhaywood]

At the end of the year, you can deduct the money you spend on daycare anyway, but if you can afford to give the money upfront (as they just reimburse you), I would do it. It basically lowers your tax amount that is due. I'm all for bringing home a bigger paycheck. The only downside is that you have to know exactly what you'll need before you get started because you could lose money if you don't use it all.

[Valerie in WA]

I'm going to say up front that my comment is probably out of line, but...

From what I know of you here at FV (admittedly, not a lot), I keep having a feeling that you might change your mind about daycare, after you meet your little bundle.

That's not to say you'll quit working, but your dh might look into that evening shift job again, or you might cut back your hours. If you've elected the FSA, you might be stuck with the deductions and chosing not to use daycare. Then the money is just gone.

Now, for a more appropriate comment ...

Do you itemize on your taxes? I'm under the impression that you rent your home and most renters do not have enough deductible expense to itemize; they just take the standard deduction. In that case, it's usually more beneficial to take all the pre-tax deductions your employer offers.

OTOH, I'm not familiar with the details of the dependent care credit. But your own math shows that it's the more economically valuable to you, so I'd go with that.

I think I've managed to just muddy the water! LOL!

[Telephus44]

Trust me, I'm not offended - and I'm trying to remember that everyone tells me "things will be different after the baby's born" - and that for the most part they are wiser and have more practical experience than I do!

DH and I don't have any options (other than switching jobs) for changing hours or shifts. He currently works as a Network Engineer for the Boston Stock Exchange (they don't trade at night! LOL) and I work as a Customer Service Rep for a national envelope manufacturer (Its a 8-5 place, and I have a full-time load on my plate - we could easily hire another CSR in my office, and they have a policy that all CSR's are full-time, salary positions - on the bright side, my pay is significantly hire than a normal CSR position, but they aren't able to offer the flexibility).

No, we don't currently itemize on our taxes. We're hoping to buy a house next year, which will most likely mean we'll itemize for 2007, but I'm not betting on it yet (not sure if house prices will come down enough). I looked into the tax information a little bit, and since the dependent care is a credit, not a deduction, then it shouldn't matter whether we itemize or not.

[treeluva]

I have been using daycare for the last 7 and half years.

I find that it is better for me to just pay the people, and then take the credit.

As far as the tax issue, I simply upped my exemptions from 0 to 6, although I can claim 10 exemptions. I paid 140 dollars in federal taxes last year, and still got a significant amount back. (Of course, that is going off of making 21 grand taxable income a year) Before last year, I got even more back, due to the Earned Income Credit, but last year, since I rented my house, I had earned too much investment income to qualify.

Things may change after the baby comes, and you may decide to stay home. I would at least see how you feel with working and the baby before you sign up for this plan. You may decide to keep working, and, if you do, then the plan may be a good idea. I would check with a tax specialist.

[PrairieRose]

Depending on what tax bracket you're in, the credit will probably amount to more in savings than the break. A break only saves you your tax bracket times the amount of the break. (so if you were in the 30% bracket, that times $3000. = $900, which you may have already known)

[SHOPGIRL]

Sara,

I'm going to do some research on this. I use an FSA for basic medical expenses, but I'll need to investigate this for the fall. My FSA account goes from October to October. I'm going to be looking at either putting two kids in daycare next year or I'll be paying someone to come to my house. Either way, its going to be a big expense. I was under the understanding that you could use your child care pre-tax dollar tax credit and take the usual exemptions for your kids.

So, this is what I would do. If you did your own taxes with tax software, I'd use this years numbers, but add a child and see what happens. That might be the best way to figure it out. Or, if you have a trusted tax professional, I'd ask them.

[amysh]

I would second what Prairie Rose said a tax CREDIT is generally much better than a tax DEDUCTION:

The difference between a deduction and a credit is that a credit reduces the tax, while a deduction reduces the amount of income that is taxed. A "tax deduction" is subtracted from your adjusted gross income beforeyou caluclate your federal income taxes. A "tax credit" entitles the taxpayer to subtract the amount of the credit (dollar-for-dollar) from the total federal income tax bill. It *sounds* like a $3000 credit would be better than a $1700 savings, but I won't bet my life that I understood all your calculations correctly, and I've not used either a childcare FSA or the child care credit.

That said, you might talk with your accountant, if you have one. Also, would your HR department be of any help?

Good luck!

Amy

[Telephus44]

Wow, thanks Shannon for the tip to use my tax program to estimate the difference. Here's what I did (in case you wanted to try this yourself).

First, I looked on the Massachusetts state web site to try and find an "average" cost of daycare in my area. Since I couldn't locate the exact number, I chose to use the maximum allowable state re-imbursement from the Boston area (which ended up being $12,194 per year - I remember someone telling me it's closer to $9,000 per year, but I figured I'd rather guess high).

Secondly, I went in and "added" a dependent to my tax return (FYI - if you try this at home with Taxcut, you have to put in a SSN, or it won't let you claim the dependent. I just made something up and it took it), and put in that I paid $12,194 in daycare costs. I'm eligible for a $600 credit. (Also - having done more research on this now - the credit re-imburses you for between 20-35% of your costs to a maximum of $3,000 for one child, and $6,000 for two or more. The percentage re-imbursed and amounts eligible vary by income level - I couldn't find an exact formula, I just let the program calculate in my situation).

Thirdly, I used my current paycheck and my final paystub from Dec 2005 to figure out (approx) what my W-2 would look like if I use the full $5000 Daycare FSA allowance. I entered those numbers in and we end up saving around $1614 (close to the $1700 I calculated above). Since DH actually started a new job paying more money this March, the numbers won't be entirely accurate, but I figured it was close enough for an estimate.

Fourthly, I realize that if I have $12,000 costs, and $5,000 is paid for from my FSA, I can still claim the dependent care credit on the remaining $7,000. I re-plugged in the credit from step 2 and guess what? My credit is still - $600.

So I guess I'll be going with the FSA! Many thanks to Shannon for the suggestion!

My FSA does run Jan-Dec, but since we have also have to elect for the Calendar year in October (so in Oct 2006, I'll need to make my choices for 2007). I also think that based on projected medical expenses, I'll up my Healthcare FSA contribution too.