If you have to pay for child care, the federal government offers you two ways to save on taxes. A flexible spending account, or FSA, allows you to set up a tax-free account for spending on a nanny or day care. The Child Care Credit lets you subtract some of your costs from your tax bill. If you meet the qualifications for both options, you may have to do some math to see which one benefits you most.
Child Care Credit
You can claim the credit if you -- and your spouse, if you're married -- have to have child care to work or look for work. Depending on your income, the credit is 20 to 35 percent of your qualifying child-care expenses. The maximum qualifying expense is $3,000 for one child and $6,000 for two or more. Internal Revenue Service Publication 503 details what sort of child care qualifies and other requirements you have to meet.
The FSA Option
Some employers offer FSAs as part of a cafeteria plan that lets you choose among different benefits. If your employer doesn't offer an FSA, you'll have to settle for the child-care credit. With an FSA, you can choose to save up to $5,000 of your pre-tax salary in the account, or $2,500 if you file separate marital returns. Your deposits are exempt not only from income tax but also from Social Security and Medicaid taxes. No tax is assessed on withdrawals as long as they're for qualifying expenses.
Crunching the Numbers
If you have the choice of an FSA or tax credit, "Kiplinger" says, the FSA usually works out better. For example, the magazine says, if you have $5,000 in child-care expenses and qualify for a 20 percent tax credit, you get $1,000 off your tax bill. The FSA will save you slightly more. However many variables need to be considered, such as the lower FSA amount for couples who file separate returns. Your best bet is to run your taxes both ways and see which one makes sense for you.
If you're paying child-care costs that exceed $5,000, it's possible you can take both options. For example, if you're paying $7,000 to put two kids in day care, you can use your FSA to cover $5,000, then take a child-care credit for some of the rest. The amount of expenses that qualify for the credit shrinks if you have an FSA, though. If, say, you hire a nanny for one child and contribute $2,000 to an FSA, you subtract the contribution from the maximum expense. Instead of $3,000, the highest qualifying expense is $1,000.
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