Dependent Care Flexible Spending Account - Does it save money?

Question

I have been participating in my company's FSA for daycare expenses. I allocated $5000 for 2006 and used all of it. Now that I am preparing taxes I notice that I have to add these $5000 on line 7 of 1040A and therefore increase my total income by that amount and therefore also my taxes. What is the point then of FSA money if you have to pay taxes anyways? state savings? social security saving? I noticed that if I would have not done a FSA I would be able to claim a $3000 x 0.20 = $600 tax credit. Am I missing something about the FSA?

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Frederick Lorca · Accepted Answer

You need to file Form 1040 and complete Part III of Form

2441. If the entire $5,000 was applied to qualified expenses, none of the FSA money gets added back into your income. Assuming you are in a 25% marginal income tax bracket and that your salary is under the annual FICA ceiling, you netted tax savings of $1,824 by using the FSA instead of the child care credit. That's because the $5,000 was excluded from both income and FICA taxes, on which the combined tax rate is 32.65% (25% income tax + 7.65% FICA tax). You would had to have earned $7,424 ($5,000 / .6735) after-tax in order to have been left with the $5,000 paid for child care expenses. That leaves a difference of $2,424. Subtract out the $600 child care credit you would have claimed had the expenses been paid from after-tax salary, and you're left with a net tax saving of $1,824. Frederick Lorca

Herb Smith · Answer

I believe you are incorrectly reading the instructions for Line 7. The FSA amounts ARE NOT included in Box 1 of your W-2, therefore are not taxable income. The only time you would add these amounts back to income is if you DID NOT expend the funds for daycare.

Assuming your qualified daycare expenses are equal to, or exceed, $5000, the FSA is equivalent to a tax credit of $1250. That assumes a marginal tax rate of 25%.

Did you perform the calculations on the back of form 2441?

Bill Brown · Answer

You only the portion of the $5,000 that exceeds your child care costs.

You should consider which is better, a $600 tax credit or a $5,000 tax deduction. If you are in the 15% or higher tax bracket, the deduction is better since it would save you at least $750 in taxes.

Yes.

Don Priebe · Answer

The $5000 doesn't end up on line 7.  Schedule 2 (form 2441for 1040 filers) documents that you spent it on child care. --Don  EA in Upstate NY

Rod · Answer

you have to do the 2441 form to show you spent the money soit does not get added to your income it then saves youincome tax on the 5k and FICA taxes also (social securityand medicare)

rick++ · Answer

I believe the purpose is to detect whether you paid too muchsocial security tax, especially in the case of multiple W2s.Some pretax deductions are taxed for SS (e.g. 401K) and somearent.

Phoebe Roberts, EA · Answer

Fill out page 2 of the 2441.Phoebe :)

Tobi · Answer

Thanks for the replies ... I actually just used TurboTax and the program uses Schedule 2 (Form 1040A). There in line 17 I enter $5000 and my income on line 18. The next item is in line 22 which reads $5000 in TurboTax and next to it are instructions to add this to line 7 of form 1040 with 'DCB' written on the side. TurboTax does it automatically and updates line7 to read (income + $5000)!!! Is TurboTax wrong?

Thanks!

Tobi · Answer

I actually just did page 2 of 2441 manually and here is what I put (btw, I received $4999 from FSA) line 12: $4999 line 13: $0 line 14: $0 line 15: $4999 line 16: $4999 line 17: $4999 line 18: $XXX line 19: $XXX line 20: $4999 line 21: $0 lien 22: $4999 line 23: $5000 line 24: $4999 line 25: $4999 line 26: $4999 line 27: $0 line 28: $4999

now instructions to line 28 say: Taxable benefits. Subtract line 27 from line 22. If zero or less, enter -0-. Also, include this amount on Form 1040, line 7, or Form 1040NR, line 8. On the dotted line next to Form 1040, line 7, or Form 1040NR, line 8, enter "DCB" This is why I/TurboTax is including it! Is this wrong?

Phil Marti · Answer

Line 24 is zero, the smallest of lines 20, 21 or 23. The label "deductible benefits" is probably throwing you, but if you look at the instructions you'll see that this figure winds up on an income statement somewhere. Doesn't apply to your situation.

Once you fix line 24, line 27, "Excluded benefits," will go to $4999.

Dependent Care Flexible Spending Account - Does it save money?

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