Dear Readers: Wikipedia mentions: "If one spouse earns less than $5,000 then the benefit is limited to whatever that spouse earned. Many plan coordinators do not warn of this limit. This limitation can create a situation where the earning spouse sets up a Dependent Care FSA and dutifully sends in receipts to withdraw funds and then at tax time the FSA is effectively eliminated and all the work wasted. See IRS Form
2441 Part III for details."
I have 3 kids in daycare. We expect my wife's income to be a little over $3,000 next year (well below the 5,000 limit mentioned). Should I _NOT_ enroll in the dependent care fsa offered by my job? I read Form 2441 Part III, but don't understand what happens if she makes less than $5000. Does the remainder of the pre-tax fsa money somehow convert to taxable income?
No, all the work is not wasted, even if the spouse has no earned income. You still saved 7.65% payroll tax (Soc. Sec. and Medicare) on the amount in the FSA.
You should enroll and only put $3K in the FSA, not the full $5K.
Note: if you are sure your reimbursable expenses will be at least $5K, so that you won't forfeit any, then you can still get the partial payroll tax benefit mentioned above -- of course, if your salary already exceeds the annual maximum subject to social security tax, this benefit is greatly reduced (to 1.45% Medicare tax savings only). You may also decide you'd rather not reduce your credits under the SS system this way.
Yes, it will go back on your Form 1040 Line 7 as wage income for income tax purposes with notation "DCB" on the dotted line. If you do not have enough withholding to cover this, it can cause an unexpected hit to your refund or balance due.
The *credit* is based on any excess out-of-pocket qualified expense that wasn't already provided via the FSA. (Even with only one child, up to $5K of employer benefit can be used if the other limits are met.) So if you used $4K in the FSA and had $4.5K total qualified expense, the remaining $0.5K can be used for the credit.
Change "and" to "or" -- it is the LOWER of the two, not combined (contrasted to, say, IRA contributions where one earned income can be spread across both spouses). For example, if one spouse has no earned income, then no credit and no tax-free employer benefit is allowed.
No, see above. However, there are special rules that allow you to "fake" earned income for a spouse who is a full time student or disabled.
Finally, as usual your state rules may greatly affect this as well. For example, the California the child/dependent care credit is refundable, which for some lower-income taxpayers would make it a much better deal than the employer-provided benefit.
I have sufficient withholding (got a sizeable refund last year) and have not had any financial or family status change since then. I don't even mind submitting all the dependent care fsa receipts. With this in mind, I would still like to request the max $5000 because my wife may increase her work/salary in the coming year. Since it returns to taxable income, am I doing something illegal or peronally financially damaging by doing so?
I live in New York State. Would you be aware of any similar rule here?
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