Dependent Care FSA and Child Care Credit Questions?

[Swat]

My wife and I are expecting our first child next month and we are addressing open enrollment for next year. One of the options is a Dependent Care FSA. I am trying to wrap my head around this option and also the "Child and Dependent Care Credit." Any thoughts would be appreciated.

Background:
-Starting in February, my wife will go back to work part time. Her current annual income is about $100k but will likely be reduced to ~$50k when she goes part time.
-For 2017, we will have one child.
-I will be on a resident's salary, making ~$53k
-Her employer offers the option to contribute up to $5k to a Dependent Care FSA

Questions:
1) Is there a comprehensive list of what constitutes "childcare expenses?" I'm assuming daycare expenses are an obvious, but what about all of the other miscellaneous expenses that we'll have to pay so my wife can continue to work. Food, clothing, education, camps, transportation, etc...
2) My understanding is that my contributions to the Dependent Care FSA will reduce the "Child Care Credit." Which is more valuable? For instance, if we expect to spend $4k in childcare expenses, should $4k go into the FSA or should it be $3k and the other $1k for the credit? What about if we spend $8k a year in child expenses (essentially anything over $5k max for FSA).
3) Are we able to pay family members for childcare that counts towards this benefit? For instance, if I pay my mother $8k to watch out son, can that be paid via the FSA or can it count towards the Child Credit? What if I pay her "under the table?" How would that work?

Thanks.

[MsPeacock]

You can't pay anyone under the table and use a childcare FSA. The forms to get reimbursed require either a SSN or tax ID number from the childcare provider, as well as either a receipt or signature (e.g. From a daycare center - reciept, nanny or sitter - signature) It covers childcare only, not clothing or food. Daycamp can be claimed, but not overnight camps. I don't think transportation counts, even if provided by the daycare, but would have to check this. A preschool, which is what I assume you mean by education, would count.

I don't know about the FSA vs tax credit. My childcare costs were always well in excess of 5k per year so I always maxed that and I am not sure if I got the tax credit as well or not.

[notactiveanymore]

1) For the FSA Dependent Care, have your wife ask her benefits administrator for your FSA elibigle expense list. I believe they are mostly the same, but you want to make sure you know what your specific FSA covers and what records you need to comply with the reimbursement rules. For the child care tax credit, here are some facts: https://www.irs.gov/taxtopics/tc602.html

2) If you have an FSA, it almost always makes sense to use it. Especially at your income levels because the money put into the FSA is exempt not just from income tax, but also from payroll taxes. Meanwhile the child care tax credit at your income level would net you a tax credit of 20% of the first $3000 in child care expenses. You cannot use the tax credit on top of the FSA when you only have one child. So even if you have $8000 in childcare expenses, the best bet is to use the FSA for $5000. If you have two children, the tax credit goes up to the first $6000 in expenses, so you could do the FSA up to $5000 and then claim another $1000 credit at 20%.

3) I mean, this one feels pretty obvious. You can't pay someone under the table so that the money is not taxed and expect to be able to pay with your own tax-free money. You can pay grandma with the FSA money, but she's going to have to claim that income. And looking at the IRS info, if she's doing it in your home, you could technically be required to pay unemployment insurance and take out payroll taxes as well. I doubt that would be an issue, but yeah no, you can't help someone avoid income taxes with your tax-free child care money.


Related story:

One year when I was 18, I had done a bit of summer nannying for a family and was paid in cash/check the whole time (maybe 10-15 days for 5 hours). Then they called the next January and tried to say they were going to claim that child care expense on their taxes and so they were going to send me a 1099. They were paying me $8 an hour and I certainly wouldn't have taken that rate if I knew I'd be paying taxes on it - those kids were not easy! I mean, c'mon. That was a complete non-starter.

[Need2Save]

You will also want to refer to IRS Publication 503 on Child and Dependent Care Expenses. 

https://www.irs.gov/pub/irs-pdf/p503.pdf

Food, clothing, def. do not count. 

Agree totally with theotherelise that the person you pay has to report the income to the IRS and provide you an SSN or EIN. Most Dependent Care FSA administrators will not process claims without a tax id and a paid invoice to back up the expense. 

Also, as stated - you can't double dip and take the credit and also use the FSA for the same expenses. 

Another thing to point out is that the Dependent Care FSA is used "as you go".  You can only get reimbursed up to the amount you have paid in YTD.  Unlike the Health Care FSA which gives you up to your full annual election on day one of the year.  So if you pay, say $100 each paycheck into the FSA, you can only get $100 a paycheck reimbursed to you until the next paycheck.  You can't use the full $5,000 early in the year. 

It really sucks that the limit  is only $5,000 a year as that gets no where near what most families pay for child care in the U.S.

[Proud Foot]

I will second what the Need2Save and theotherelise said.  I'll also add that at your income maxing out the Dependent Care FSA is the way to go.  Your income is higher than mine and I'm not sure what your state taxes are but when I compared the Dependent Care FSA vs the Credit my wife and I had around an $1,100 greater tax benefit for using the FSA.

[seattlecyclone]

In general, a household with one child and an average to high income will benefit much more from the dependent care FSA than the tax credit. Even after having two kids, it's generally better to max out that FSA for the first $5k of expenses and claim a credit on the next $1k.