How does the dependent care credit work?

If both spouses are working or going to school, or you are a single parent who is working, the dependent care credit AND a pre-tax dependent care program at work may be available to you.  Dependent care expenses include nanny, day care, after school programs and day camps.  The social security number or EIN of the provider must be reported.

If your employer has a $5000 pre-tax savings program for dependent care, max this out first if you are at least in the 25% tax bracket and you have at least 5k in dependent care expenses.

The dependent care credit is for expenses of $3000 per child, $6000 per 2 or more children, but you have to reduce this amount by anything put into the pre-tax program at work. For most taxpayers, the credit is 20% of expenses, or a maximum of a $1200 credit for 2 or more kids.  

Lets see how this plays out with a few examples.  In previous posts, I introduced you to Tobias and Linsdsay who are in the 28% marginal tax bracket. If Lindsay has a pre-tax program available, she could put in $5000, saving her $1400 in tax. If she opted for the credit, her credit would only be $600.

Lindsay’s parents George and Lucille had four children – Lindsay, Michael, and George Oscar Bluth II, and Buster. The parents are in the 33% marginal tax bracket.  Assuming both George and Lucille received paychecks from the family company, and they had more than $6000 in dependent care expenses, they would be eligible for a $1200 dependent care credit for two or more children. However, there is a better way. Since their company offers the pre-tax program, they should max that out first at $5000, saving $1650. They can take the remaining portion of the dependent care credit (6000-5000) = 1000, it’s a 20% credit, so they would receive an additional 200, upping their total savings to $1850.

Summary

If you have access to a dependent care savings program through work – take advantage of it. If you have two or more kids, you can take this AND a portion of the dependent care credit.