Child Care Tax Credit: Is Form 2441 Calculating Correctly?

Lead: Today's tax question comes from Jimmy. He asks, "I'm in a Child Care section 125 cafeteria plan. I paid the day care center $3600. From my paycheck I had pretax dollars deducted from my check of $2,000. I submitted $2,000 in bills to my employer. Here's the rub, when I got my W2 the employer put $2,000 in box 10. On my Form 2441 child care tax credit, instead of getting the $3,600 x 20% or $720. I'm getting penalized: the Box 10 amount is subtracted from the $3,600 so a net $1,600 x 20% or $320 is calculating. So I'm losing $400 on my tax refund. If the employer was paying me solely as a benefit from their own funds I can understand this. The fact that they are paying me back with my own money that I paid in should not penalize me. Am I right on this? Is the W2 wrong?"

The calculations you described for the allowable portion of your Child and Dependent Care Tax Credit is right. See, for example, the IRS Instructions for Form 2441 Line 15 and the IRS answer to questions about Dependent Care Benefits in a flexible spending account.

Since the money in your flexible spending account was pre-tax dollars, you cannot get a second tax benefit (the Child Care Credit) using the same dollars. So calculating your credit on $1,600 in qualifying expenses is the correct answer in your scenario.

Generally speaking, contributing money to a Dependent Care Benefits flexible spending account provides a better tax break than the Child Care Tax Credit. That's because dependent care benefits are excluded from federal income taxes, Social Security taxes and Medicare taxes. Assuming you are in the 25% tax bracket, your combined tax savings through a dependent care flexible spending account is 32.65% (that's 25% for your marginal income tax rate and 7.65% for your share of Social Security and Medicare taxes). That tax break exceeds the 20% tax credit you are figuring on Form 2441.

In fact, I would urge you to contribute more to your flexible spending account to make sure that most of your day care expenses are paid through the flexible spending account.

Hope this helps.

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