DoD recently announced that servicemembers will be able to establish dependent care flexible spending accounts. It appears Congress does not have to take action for this to go into effect. A significant amount of fanfare accompanied the announcement. But is it really that big of a deal? I’m not so sure. Let’s take a look.
Taxpayers can deposit $5,000 into a dependent care flexible spending accounts (DCFSA….I just made up that acronym). The deposit is pre-tax so the servicemember doesn’t pay Federal and if applicable, State income tax on the amount deposited. That’s a good deal. The problem is there is also a dependent care credit and it might be a better deal.
The dependent care credit is calculated based on a maximum care amount of $3,000 if you have one child needing care and $6,000 if you have two. Any money deposited into a DCFSA reduces the care amount you calculate the credit on. So, let’s look at some scenarios.
Lt and Mrs. Smith have two children. They both work so they qualify for either the DCFSA or the dependent care credit. Their taxable income is $72,300. That puts them in the 12% tax bracket. So if they contribute $5,000 to the DCFSA they’ll reduce their taxes by $600. If they didn’t contribute to the DCFSA and paid for the care out of pocket they would be eligible for a credit equal to 20% of the $5,000 or $1,000. They would net an additional $400 versus contributing to the DCFSA.
Now let’s look at Maj and Mrs. Jones who also have two children. They both also work and their combined taxable income is $105,000. That puts them squarely in the 22% bracket. A $5,000 contribution to a DCFSA will reduce their tax by $1,100. Greater than the $1,000 credit they would receive.
In general, lower income makes the credit more valuable than the DCFSA and higher income tilts the scales towards the DCFSA instead of the credit. My concern is that most people will here “benefit” and “dependent care flexible spending account” and default to the DCFSA. This could be a big mistake for those in the enlisted force (their credit could equal $1,500 and the DCFSA would only save $500 in taxes).
If you only have one child, the calculations change and the DCFSA may win the day as you can contribute more than $3,000 to the DCFSA
There is one more thing to keep in mind and again it applies to those at the higher income levels. If you’ve heard me speak, I say that Adjusted Gross Income (AGI) is the most important number on the tax return. By reducing your AGI via contributions to a DCFSA you may make yourself eligible for credits or deductions you weren’t eligible before the contribution. It could be a force multiplier.
Always check the math when someone talks about a new tax benefit. The old tax benefit may be just as good or better.
Military Finances are Different
Normally, I talk about benefits that military members have, and civilians don't. In this case, military members are getting a benefit that is currently available to civilians. The typical case is that military members have financial and tax benefits not available to civilians. That is why we think you should work with a financial planner or advisor that works with current and retired military members each and every day. If you'd like to see how we do things, use the button below to schedule a free initial consultation.
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