Credit or Debit? It Matters For Employees With Dependent Care Costs

Photo illustration by istockphoto.com.
Photo illustration by istockphoto.com.

Paper or plastic? Credit or debit?  These are common questions you hear at the grocery store, but do your employees consider what is the best way, credit or debit, when it comes to paying for dependent care?

I don’t mean actually charging the costs to a credit card. What I am referring to is whether to take the tax credit at the end of the year on their tax return, or, to have the funds withheld (debited) pre-tax from payroll using the Dependent Care Expense Account.

The best answer to this is based on what their marginal federal tax bracket is.

For your employees in either the 10 percent or 15 percent federal tax bracket, it may make more sense for them to take the credit at the end of the year and steer away from the payroll deduction. They may actually qualify for up to a 35 percent tax credit of up to $3,000 per child (maximum of two, or $6,000).

Here are some examples at various income limits:

  • Adjusted Gross Income (AGI) up to $15,000 = 35 percent credit.
  • AGI of $33,000 to $35,000 = 25 percent credit.
  • AGI of $23,000 to $25,000 = 30 percent credit.
  • AGI over $43,000 = 20 percent credit.

For employees in the 25 percent or higher federal tax bracket, it probably makes more sense for them to take advantage of the payroll deduction option.

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As income increases, the federal tax credit phases down to only a 20 percent tax credit so the savings from avoiding paying tax altogether on the funds is higher than the credit you would have been eligible for. This tax savings not only includes their federal and most state income taxes, but also the 7.65 percent FICA tax for Social Security and Medicare.

Plus, they can contribute as much as $5,000 to the Dependent Care Expense Account (DCEA), even if they only have one (1) child. Some employers even match funds going into the DCEA, so employees should always check with the HR Department to see if this applies.

This was originally published on the Financial Finesse blog for Workplace Financial Planning and Education.

Linda Robertson is an experienced financial planner with FinancialFinesse.com, the nation’s leading provider of unbiased financial education programs to corporations, credit unions and municipalities with over 400 clients across the country. Her focus is on retirement and tax planning, and her background includes positions with NationsBank, H & R Block, and Metropolitan Life. Contact her at linda.robertson@financialfinesse.com .

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