Should I enroll in a Dependent Care (Section 125 Flexible Spending Plan)?

Answer 1

The answer depends on your adjusted gross income and if you owe tax. I'll give you two examples to illustrate.

If your adjusted gross income is high enough to exclude you from the Earned Income Credit, then you have to look at your tax bracket, and compare it to the credit you will receive by taking the Child and Dependent Care Credit. If you are in a tax bracket over 20% and your income is over $43,000, then the Section 125 plan is better for you than the credit for the first $3,000 of child care for one child.

At the other extreme, suppose you qualify for the Earned Income Credit and your tax bracket is zero. Then using a Section 125 plan to pay for child care changes your adjusted gross income but does not change your taxes. However, the change in income may greatly affect the amount of Earned Income Credit you receive. For $3,000 of child care, the difference in EIC may be as much as $1,000 more or $1,000 less, depending on where you are on the EIC table.

I have seen people lose a lot of refund money by using a Section 125 for child care. So figure your refund both ways before you sign up for the flexible spending plan.

Answer 2

Do you have dependent care expenses that qualify for the plan and are reasonably predictable? If you do, a Flexible Spending account allows you to pay with pre-tax dollars. Remember any money in the plan that is not spent during the year is lost. You can't carry it over to the following year. Also note, the deduction on the 1040 for dependent care expenses does not apply to expenses paid though a Flexible Spending account because they have already been exempted from tax. You need to review your actual expenses with an adviser to answer this question.