Should You Use Your Employer's Dependent Care Program?

Having kids is expensive. Fortunately, the government provides for a credit or pretax payroll deduction for dependent care expenses. So which strategy is best?

Although a tax credit is better than a tax-deduction, in most cases, my clients are better off taking a pre-tax payroll deduction in their employer’s flexible spending account (aka FSA, Sec 125 plan or cafeteria plan).

The reason is that the dependent care credit phases out pretty quickly and is basically a Federal Credit. In contrast, your FSA deduction reduces federal income tax, Social Security tax, Medicare tax and California tax and is there is no phase-out imposed on high income earners.

In 2026, my clients will definitely be better off with the dependent care FSA due to a new law change that increases the maximum FSA payroll deduction from $5,000 to $7,500 ($3,750 for married filing separately)

EMPLOYERS MUST AMEND THEIR PLANS TO ALLOW THE HIGHER CONTRIBUTION LIMIT. MOST EMPLOYERS WILL AMEND THEIR PLAN BUT SOME WILL OPT TO KEEP THE $5,000 CONTRIBUTION LIMIT.

Since almost all of my clients have single AGI over $103,000 or $206,000 (married filing jointly). the maximum credit would be 20% of $3,000 or $6,000. So having two qualifying children with dependent care expenses would lead to a $1,200 tax credit ($6,000 maximum times 20% credit). [Therefore, a 20% credit only saves you $600 in taxes if you have one child.]

In contrast, the dependent care pretax payroll deduction saves more in taxes. Eligible expenses are currently $5,000 (regardless of how many kids). 

Your savings depends on your tax rate but with Federal, state and 7.65% FICA (social security and Medicare) taxes your tax savings really adds up.

For example, if your combined tax rate (Fed, state and FICA) is 40%, a $5,000 dependent care payroll deduction saves you $2,000. If you elected to use the $5,000 dependent care credit (on 2 children) your tax savings would be $1,000.