Question

Ava and her husband, Leo, file a joint return and are in the 24% Federal income tax bracket. Ava’s salary is $75,000. Her employer offers a child and dependent care reimbursement plan that allows up to $5,000 of qualifying expenses to be reimbursed in exchange for a $5,000 reduction in the employee’s salary. Because Ava and Leo have two minor children requiring child care that costs $5,800 each year, Ava is wondering if she should sign up for the program instead of taking advantage of the credit for child and dependent care expenses.

Analyze the effect of the two alternatives. How would your answer differ if Ava’s salary was $30,000, the couple’s AGI was $25,000, and their marginal tax rate was 10%.

Answer 1

Child and Depedent Tax Credit:

The Child and Dependent Tax Credit Rate will depend on the Adjusted Gross Income (AGI).

The limit is upto $3000 for one child and $6,000 for two or more child.

To be eligible the child must be under the age of 13 or disabled.

Situation 1: AGI is $75,000 and Marginal Tax rate id 24%

When the AGI is $75,000, the Child and Dependent Tax credit rate is 20%

So, the Tax credit is ($5,800 * 20% ) = $1,160

If they opts for reduction fo $5,000. then they wil get an advantage of ($5,000 * 24%) = $ 1,200 for Income Taxes

For FICA Taxes ($5,000 * 7.65%) = $382.5

So, a total of $1,582.5 of advantage they can get by aopting for child and dependent care reimbursement plan

They can get more benefit of $422.5 ($1,582.5 - $ 1,160) by opting Child and Dependent care reimbursement plan and hence they should opt it.

Situation 2: AGI is $25,000 and Marginal Tax rate id 10%

When AGI is $25,000 the credit tax rate for Child and Dependent care is 30%

So, the tax credit is $5,800 * 30% = $1,740

If they opt for child and dependent care reimbursement the saving s will be as follows

$5,000 * 10% of income tax = $500

and $5,000 * 7.65% of FICA Taxes = $382.5

Total savings = $500 + $382.5 = $882.5

In this case, they have to opt Child and Dependent tax credit as they can get a benefit of $857.5 ( $1,740 - $882.5)