Uncle Sam Pitches in for Child Care

Dear Tax Talk,

I need some assistance deciding how to save on taxes. My wife and I gross about $135,000 combined. I have two questions.

First, I would like for you to clarify if the following is indeed tax-deductible given my situation.

My daughter is currently 3, turning 4 in October. She is eligible to attend pre-k through our local school program, which is three times a week, but due to state and local budget issues, no transportation will be provided. This is a problem for us.

Because my wife and I are both professionals who work corporate hours, we are unable to take our children to school and rely on day care/school to resolve this for us.

Because our local school district will not provide transportation, our solution is to enroll our child at our local Catholic school, which offers a before/after-care preschool program from 7 a.m. to 6 p.m. Before-care is from 7 to 9 a.m. From 9 to 2 p.m. is the pre-k session; then from 2 to 6 p.m. is after care. The total cost for 2011-2012 is about $8,135, which is roughly broken down as follows:

Tuition: $3,350 Registration fee: $200 Instruction/student fee: $250 Tuition set-up fee with external firm: $45 Before- and after-care expense: $4,100

Does the total before/after-care and preschool expense of $8,135 qualify for the child/dependent care credit? It is my understanding that it does under the education section (page 6) of IRS Publication 503, but just want to make sure I am right.

Also, how can I utilize the flexible spending for before and after care and still take advantage of the child credit? Total expense for my daughter is $8,135 and for my son, since he is a kindergartner, before and after care is about $4,000 a year, or together about $12,000. -- Ernesto

Dear Ernesto, Married and unmarried parents who work can qualify for a child care credit to help with the costs of providing child care. Certain cafeteria plans allow participants to contribute to a flexible spending account that can be used for child care expenses. Expenses paid with FSA money cannot be claimed for the child care credit. Also, the maximum expenses eligible for the child care credit are reduced by the FSA paid expenses.

Expenses for a child in nursery school, preschool, or similar programs for children below the level of kindergarten are expenses for care, even though labeled education. Expenses to attend kindergarten or a higher grade are not expenses for care; however, before- and after-school care expenses do qualify until age 13. Hence, the $12,000 you spend for the kids qualify as care expenses.

The maximum you can put into the FSA is $5,000. Because this is less than your expenses, you won't have to recognize any income from the FSA. The FSA reduces your child care work-related expenses to $7,000. The maximum expenses eligible for the credit when you have two eligible children is $6,000. However, the $6,000 is reduced by the $5,000 from the FSA, so your maximum eligible credit is $1,000. Use Form 2441 to compute the child credit and FSA exclusion.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.