The Basics of a Dependent Care FSA

A dependent care flexible spending account is an employer-sponsored benefit that lets you set aside up to $5,000 per household before taxes to pay for childcare or adult dependent care while you and your spouse work. The money bypasses federal income tax, Social Security and Medicare tax, and California state income tax. It does not, however, bypass California SDI — the state disability insurance deduction still applies to your full gross wages.

You pick your annual election during open enrollment. The amount gets split across your paychecks and deposited into the account. When you pay for qualifying care, you submit a claim and get reimbursed. Unlike a health care FSA, the full balance isn’t front-loaded — you can only pull out what’s been contributed so far.

California’s Tax Wrinkle

Here’s the part that trips people up: California conforms to the federal dependent care FSA rules, but the Franchise Tax Board also offers a separate Child and Dependent Care Expenses Credit at the state level. The state credit is a percentage of the federal credit, and it phases down as income rises. For most families earning above $100,000, the FSA produces better results than skipping it in favor of the credit alone.

You can’t claim both on the same dollars. If you put $5,000 into the FSA, that $5,000 comes off the top of your eligible expenses for the credit calculation — both federal and state. So the question is: does the tax exclusion beat the credit? For a dual-income LA household in the 9.3% California bracket and the 24% federal bracket, the FSA usually wins by $400 to $700.

Actual Savings for LA Families

A Los Angeles family in the 24% federal bracket and 9.3% California bracket saves roughly $1,665 in income tax on a $5,000 FSA contribution. Add the 7.65% FICA savings and the total reaches about $2,048.

That’s less than what a New York City family saves (because there’s no city-level income tax in LA), but it’s still a guaranteed return on money you were going to spend anyway. Think of it this way: declining the FSA means you’re paying your daycare bill with dollars that were taxed at a combined rate above 35%. No investment gives you a guaranteed 35% return.

What Expenses Qualify

The IRS rules under Publication 503 apply regardless of which state you’re in. Qualifying expenses for LA parents include:

• Licensed daycare centers — full-time or part-time programs for kids under 13
• In-home care (nanny, au pair) — you’ll owe nanny taxes as a household employer on top of the FSA reimbursement
• Before- and after-school care — supervision programs, not academic tutoring
• Summer day camps — overnight camps are excluded
• Preschool — qualifies because the primary purpose is custodial care, not education

Kindergarten tuition does not qualify, and neither does food or clothing unless it’s included in the overall cost of care and can’t be separated out. Most licensed centers in LA bundle meals into their rates, which is fine — you don’t need to back those out.

Use-It-or-Lose-It and Other Traps

Dependent care FSAs have no rollover. Any balance left in the account at the end of your plan year (or the grace period, if your employer offers one) vanishes. This is the single biggest reason people under-elect or skip the account entirely — they’re afraid of losing money.

The fix is simple: estimate conservatively. If you know you’ll spend at least $4,000 on summer camp and after-school care, elect $4,000. You don’t have to max out at $5,000. Leaving a small buffer is better than forfeiting hundreds.

One more thing California families should watch: if you or your spouse earns under $5,000 for the year, your FSA cap drops to the lower earner’s income under IRC Section 129(b). Part-time freelancers and gig workers in the entertainment industry — which describes a lot of LA households — should double-check their projected earnings before setting an election amount.

Sources

• 26 U.S.C. § 129 — Dependent Care Assistance Programs
• IRS Publication 503 — Child and Dependent Care Expenses
• IRS Topic 602 — Child and Dependent Care Credit
• IRS Topic 756 — Employment Taxes for Household Employees
• IRS Topic 751 — Social Security and Medicare Withholding Rates
• California Franchise Tax Board