Polly and her husband Leo file a joint return and expect to report 2012 AGI of $
ID: 2357511 • Letter: P
Question
Polly and her husband Leo file a joint return and expect to report 2012 AGI of $75,000. Pollys employer offers a child and dependant care reimbursement plan that allows up to $7,000 of qualifying expenses to be reimbursed in exchange for a $7,000 reduction in the employess salary. Because Polly and Leo have two minor children requiring childcare that costs $6,500 each year, she is wondering if she should sign up for the program instead of taking advantage of the credit for child and dependant care expenses. Polly and Leo are in the 25% tax bracket. Analyze the effect of the two alternatives. How would your answer differ if Polly and Leo AGI was $25,000 instead of $75,000? Assume in that case that their marginal tax rate is 10%.Explanation / Answer
Case 1: AGI = $75,000 with a tax bracket of 25%
Without signing up for the reimbursement plan, Polly and Leo jointly file $75,000 * 0.25 = $18,750 in 2012 taxes.
Net Income (after-tax and childcare expenses - to be paid out of pocket) = $75,000(AGI) - $18,750(tax) - $6,500(childcare cost) = $49,750
If they sign up for the childcare reimbursement, their AGI falls by $7,000 to $68,000. This means that their joint filing of 2012 taxes will be $68,000 * 0.25 = $17,000
Net Income (after-tax and childcare expenses - reimbursed) = $68,000(AGI) + $7,000 (reimbursement) - $6,500(childcare cost) - $17,000(tax) = $51,500 which is greater than $49,750 (without enrolling in the reimbursement plan)
Thus it is easy to see that the family is better off by taking a smaller AGI and opting for the childcare reimbursement plan. So they should sign up for the program.
Case 2: AGI = $25,000 with a tax bracket of 10%
Without signing up for the reimbursement plan, Polly and Leo jointly file $25,000 * 0.1 = $2,500 in 2012 taxes.
Net Income (after-tax and childcare expenses - to be paid out of pocket) = $25,000(AGI) - $2,500(tax) - $6,500(childcare cost) = $16,000
If they sign up for the childcare reimbursement, their AGI falls by $7,000 to $18,000. This means that their joint filing of 2012 taxes will be $18,000 * 0.1 = $1,800
Net Income (after-tax and childcare expenses - reimbursed) = $18,000(AGI) + $7,000 (reimbursement) - $6,500(childcare cost) - $1,800(tax) = $16,700 which is greater than $16,000 (without enrolling in the reimbursement plan)
Thus it is easy to see that the family is better off by taking a smaller AGI and opting for the childcare reimbursement plan. So they should sign up for the program.
Answer: In both cases the numbers work out such that it is advantageous for Polly and Leo to sign up for the childcare reimbursement plan, even though it causes a drop in their AGI.