The Basics of Flex Spending Accounts.

• Flexible spending accounts are similar to 401k retirement plans. They are a benefit offered through an employer that allow workers to set aside funds on a pre-tax basis. In exchange for this tax benefit, the money is restricted in its use. Employees using an FSA for child care can contribute up to $5,000. But be careful in your planning: One big difference between FSAs and 401k plans is that the FSA does not carry over from year to year. FSA accounts are "use it or lose it."
  
  

Child-Care Tax Credit

• The child-care tax credit allows parents with dependent children to write off up to 35 percent of child-care expenses. There are some important limits. The size of the credit gets smaller as a person's income grows, and only workers who earn less than $15,000 can claim the full 35 percent. There is also a ceiling for the qualifying expenses: $3,000 for one child and $6,000 for two or more. For example, a person earning less than $15,000 can claim a tax credit on 35 percent of $3,000 in expenses for one child or $6,000 for two or more. If this taxpayer paid more than $3,000, but had only one child, she could not claim a credit on more than $3,000.
  
  

Warnings

• That little old lady down the street, the one you pay under the table to watch your newborn, could cost you a bundle in tax breaks. To be eligible for the tax credit and for payments under the flexible spending account, "you must identify the care provider(s) on your tax return," according to the IRS. Also, you cannot use these tax provisions to pay your spouse or dependents. If the caregiver is also your child, but not a dependent, she must have turned 19 in the year for which you are claiming the expenses.
  
  

Significance

• You cannot use the tax credit and the FSA for the same expenses, but if your expenses exceed the limits of one, you can claim the difference using the other. For example, if your dependent child-care expenses exceed $5,000 per year, which is pretty easy to do, you have maxed out your limits with the FSA. You can claim the difference using the child-care tax credit.
  
  

Considerations

• Knowing whether to use the flexible spending account or the child-care tax credit requires some calculation. If you are a very low-income wage earner, and work part time, the tax credit may offer the largest advantages, because the size of the credit is larger than the amount of money withheld from taxes. In most cases, according to Kiplinger's personal finance, a full-time worker is probably better off using the flexible spending account option.