Question

Discussion Question 12-6 (LO. 4, 7)

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.

If required, round your intermediate computations to the nearest dollar.

Click to view Percentage Credit based on Adjusted Gross Income.

a. If Ava and Leo take advantage of the plan, they would

Correct

save income taxes because the reimbursement of child care expenses is excluded from  gross income. The income tax savings  associated with participating in the plan would be $. In addition, Ava will save $ in FICA taxes due to the reduction in salary.

Alternatively, if Ava does not take advantage of the plan, their child and dependent tax credit will be $. Therefore Ava and Leo's income taxes will be $ higher  if they do notparticipate in the plan.

b. Assume, instead, that Ava and Leo's AGI is $25,000 and they are in the 10% tax bracket.

The income tax savings  associated with participating in the plan would be $. In addition, Ava will save $ in FICA taxes due to the reduction in salary.

Alternatively, if Ava does not take advantage of the plan, their child and dependent tax credit will be $. Therefore Ava and Leo's income taxes will be $ lower  if they do notparticipate in the plan.

Answer 1

Since the year is not mentioned, we will consider the Tax brackets for the 2018 tax year (returns filed in 2019).

Tax brackets & the applicable rates are:-

For the first $19,050, 10% = $1,905

For the next $58,350, 12% = $7,002

For the next $87,600, 22% = $19,272

For the next $150,000, 24% = $36,000.

Available tax credit for 2 minor dependents would be $1,000 + $3,000 + 20% of the Child care cost incurred.

For being in the Tax Bracket of 24%, the total income of the couple has to be from $165,000 to $315,000, after the standard deduction of $24000. We will assume the income of Leo to be $124,000.

Case 1 - With the income of $75000 of Ava,

Total Income = $199,000

Standard deduction = $24,000

Taxable Income = $175,000

Regular Taxes = $30,579

Tax Credit = $5,160

Net Tax Liability = $25,419.

Case 2 - With the income of $70000 of Ava, $5,000 reimbursed & reduced from the salary ,

Total Income = $194,000

Standard deduction = $24,000

Taxable Income = $170,000

Regular Taxes = $29,379

Tax Credit = $4,160

Net Tax Liability = $25,219.

Therefore, the Net Tax Liability is lower by $200 if Ava signs up for the program.

Part B of the question is not clear as, if the AGI is $25,000, how can they be in the 10% Tax bracket. Further, is Ava signs up for the program and her income is reduced, the tax liability will be lower in any case & with the 10% bracket, they may also get a refund through tax credit.