The amount of employer-provided benefits that you can exclude or deduct is limited to the smallest of the following amounts:
The amount of dependent care benefits you received,
The total amount of qualified child and dependent care expenses you paid,
Your earned income,
Your spouse’s earned income, or
$5,000 ($2,500 if married filing separately)
There is a special provision for non-taxable combat pay. When you are calculating the amount of dependent care benefits that you can exclude or deduct from income, you may elect to include your non-taxable combat pay in your earned income. This may decrease the amount of employer benefits you can exclude, but it will also increase the earned income limit on your work-related expenses for calculating the credit. You should figure your exclusion and credit both ways, including or excluding combat pay, to see which way gives you the greater tax benefit.
The effect of the exclusion of employer-provided benefits is that you must reduce your qualifying child and dependent care expenses by the amount you exclude or deduct, and your dollar limit is reduced.
Earned Income Limit
Your earned income or your spouse’s earned income is one of the limits for excluding or deducting employer-provided benefits, but earned income is also a limit in determining the amount of work related expenses that qualify for calculating your credit.
Your work-related expenses cannot be more than:
Your earned income if you are single, or
The smaller of your earned income or your spouse’s earned income if you are married.
If you are self-employed, your net earnings are included in your earned income.
For each month or part of a month your spouse was a student or disabled, he or she is considered to have worked and earned income. His or her income for each month is considered to be at least $250 ($500 if there is more than one qualifying person being cared for). If your spouse also worked during part of that month, use the higher of $250 (or $500) or his or her actual earned income in figuring the earned income limit. If, in the same month, both you and your spouse were either students or disabled, only one of you can be treated as having earned income in that month.