Dependent Care FSA Pre-Tax Benefit - Gotcha! Spousal Income came out zero

I contributed to Dependent Care FSA from my employer where I had paid for my 4yr old's preschool and had contributed $2000 into the plan starting midway in 2005 assuming spouse will have income. I just got reimbursed by the FSA account for the 2K I put in (supposedly pre-tax). BUT, it so happened that spouse only ended up looking for work the whole year and did not have any income. Now W2 shows this $2K in box 10 and my tax software wants to add it to the income in Box #1. The income in Box #1 is my salary minus 401k deductions only, and does not account for (reduction for) the amount in box 10.

Is there still a way to claim the pre-tax benefit since IRS says both parents must work or be looking for work ? Though I know IRS also seem to want the spouse to have income as well (how could someone who looked hard for work but did not get any have an income beats me, but) which is missing in our case.

Any suggestions ? In worst case how do I atleast not have the DC FSA amount in Box 10 not added to the income and come out with zero pre-tax benefit ? Thanks in advance for any pointers.

Ennemm,

You are right, the rules say "while at work or looking for work". It does not say the provider must find work.
Was your spouse was looking for work on each day your dependent was in pre school?

Why not put $1 as income for your spouse and see how your software handles that?

Then you could always attach a note to your return and mail it in.

Have you talked with the the software support folks?

clydewolf: thanks for replying. I am really tearing mad on how to resolve this and will greatly appreciate further response.

My spouse was looking for work all the time which also involved researching jobs as well as technical materials and thus (I thought) well suited for the pretax benefit except that the income part missing.

At this point I am just aiming to not have the extra tax liability and get what I would have without participating in DC FSA plan with employer, that is, not have the Box 10 amount added to my taxable income in Box 1. I found an IRS FAQ, that may seem simple but I do not understand fully: http://www.irs.gov/faqs/faq7-1.html (see 2nd question)

If I plan to attach a note as you say (seems most appropriate), should I just skip adding of Box 10 amount to Box 1 amount onto line 7 of 1040 and not fill out any Form 2441 (as I am not eligible due to zero income) ?

Software support folks were no help (TaxCut: never again) and seem to have a known issue but their short explanation is not helping: http://answer.taxcut.com/index.cfm?svc=152&DocFile=http://www.kb.techknow-how.com/exports/partner_data/30/html/30-234881841.html

My employer insists that they are supposed to put DC FSA amount in Box 10 upto $5K, and are not reducing Box 1 amount by that much.

So the IRS, the employer and the software support are all not helping the issue, on how to get zero pre-tax benefit on having participated in DC FSA but not qualifying for pre-tax benefits due to zero spousal income.

Help!

Resolved:

Careful examination of all pay slips reveal that through out the year, the DC FSA amount was being deducted before calculating gross income, thus absent from any taxation whatsoever. So YTD gross income / one in W2 box 1 actually did not have that included. So it should be okey for box 10 amount to be added to Box 1.

But as far as eligibility though, the IRS could have improved on the language on "looking for work" portion to more explicitly say that income not earned when looking for work does not qualify one for the benefits. Seems unfair though for very specialized knowledge workers who spend time looking for work but do not end up earning and still have to spend on child care the same as a working couple.

Ennemm,

Looking into this further, the rules do state that for a couple to claim the Dependent Care Credit, both spouses must have earned income.
Unless one of the spouses is a full time student or unable to care for themselves.

This is just another quirk in the tax laws.