One of the most valuable tax credits for working parents is the child and dependent care credit. This credit is claimed by millions of people annually and has provided relief on the tax burden faced by many Americans who rely on childcare. The American Rescue Plan Act, the most recent economic stimulus package passed in Washington, offers an enhanced child and dependent care credit for 2021. While these enhancements are temporary, they could very well be extended into the future.
Before looking at the implications of the enhanced credit, it is important to understand the basics of the child and dependent care credit for the current 2020 tax year. You can claim the child and dependent care credit if you paid someone other than your spouse to care for your child or a dependent. The childcare credit applies to children who were under 13 during the period they were provided care. In addition to children under 13, the credit also applies to (1) a spouse who was physically or mentally incapable of self-care and lived with you for more than half of the year, and (2) an individual who was physically or mentally incapable of self-care and lived with you for more than half of the year. The latter individual must be either (1) your dependent or (2) could have been your dependent except he or she received gross income of $4,300 or more, he or she filed a joint return, or you (or your spouse, if filing jointly) could have been claimed as a dependent on another taxpayer’s 2020 return.
Childcare is expensive and this credit is designed to relieve working families of a portion of this financial burden. The credit allows you to reclaim up to 35% of your qualifying expenses up to $3,000 for one child or dependent and $6,000 for two or more children or dependents. This generates a maximum credit of $1,050 for one dependent and $2,100 for two or more dependents. The credit you receive is dependent on your Adjusted Gross Income (AGI). If your AGI is less than $15,000 you can receive the full 35% credit for all qualifying expenses. For every $2,000 that your AGI exceeds $15,000, your credit reduces by 1%. For example, if your AGI is $25,000, then your credit is 30% of allowable expenses. The 2020 childcare credit is non-refundable. This means that in the event the credit reduces your tax below zero, it will not trigger a refund. For example, if your tax bill pre-credit is $500 and your credit is worth $600, only $500 is applied to your tax bill. You do not receive the remaining $100.
The American Rescue Plan Act has made several changes to the child and dependent care credit for the 2021 tax year. It made the credit refundable for U.S. citizens who reside in the U.S. for more than half the year. In the example discussed above, if the scenario were for the 2021 tax year you would receive the $100 as a refund on your 2021 tax return. This provision specifically helps lower-income individuals because they are more likely to lose all or some of the credit when its non-refundable. The maximum percentage of eligible childcare expenses for 2021 is bumped from 35% to 50%. More expenses can be subject to the credit as well; the plan allows for a credit of up to $8,000 in expenses for one child or dependent and $16,000 for two or more children or dependents. This would put the maximum credit amount available (with the 50% percentage) for the 2021 tax year at $4,000 for one child and $8,000 for two or more children. The phase-out structure has also been adjusted so more families will be eligible to receive the maximum credit. The phase out won’t begin until AGI reaches $125,000, meaning families with AGI under $125,000 will be eligible for a credit worth 50% of eligible expenses. The percentage is gradually reduced from 50% to 20% for families with an AGI between $125,000 and $185,000. The 20% stays constant for families with an AGI between $185,000 and $400,000 and is gradually reduced again from 20% to 0% for families with an AGI exceeding $400,000. The credit is completely phased out for families with an AGI above $440,000.
There are specific rules governing what type of childcare is covered, which expenses are eligible, earned income requirements, etc. You can find this information in IRS publication 503 or by talking to a tax professional. This is an extremely valuable credit for both the 2020 and 2021 tax years, and it could save you thousands on your next tax return.
Sources: https://www.kiplinger.com/taxes/602508/child-care-tax-credit-expanded-for-2021?rid=EML-tax&rmrecid=4737515364&utm_campaign=20210410-tax&utm_medium=email&utm_source=tax, https://www.1040.com/tax-guide/taxes-for-families/child-and-dependent-care/#:~:text=The%20credit%20is%20for%20the,jointly%2C%20must%20have%20earned%20income., & https://turbotax.intuit.com/personal-taxes/online/live/overview/