One of the less promoted aspects of the American Rescue Plan Act was the significant enhancement of the child and dependent care tax credit for 2021. The expanded credit is dramatically more valuable, and now refundable as well, so I wanted to share details on how it works so we can help you maximize its value to you.
What is the Child and Dependent Care Credit?
The Federal government provides a tax credit to reduce your child or dependent care costs. This is a direct reduction of your Federal Income Tax liability.
Why is this tax change a big deal?
Previously, the credit was much smaller than it is now. It phased out starting at $15,000 and was only good on the first $3k of expenses, so many of our clients had only $600 or $1,200 of max value for it...so it was helpful, but it didn’t really move the needle on child care decisions.
All of a sudden it’s worth as much as $8,000 for a family with two kids, so it can really help out this year... we think it is especially important for clients looking (right now!) to make decisions regarding summer care options for children.
What expenses qualify for the Dependent Care Credit?
Expenses that are ‘employment-related’ costs of taking care of your qualifying dependents qualify. The typical expenses that qualify for the credit are payments to a day-care center, nanny, or nursery school. The cost of kindergarten or above doesn't qualify because it's primarily an education expense. However, the cost of before and after school programs may qualify as care expenses. Summer day camps qualify.
What does ‘employment-related’ mean?
The expense must enable you and your spouse, if you have one, to work. This means that a family with a non-working parent cannot claim the credit (unless they’re in school full time, but ask us about those rules).
Who are ‘qualifying dependents?’
Qualifying dependents are generally children under 13 (or a handicapped spouse or dependent) who lives in your household for over half of the year.
How much is the Dependent Care Credit?
The credit is 50% of up to $8,000 you spend on one qualifying dependent or 50% of up to $16,000 you spend on two or more qualifying dependents. That means you can get back up to $4,000 for one child or $8,000 for two children.
What are the income limitations?
If your AGI is $125,000 or less, you get the full credit.
If your AGI exceeds $125,000, your credit percentage (which starts at 50%) drops by 1% for every extra $2,000 (or fraction thereof) of AGI you have, down to a floor of 20%.
If your AGI exceeds $400,000, your credit keeps dropping by 1% for every extra $2,000 (or fraction thereof).
Examples:
Taxpayer A makes $90,000 of AGI.
Taxpayer A’s AGI is less than $125,000, so Taxpayer A gets a full 50% credit for any eligible Dependent Care Costs.
Taxpayer B makes $135,000 of AGI.
Taxpayer B’s AGI is $10,000 higher than $125,000, so Taxpayer B gets a 45% credit for any eligible Dependent Care Costs. (Calc = $10,000 overage / $2,000 = 5 % reduction)
My child stays with my mom/sister/cousin/friend during the summer. Can I pay them and claim the credit?
Eligible Dependent Care Expenses must be from legal child care sources. You must provide the care-giver's name, address, and social security number (or tax ID number if it's a day-care center or nursery school). A day-care center must be in compliance with state and local regulations.
Is the credit refundable?
Yes! This credit can be directly refunded to you when you file your 2021 taxes.
How can I maximize the value of the Dependent Care Credit for my family in 2021?
If you have children under 13, some of the most common options to max out this credit are as follows:
If you have a child below the kindergarten age, nursery school / nanny / daycare expenses will all qualify for the credit (even if the school has a significant educational component)
If you have a child from Kindergarten through age 13, expenses that aren’t for education can be covered. After school care, for example, generally qualifies.
The full amount paid for a day camp in summer, even if it specializes in particular activities like computer or lacrosse camp, will qualify if they enable the parent(s) to work. Overnight camp costs are limited to the part of the day that the parent(s) are working.
While the expanded credit is currently only available for 2021, we expect that an extension of the credit will be built inside of the coming infrastructure bill or the next major spending bill, so it is likely that these rules can help you for several years to come.
