If you are paying someone to take care of your children or another person in your household while you work, you might be eligible for the child and dependent care credit. This credit "gives back" a portion of the money you spend on care, and can reduce your tax bill by hundreds or even thousands of dollars.
Benefits of the tax credit
The child and dependent care credit is a tax break specifically for working people, says Matt Becker, a financial planner and founder of Mom and Dad Money. "Child care is expensive, and the cost gives many parents pause about whether it's worth returning to the workforce," Becker says. "But the child and dependent care credit can make it a little easier for parents to keep working without putting too much stress on their budget."
He cites two major benefits:
- This is a tax credit, rather than a tax deduction. A deduction simply reduces the amount of income that you must pay tax on. A $1,000 deduction, for example, might reduce your tax bill by only $150 or $200 depending on your tax bracket. A tax credit, however, directly reduces your taxes, "dollar for dollar." A $1,000 tax credit cuts your tax bill by $1,000.
- You can claim the credit regardless of your income. A lot of tax breaks have income limits and are not available at all to people with incomes above those limits. The child and dependent care credit does get smaller at higher incomes, but it doesn't disappear. "Those with a higher income may not get quite as much benefit, but they will still get something," Becker says.
Care you can claim
To qualify for the child and dependent care credit, you must have paid someone to care for one or more of the following people:
- A child age 12 or younger at the end of the year whom you claim as a dependent on your tax return
- Your spouse, if that person is unable to take care of himself or herself and has lived in your home for at least half the year
- Any other person claimed as a dependent on your return, if that person can't take care of himself or herself and has lived in your home at least half the year
Limits on who can provide care
You can claim the credit for money you paid for care as long as the recipient was not one of the following people:
- Your spouse
- A parent of the child being cared for—for example, you couldn't claim the credit if you pay your ex-husband or ex-wife to care for the children you have together
- Anyone listed as a dependent on your tax return
- Your own child age 18 or younger, regardless of whether he or she is a dependent on your tax return—for example, you couldn't pay your 17-year-old child to look after an 8-year-old sibling and then claim the credit
There are several other tests you must meet to claim the credit:
- You (and your spouse, if you're married) must have "earned income," meaning money earned from a job. Non-work income, such as investment profits, doesn't count.
- You must have paid for the care so that you could work or look for work. Being a full-time student or a parent unable to care for themself does count as "working" for the purposes of the credit even if you don’t receive any income for it.
- If you are married, you must file a joint tax return.
- You must provide the name, address and Taxpayer Identification Number (TIN) of the person who provided the care. The taxpayer ID number is either a Social Security number (SSN) or an Employer Identification Number (EIN). Ask your care provider for the number.
Figuring the credit
The size of your credit is based on how much you spend for child and dependent care, as well as your income. TurboTax guides you through the process of figuring your credit and fills in the proper form for you, but in general, it works like this:
- Add up the total amount of your care expenses that qualify for the credit. The maximum amount of care expenses you're allowed to claim is $3,000 for one person, or $6,000 for two or more people.
- If your employer gives you money to pay child care expenses, or if you have money withheld from your pay on a pre-tax basis, you must subtract this money received from your allowable expenses.
- Compare your claimed expenses with your earned income and, if you're married, your spouse's earned income. Take the smallest of all these amounts. These are your "allowable expenses."
- Your credit is a percentage of your allowable expenses. That percentage ranges from 20% to 35%. The higher your income, the smaller your percentage, and therefore the smaller your credit. But as Becker notes, there is no upper limit on income for claiming the credit.
Financial planner Mathew Dahlberg notes that while the child and dependent care credit is attractive, it may be possible to save even more money. If your employer provides a way to pay for child care with "pre-tax" dollars—that is, money that's taken out of your paycheck before taxes are calculated—the amount you save in taxes may be greater than what you get with the credit. This might be possible with a Flexible Spending Account or similar account. He advises checking with your employer's human resources department to explore your options.
And while you're at it, take time to learn about other tax breaks available to parents.
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