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.
For information on the third coronavirus relief package, please visit our “American Rescue Plan: What Does it Mean for You and a Third Stimulus Check” blog post.
Benefits of the tax credit
The Child and Dependent Care Credit is a tax break specifically for working people to help offset the costs associated with caring for a child or dependent with disabilities.
There are two major benefits of the credit:
- This is a tax credit, rather than a tax deduction. A tax 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.
- A lot of tax breaks have income limits and are not available at all to people with incomes above those limits. In most years you can claim the credit regardless of your income. The Child and Dependent Care Credit does get smaller at higher incomes, but it doesn't disappear - except for 2021. In 2021, the credit is unavailable for any taxpayer with adjusted gross income over $438,000.
Care you can claim
To qualify for the child and dependent care credit, you must have paid someone, such as a daycare provider, 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 person you paid 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-spouse 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 they are 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 themselves 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.
- 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 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.
- The higher your income, the smaller your percentage, and therefore the smaller your credit. There is no upper limit on income for claiming the credit for tax years except for 2021.
For tax year 2022, 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. The percentage of your qualified expenses that you can claim ranges from 20% to 35%.
The American Rescue Plan brings significant changes to the amount and way that the child and dependent care tax credit can be claimed for 2021. The plan increases the amount of expense eligible for the credit, relaxes the credit reduction due to income levels, and also makes it fully refundable. This means that, unlike in other years, you can still get the credit even if you don’t owe taxes.
- The amount of qualifying expenses increases from $3,000 to $8,000 for one qualifying person and from $6,000 to $16,000 for two or more qualifying individuals
- The percentage of qualifying expenses eligible for the credit increases from 35% to 50%
- The beginning of the reduction of the credit is increased from $15,000 to $125,000 of adjusted gross income (AGI).
- The credit is unavailable for any taxpayer with 2021 adjusted gross income over $438,000.
Also for tax year 2021, the maximum amount that can be contributed to a dependent care flexible spending account and the amount of tax-free employer-provided dependent care benefits is increased from $5,000 to $10,500 ($5,250 for married filing separately).
While the child and dependent care credit is attractive, you may save even more money with other options. For example, 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 may be possible with a Flexible Spending Account or similar account.
- Consider 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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