In one of last month’s blogs, we discussed changes to the Child Tax Credit for this tax year. While this credit is available to anyone with a qualifying child, working parents with children ages 12 and younger, who pay for childcare, can also receive additional tax credits.
According to Care.com and the Center for American Progress, the national average annual cost of care for one child in a typical daycare setting is $17,700. This amount increases to $31,800 annually if you hire an in-home nanny.*
In my recent search for a daycare provider, I can confirm that at least in my part of town those national averages seem to be pretty on par.
As with the Child Tax Credit, there have been significant changes to the Child and Dependent Care Credit for this year as a result of the American Rescue Plan.
2020 Care Credit
Last year, the amount of the credit depended on the percentage of work-related expenses you paid to the person or childcare facility caring for your child with a maximum of $3,000 in paid expenses for one child and $6,000 for two or more.
This credit was also reduced at various income levels. It started at 35% of paid expenses and was then reduced, but did not go below 20%, depending on your Adjusted Gross Income (AGI). For those with AGIs above $15,000 the credit was reduced 1% for each $2,000 over the amount your AGI was over $15,000. Meaning AGIs starting at $43,000 would only qualify for 20% of paid expenses.
This credit was also nonrefundable, so if your tax liability after all other adjustments was $0, you would not have received an additional benefit in the form of a tax return.
These formulas can be confusing, so here’s an example of the tax credit at work.
You and your spouse have an AGI of $250,000 a year, have one child, and have qualified childcare expenses of $17,000 (around the national average).
Your income level determines that you can only claim credit for 20% of qualifying expenses, with a max of $3,000 in expenses, equaling a $600 tax credit. (20% * $3,000 = $600)
If this same family had two children and paid $34,000 in expenses, they’d be limited to $6,000 in expenses equaling a $1,200 credit. (20% * $6,000 = $1,200)
2021 Care Credit
This year the amount of qualified expenses you can claim has increased to $8,000 for one child and $16,000 for multiple children.
Additionally, instead of the original 20-35% taxpayers could claim on expenses last year, the amount has increased to 20-50% for 2021.
The credit is still subject to different income thresholds, but the AGI limits have increased. Families with AGIs of $125,000 or less can claim up to 50% of expenses. The credit is reduced from 50% to 20% for AGIs between $125,001-$183,000. The credit will stay at 20% for families with AGIs between $183,001-$400,000. The credit is reduced once more from 20% all the way down to 0% for families with AGIs between $400,001-$440,000.
Unlike last year, this credit is refundable if you live in the US for more than half of the year, meaning that if you are at or near a $0 tax liability and claim this credit, you could receive a refund.
Here’s an example to see this year’s credit at work.
Using the same numbers from last year’s example.
You and your spouse have an AGI of $250,000 a year, have one child, and have qualified childcare expenses of $17,000.
Your income level determines that you can only claim credit for 20% of qualifying expenses, with a max of $8,000 in expenses. This equals a $1,600 tax credit, a thousand more than last year. (20% * $8,000 = $1,600)
If this same family had two children and paid $34,000 in expenses, they’d be limited to using only $16,000 in expenses equaling a $3,200 credit, two thousand dollars more than last year. (20% * $16,000 = $3,200)
Other Qualifying Persons
There are a few other circumstances where taxpayers can receive this credit for expenses for other dependents who are incapable of self-care. Those are outlined in this IRS publication.
There are also specific rules regarding what’s considered a work-related expense, the type of care provided, and who’s providing the care. To find out if you’re eligible, you can take this questionnaire provided by the IRS.
This tax credit certainly won’t cover all your childcare expenses, but it beats a sharp stick in the eye! So, if you can, don’t forget to use it along with the regular Child Tax Credit.
As with the some of the other expanded tax breaks for parents this year, this is subject to change for the 2022 tax year.
*Source: Care.com & Center for American Progress