The federal Child Tax Credit is recognizable to most American families with children since parents of more than 60 million children received boosted payments in 2021.
However, another tax credit is available to less well-known parents than the CTC but may be far more generous, giving up to $8,000 in tax credits this year.
The Child and Dependent Care Credit were bolstered by the 2021 American Rescue Plan, which increased the amount parents may claim on their tax returns for childcare expenditures while also fully refunding the credit.
This is critical because if your tax credit exceeds your IRS debt, you will get the difference in your tax refund.
The Child and Dependent Care Credit is not a new concept; it dates back to the 1970s and is created to assist working parents in defraying the expense of daycare, after-school programs, and summer camps.
However, the credit has not kept pace with rising child care costs, with the child advocacy group First Five Years Fund reporting in 2018 that it covered just approximately 10% of the average annual cost of care for two children in the United States.
The American Rescue Plan benefited families in several ways. This includes a significant extension of the Child, and Dependent Care Credit, which the Biden administration has stated to assist parents in returning to work.
Parents may now claim a tax credit of up to $8,000 — roughly four times the previous cap of $2,100.
By comparison, the enhanced Kid Tax Credit pays $3,600 for each child under six and $3,000 for children aged six to seventeen.
“They’re acknowledging the rising expense of child care in our society,” said Robbin Caruso, co-chair of Prager Metis’ National Tax Controversy Practice. “This is a tremendous opportunity for taxpayers that should not be passed up.”
According to Care.com, the average weekly charge for a child care center in 2020 was $340, equating to about $1,400 per month.
The cost of child care is driving some parents out of the workforce, with a Bankrate.com poll revealing that one in five parents aged 25 to 31 quit their employment to focus on childcare responsibilities.
Experts say that the tax credit is also fully refundable is critical since it may enhance many parents’ tax refunds this year.
Tax credits reduce a person’s tax burden on a dollar-for-dollar basis, whereas deductions reduce a person’s overall taxable income.
It implies that tax credits, such as the Child and Dependent Care Credit, are more useful to taxpayers than deductions – and become much more attractive when fully refundable.
How am I to obtain $8,000?
The maximum tax credit that parents may earn is $8,000 for households with two or more children.
The enhanced tax credit allows families to claim a credit equal to 50% of their child care expenditures, up to $16,000 for families with two or more children.
In other words, families with two children who spent at least $16,000 on daycare in 2021 can claim an additional $8,000 in tax credits from the IRS.
Before the American Rescue Plan, parents could claim just 35% of up to $6,000 in child care expenditures for two children or a maximum credit of $2,100.
Parents with one kid may deduct 50% of their child care expenditures, up to $8,000. This implies that parents with a single kid may claim a maximum tax credit of $4,000 this year. (Before the American Rescue Plan, the maximum tax credit for parents with one kid was $1,050.)
Many parents “may be unaware of the boost,” Lisa Greene-Lewis, a certified public accountant and tax specialist with TurboTax, said of the sweetened Child and Dependent Care Credit.
The enhanced tax credit is available to parents and adults with dependents who paid for the care of a qualified individual to work or search for a job during 2021.
According to the IRS, an eligible individual might imply one of the following:
- A dependent kid under the age of 13 years.
- A spouse or dependant of any age who is incapable of self-care and resides with you for more than six months of the year.
- The latter is critical since it extends the benefit to those caring for elderly or disabled adult children and taxpayers who claim senior relatives as dependents and pay for their care.
“If you have a disabled child, there is no upper age restriction,” Greene-Lewis explained.
Additionally, the tax credit has income restrictions comparable to the Child Tax Credit and stimulus cheques. For individuals earning more than $125,000, the credit percentage is lowered by one percentage point for every $2,000 of adjusted gross income.
That implies that someone earning $127,000 may deduct 49 percent of their child care expenses.
Families earning more than $183,000 are only allowed to deduct 20% of their child care costs. However, the benefit is phased out entirely for households earning more than $428,000.
One critical element, Caruso noted, is that married parents must typically file a joint return to receive the credit. Generally, she added, those who are married but file separately cannot get the benefit.
What kind of costs are deemed legitimate?
Because the Child and Dependent Care Credit is intended to assist working families in paying for child care, parents must have spent money caring for their children or dependents to work or seek a job.
Individuals who pay for the care of elderly dependents may deduct costs such as adult daycare.
Care can be provided in or out of the house and may include everything from nannies to child care centers.
However, the IRS needs parents to enter the provider’s name, their Social Security or Employer Identification Number, and check a box indicating if they are a household employee. (You may see the tax credit application form here.)
- Day camps are eligible; however, overnight camps are not, as they do not require a parent to work or seek a job.
- The IRS explains that before- and after-school activities are also deductible as child care costs.
- Care supplied by a non-dependent relative may count as a cost.
- “It may count as summer camp, sports camp, or anything else that enables you to work or search for a job,” Greene-Lewis explained.
Which costs are not covered?
As with the distinction between overnight and day camps, the IRS does not consider all types of expenses to be acceptable.
If you enroll your kid in a private school, the IRS states that you cannot claim tuition as a Child and Dependent Care Credit cost since K-12 tuition is considered an educational expense, not a child care expense. (However, as previously stated, the IRS states both before- and after-school programs are qualified.)
Care supplied by dependents or spouses will not qualify. Essentially, the IRS argues that you cannot pay an older adolescent to care for a younger youngster and then claim a tax credit. Paying your spouse or wife to care for their child is a non-starter.
One point to note: If you paid for child care using a Flexible Spending Account — which allows individuals to set aside pre-tax money to pay for preschool and other child-related expenditures — you would be unable to claim this credit for those payments. That is because people would be able to claim two tax advantages on the money.
What if I worked part-time, was enrolled in school, or worked from home?
According to the IRS, parents must be employed or actively seeking employment to qualify, although there is some wriggle space in some places.
According to the IRS, parents are regarded as working during any month in which they are enrolled as full-time students.
Work might be full- or part-time for an employer or yourself in your own business or partnership. Additionally, it can occur either inside or outside of your home.
One significant caveat: While credit benefits job seekers, it is only available to taxpayers who earn money during the year. Therefore, if you looked for employment but were unable to find it (and thus had no income in 2021), you will be unable to claim the tax credit.
What will happen to the tax credit in the coming year?
As is the case with several other provisions in the American Rescue Plan, the enhanced Child and Dependent Care Credit is only effective for the 2021 tax year – the year for which individuals are currently submitting their tax returns.
The tax credit will revert to its prior form in 2022. This implies that next year when parents file their tax returns, the benefit will be lowered to the former limit of $2,100.