While monthly child tax credit payments have gotten more attention, the American Rescue Plan Act offers another benefit for families with younger children – an enhanced child and dependent care credit for 2021. Not only will millions of families get a larger credit when they file their tax return next year, but many more Americans will get the full credit amount for 2021. It will also generate tax refunds for many families, which is something the credit didn't do before. These enhancements will make a significant impact on the bottom line for millions of people with childcare expenses this year.
- SEE MORE 2021 Child Tax Credit Calculator
The changes are only temporary, though. As it stands right now, they only apply to the 2021 tax year. However, President Biden wants to make the child and dependent care tax credit enhancements permanent. So, stay tuned for further developments!
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Child and Dependent Care Credit Basics for 2020
You may have claimed the child and dependent care credit on your 2020 tax return if you paid someone to care for your child last year so that you (and your spouse, if filing a joint return) could work or look for work. The child must have been a dependent who was under age 13 when the care was provided.
For 2020, the credit amount was a percentage of certain work-related expenses you paid to a care provider for the care of your child or a disabled person. The percentage depended on your adjusted gross income (AGI). It started at 35%, but it was then reduced (but not below 20%) by one percentage point for each $2,000 (or fraction thereof) that your AGI was over $15,000. So, for example, if your AGI was $25,000, then your credit was worth 30% of allowable expenses.
However, the total expenses used to calculate the credit were limited. You could only use up to $3,000 of paid expenses if you had one child/disabled person in your family, or up to $6,000 of paid expenses for two or more. That means the maximum credit for 2020 was $1,050 if you had one qualifying child/disabled person (35% of $3,000) or $2,100 if you had more than one (35% of $6,000).
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The 2020 credit was also non-refundable. That means it couldn't reduce the tax you owed below zero and, therefore, trigger a refund on its own. For example, if your 2020 tax bill before applying the credit was $500, and your credit was worth $600, only $500 of the credit was actually used. You didn't get the remaining $100 as a refund on your 2020 tax return. Instead, it was wasted.
Changes for 2021
The American Rescue Plan Act made several changes to the child and dependent care credit for the 2021 tax year. First, it made the credit refundable for people who live in the United States for more than half of the year. (If you're temporarily away from home because of illness, education, business, vacation, or military service, you're generally treated as living in that home during that time.) Using the example above for a non-refundable credit – a $500 tax liability and a $600 credit – that means you would get the excess $100 back as a refund on your 2021 tax return. The extra credit amount won't go to waste. This helps lower-income people the most since they are more likely to lose all or some of the credit's worth when it's non-refundable.
There are other changes that increase the potential credit amount for 2021. First, the maximum percentage for 2021 is bumped up from 35% to 50%. More paid expenses are subject to the credit, too. Instead of up to $3,000 in expenses for one child and $6,000 for two or more, the American Rescue Plan Act allows the credit for up to $8,000 in expenses for one child and $16,000 for multiple kids. When combined with the 50% maximum credit percentage, that puts the highest credit amount available for this tax year at $4,000 if you have just one child and $8,000 for two or more children.
The phase-out structure is also changed so that many more families will get the maximum credit amount. Instead of the credit percentage starting to decrease when AGI exceeds $15,000, it won't be reduced until AGI reaches $125,000. So, every eligible family with an AGI of $125,000 or less will get a credit worth 50% of their qualifying expenses. The percentage is gradually reduced from 50% to 20% for people with an AGI between $125,001 and $183,001. It stays at 20% for families with an AGI from $183,001 to $400,000, but then it's gradually reduced again from 20% to 0% for taxpayers with an AGI above $400,000. If your AGI is above $438,000, you won't get a credit.
More Than Just Child Care
As the name suggests, the child and dependent care credit isn't just for childcare. It covers expenses for the care of other people, too. In addition to expenses for the care of a child under the age of 13, the credit is available for expenses to care for:
- A spouse who was physically or mentally incapable of self-care and lived with you for more than half of the year; or
- Someone who was physically or mentally incapable of self-care, lived with you for more than half of the year, and either (1) was your dependent, or (2) could have been your dependent except that he or she received gross income of $4,300 or more, he or she filed a joint return, or you (or your spouse, if filing jointly) could have been claimed as a dependent on another person's tax return.
The second category can include elderly parents living with an adult child if the parent is claimed as a dependent on the child's tax return.
A person who can't dress, clean, or feed themselves because of physical or mental problems are considered not able to care for themselves. A person who must have constant attention to prevent them from injuring themselves or others is also considered not able to care for themselves.
Additional Rules Apply
We've just scratched the surface when it comes to the overall requirements for the child and dependent care credit. For instance, there are specific rules governing the type of care provided, what's considered a work-related expense, identification of the care provider, earned income requirements, and more. You can find more information about the credit in IRS Publication 503, or talk to a tax professional about it. But one way or another, make sure you take advantage of this valuable credit if you pay to have someone else care for a child or other eligible person. It could save you thousands of dollars when you file your next tax return.
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