Do you pay someone to watch your young kids while you (and your spouse, if you are married) work during the day? You may be entitled to a dependent care credit that can offset your personal tax bill on a dollar-for-dollar basis. Even better: Thanks to the new American Rescue Plan Act (ARPA), the credit has been significantly enhanced for the 2021 tax year.
The dependent credit is available for expenses paid to a long list of providers from day care centers to babysitters to after-school programs. You can even claim the credit for summer day camp (but not overnight camp). But be aware that the tax benefits are reduced for certain high-income taxpayers.
Background: The dependent care credit, which was nonrefundable, could be claimed by a taxpayer who paid expenses to care for a child under age 13 or some other qualified individual (e.g., an elderly relative who is disabled) in order to be “gainfully employed.” Prior to ARPA, it was equal to 35% of qualified expenses for a taxpayer with an adjusted gross income (AGI) of $15,000 or less, reduced by one percent for each $2,000 that AGI increased. Thus, the credit equaled 20% for taxpayers with an AGI above $43,000.
This credit was available for the first $3,000 of qualified expenses for one child or $6,000 for two or more children. For example, if you had an AGI of $100,000 and paid $10,000 in qualified expenses for two children under age 13, the maximum credit was $1,200 (20% of $6,000).
Generally, if one spouse had no earned income, you could not claim the credit. However, if your spouse was a full-time student or disabled, he or she was treated as having monthly earnings of $250 if you had one qualified child or $500 per month for two or more children.
Key changes for 2021: ARPA includes significant improvements to the credit that apply for qualified expenses incurred in 2021. Consider the following:
- The dependent care credit is fully refundable for 2021.
- The maximum credit percentage is increased from 35% to 50%.
- The limit on qualified expenses is increased to $8,000 for one child and $16,000 for two or more children.
However, the credit percentage is gradually reduced if AGI exceeds $125,000. It bottoms out at 20% if your AGI exceeds $183,000.
In other words, the maximum credit for a taxpayer with AGI of $125,000 or less is $4,000 for one child and $8,000 for two or more children. It is $1,600 or $3,200, respectively, if your AGI exceeds $183,000.
Finally, if your AGI exceeds $400,000, the credit is further reduced until it zeroes out for an AGI above $438,000.
The other main rules remain in effect. That means you can still claim the credit for a wide range of expenses incurred in 2021.
More to come? The Biden administration has supported an extension of the enhanced dependent care credit benefits beyond 2021. We will continue to keep an eye out for more developments.