The child and dependent care tax credit is a credit allowed for expenses that a taxpayer incurs for the care of a child under age 13 or a dependent relative that enable the taxpayer to work or look for work.
The American Rescue Plan Act (ARPA) enacted March 11, 2021 expanded the credit for tax year 2021, which means that more taxpayers will be eligible for the credit and the amount of the credit many taxpayers receive will be larger.
To qualify for the credit, a taxpayer must incur dependent care expenses that enable them to work (or look for work). Qualified expenses include, but are not limited to: daycare centers, babysitters, nursery schools, pre-schools, summer day camps (but not overnight camps).
You (and your spouse if filing a joint return) must have earned income to claim the credit. Earned income includes wages, salaries, tips, other taxable employee compensation, and net earnings from self-employment. Unemployment compensation is not included in earned income. However, a credit can still be claimed if one spouse was a full-time student or disabled. In that case, the spouse would be considered to have earnings of $250 a month for one child or $500 per month for two or more children.
Prior to the ARPA, the maximum credit percentage was 35% of qualified expenses, gradually being reduced to 20% for taxpayers with adjusted gross income over $43,000 (for 2020). The credit used to be available for the first $3,000 of qualified expenses for caring for one child or $6,000 for two or more children. Therefore, the maximum credit taxpayers received was generally either $600 or $1,200, respectively.
Under ARPA, the maximum credit percentage is increased from 35% to 50%, while the limit for qualified expenses increased to $8,000 for one child and $16,000 for two or more children. As a result, the maximum credit for 2021 is $4,000 for one child or $8,000 for two or more children. However, there is some not so good news for higher-income taxpayers. The 50% amount begins to phase out if adjusted gross income is more than $125,000, and completely phases out if adjusted gross income is more than $438,000. Prior to ARPA enactment, there was no income limit to claim the credit.
Another change under ARPA is that the credit is now refundable. This means that even if your credit exceeds the amount of Federal income tax that you owe, you can still claim the full amount of the credit.
To be eligible for the refundable portion of the credit for 2021, you must have your main home in one of the 50 states or the District of Columbia for more than half of the tax year. To claim the credit, you will need to complete Form 2441, Child and Dependent Care Expenses, and include the form when you file your tax return. As of right now, these changes to the child care credit are set to expire at the end of this year. However, Congress could possibly extend it.
Article Submitted by – Viktoriya Olunin, CPA