While the monthly child tax credit payments have gotten more attention, The American Rescue Plan Act (March, 2021) offers increased money at tax time. The Enhanced Child and Dependent Care (ECDC) credit, often confused with the Child Tax Credit, is intended to help parents by providing a boost at tax time to help cover the costs for 2021.
The ECDC credit will have a significant impact on millions of families and will only apply to this 2021 tax year. There is talk that the ECDC credit will be made permanent. For now, this means that many families will get the full credit amount for 2021.
There are two major perks of the tax credit. First, it is a tax credit, not a deductible. While a tax deduction reduces the amount of income paid on tax, the ECDC credit is simply money you get. For example, you can have a tax reduction of $1,000 and this may reduce your tax by only $150 to $200 depending on your tax bracket. If you have a tax credit of $1000, however, and would receive $1000. Second, a major benefit of the ECDC credit is that you can claim it regardless of your tax bracket and income. Many tax breaks have income limits and not all people are eligible, while the tax credit does decrease with higher incomes, it does not disappear.
What you need to know.
The ECDC credit also allows eligible parents to claim up to 50% of $8,000, up to two children. Families receive up to 50% of these expenses as a refundable credit, depending on income.
- The refundable tax credit – normally up to $2,000 per qualifying dependent – was expanded to up to $3,600.
- Qualifying expenses increased from $3,000 to $8,000 for one and from $6,000 to $16,000.
- Qualifying expenses eligible for the credit increased from 35% to 50%.
- Reduction of the credit has increased from $15,000 to $125,000 of adjusted gross income (AGI).
- The maximum amount that can be contributed to a dependent care flexible spending account and the amount of tax-free employer-provided dependent care benefits is increased from $5,000 to $10,500.
How to qualify.
To qualify for the ECDC credit you must have paid someone, such as a daycare provider, to care for one or more of the following categories of people:
- A child under the age of 13 whom you claim as dependent on your tax return.
- Your spouse. if that person is unable to take care of himself or herself and has lived in your home for at least half the year.
- Any other person claimed as a dependent on your return, if that person can’t take care of himself or herself and has lived in your home for at least half the year.
- Limits on who is considered a daycare provider.
- You can claim the credit for any money you paid for care, as long as the paid caregiver was not one of the following people.
- Your spouse or a parent (e.g., step, ex) of the child being cared for.
- Anyone listed as a dependent on your tax return.
- Your own child (18-years or younger) regardless of whether he or she is dependent on your tax return (e.g., you can not play your 17-year old child to look after your 8-year old child).
- Additional requirements: taxpayers with adjusted gross incomes of $438,000 are not eligible for this credit even though they may have previously been able to claim this credit.
- You (and your spouse, if you’re married) must have “earned income,” meaning money earned from a job. Non-work income, such as investment properties, does not count.
- You must have paid for the care so that you could work or look for work. Being a full-time student or a parent unable to care for themselves does not count as “working” for the purpose of the credit, even if you don’t receive any further income for it.
- If you are married, you must file a joint tax return.
- You must provide the name, address, and Taxpayer Identification Number (TIN) of the person who provided the care. The taxpayer ID number is either a social security number or an employer identification number.
How to Calculate Your Credit.
Your credit amount is based on how much you spend on child and dependent care, as well as, your income. To calculate this for your tax form, you will need to do the following;
- Add up the total amount of your care’s expenses that qualify for the credit.
- If your employer provides you money to pay for child care expenses, or if you have money withheld from your pay on a pre-tax basis, you must subtract this money received from your allowable expenses.
- Compare your claimed expenses with your earned income and, if you’re married, your spouse’s earned income. Take the smallest of all of these amounts. These are your “allowable expenses.” Your credit is a percentage of your allowable expenses.
- The higher your income, the smaller your percentage, and therefore the smaller your credit. There is no upper limit of income for claiming the credit.
- You might remember that from your 2020 taxes, the maximum amount of care expenses you’re allowed to claim is $3,000 for one person or $6,000 for two or more people. The percentage of qualified expenses that you can claim ranges from 20% to 35%.
Weighing out alternatives.
While the ECDC credit is an attractive prospect, you could actually stand to save even more money with other options. If your employer pays for child care, for example, using “pre-tax” dollars or money that is taken out of your paycheck before taxes are calculated, then the amount you save on tax could be greater than what you would get from the credit.
We have just scratched the surface. When it comes to overall requirements for the child and dependent care credit there are many nooks and crannies. There are specific rules, for instance, governing the type of care provided, what’s considered work-related expenses, identification of the care provided, earned income requirements, to name a few. For more information, check out the credit in IRS Publication 503.
To avoid the headache of trying to figure all of this out for 2021 returns, we recommend you consult a tax professional. Reach out to Herman & Company – Accounting & Consulting with any questions. We are trained tax professionals who can help you navigate state and federal tax laws.