Your Child Care Tax Credit May Be Bigger on Your 2021 Tax Return

While monthly child tax credit payments have gotten more attention last year, the American Rescue Plan Act also offered 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 childcare credit when they file their 2021 tax return this year, but many more Americans will get the full credit amount for 2021. This 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 child or dependent care expenses last year.

Unfortunately, the changes are only temporary. They only apply to the 2021 tax year. For 2022, the old rules apply once again.

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Child and Dependent Care Credit Basics for 2020

You may have claimed the child and dependent care credit on the tax return you filed last year if you paid someone to care for your child in 2020 so that you (and your spouse, if filing a joint return) could work or look for work. If so, the child must have been a dependent who was under age 13 when the care was provided.

For the 2020 tax year, 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).

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 to the Child and Dependent Care Credit 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're 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 the 2021 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.

How to Claim the Child and Dependent Care Credit

To claim the child and dependent care credit, you must first complete IRS Form 2441 (opens in new tab). If you can check the box on Line B of Form 2441, the credit is refundable and the amount is eventually found on Line 10 of Form 2441. You must also report the credit amount on Line 13g of Schedule 3 (Form 1040) (opens in new tab).

If you have to check the box on Line A of Form 2441, your credit is nonrefundable and the amount is shown on Line 11 of Form 2441. If that's the case, you report the nonrefundable credit on Line 2 of Schedule 3.

Make sure you attach Form 2441 to your 1040 form when you file your return.

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 is considered to be unable 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.

Also note that the American Rescue Plan Act also made enhancements to the dependent care aspects of the 2021 credit. Under the law, employers could increase the maximum amount that could be excluded from an employee's income through a dependent care assistance program. For 2021, the maximum amount was increased from $5,000 to $10,500 (from $2,500 to $5,250 for married employees filing separate tax returns).

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 (opens in new tab), 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.