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If you paid a day care center, a qualifying relative, or other qualifying care provider to care for your child or other qualifying individual so that you and/or your spouse could work or look for work, you may be eligible to claim the Child and Dependent Care Credit on your 2021 tax return.

With so much publicity regarding tax year 2021 changes to the Advance Child Tax Credit payments, many taxpayers may have overlooked changes to another significant credit – the Child and Dependent Care Credit. In 2021, the American Rescue Plan Act of 2021 (ARPA), temporarily increased the benefit of the Child and Dependent Care Credit to provide additional help to working caregivers during the COVID-19 pandemic. Previously, taxpayers could claim the Child and Dependent Care Credit for between 20 and 35 percent of their eligible expenses, up to $3,000 for one qualifying person or $6,000 for two or more qualifying persons. The previous version of the credit was non-refundable. A non-refundable tax credit is a type of income tax break that reduces one’s taxable income dollar for dollar and can only reduce taxable income down to zero and will not generate a tax refund in the case that the potential credit exceeds the taxable income. Whereas, refundable tax credits, even if you don’t owe any tax, will result in a tax refund and will be paid to you.

For 2021 only, ARPA increased the limit on expenses that can be claimed to $8,000 for one qualifying person and $16,000 for two or more qualifying persons. The maximum credit amount was raised to 50 percent. For the first time, in 2021, the credit became potentially refundable. This means a maximum credit of $4,000 for one qualifying person receiving care, and $8,000 for two or more. In 2021, taxpayers with adjusted gross incomes (AGIs) up to $125,000 are eligible for the full credit, after which the percentage of expenses taxpayers can claim gradually decreases until it phases out at $438,000 in AGI.

How does the credit work?

For 2021, the credit for child and dependent care expenses is a refundable credit for taxpayers and their spouses (if married filing jointly), having a principal place of abode in the United States for more than half of 2021. A refundable tax credit directly reduces taxes dollar for dollar, and results in a refund when the amount of the credit exceeds a taxpayer’s tax liability. Taxpayers paying for the care of a qualifying person such as a child, elderly parent, or disabled family member so that they may work or look for work may be eligible for this significant tax break. The credit is designed specifically for working people to help offset the costs associated with providing care. For example, a single parent with one child paying $8,000 in child care expenses can save as much as $4,000 on an adjusted gross income of $50,000, while a married couple with 2 children paying $12,000 for care can save as much as $6,000 on an adjusted gross income of $125,000 or less.

Who is a “qualifying” person?

For purposes of the Child and Dependent Care Credit, a qualifying person is:

• A dependent qualifying child who was under age 13 when the care was provided,
• A spouse who was physically or mentally incapable of self-care and lived with the taxpayer for more than half of the year, or
• An individual who was physically or mentally incapable of self-care, living with the taxpayer for more than half of the year, and either: (a) was the taxpayer’s dependent; or (b) could have been the taxpayer’s dependent except that he or she received gross income of $4,300 or more, or filed a joint return, or the taxpayer (or taxpayer’s spouse, if filing jointly) could have been claimed as a dependent on another taxpayer’s return. (An individual is physically or mentally incapable of self-care if, as a result of a physical or mental disability, the individual is incapable of caring for his or her hygiene or nutritional needs or requires the full-time attention of another person for the individual’s own safety or the safety of others.)

What are the Child and Dependent Care Credit requirements?

• Taxpayer (and their spouse, if married) must have “earned income.” Special earned income rules apply for taxpayers, and their spouses, who are disabled or full-time students.
• The payments for care must be so that the taxpayers could work or look for work.
• If the taxpayers are married, they must file a joint return, unless they qualify for the limited exception for married taxpayers living apart from their spouse. (There are special rules if the taxpayers are divorced or separated. A noncustodial parent who is claiming a child as a dependent should review the rules in Publication 503, Child and Dependent Care Expenses.)
• Taxpayers generally must identify all persons or organizations that provide care for the child or dependent, reporting the name, address, and taxpayer identification number (either the Social Security number or the employer identification number) of the care provider on the return.

Who’s Claiming the Credit?

In tax year 2020, almost 5 million taxpayers claimed the Child and Dependent Care Credit, with over 1 million of these taxpayers also claiming the Earned Income Tax Credit (EITC). Those taxpayers claiming both the Child and Dependent Care Credit and EITC received on average $984 for the Child and Dependent Care Credit during tax year 2020. Further, almost 10,000 taxpayers claimed both the Child and Dependent Care Credit and EITC based on the need to care for a qualifying child with disabilities.

How do I claim the credit?

Taxpayers qualifying for the credit must complete Form 2441, Child and Dependent Care Expenses and attach it to their Form 1040, U.S Individual Income Tax Return, Form 1040-SR, U.S. Tax Return for Seniors or Form 1040-NR, U.S. Nonresident Alien Income Tax Return. If they received dependent care benefits from an employer (an amount is shown in Box 10 on their Form W-2, Wage and Tax Statement), they must complete Part III of Form 2441.

Taxpayers who are uncertain regarding their eligibility for the Child and Dependent Care Credit may use the Interactive Child and Dependent Care Credit Eligibility Assistant on IRS.gov to determine eligibility. Taxpayers should also determine if they are eligible for the EITC for a child of any age if the person has a total and permanent disability. Taxpayers needing assistance with EITC eligibility can use the IRS’s EITC Assistant to determine if they qualify for this credit.

Conclusion:

ARPA provided for expanded tax relief for millions of taxpayers who may be struggling financially because of the COVID-19 pandemic. Changes to the Child and Dependent Care Credit alone mean that more taxpayers are eligible for the credit for the first time, and for many, the amount of the credit will be larger than in prior years. TAS estimates most taxpayers will see a 136 percent average increase in this credit, with the credit climbing from a tax year 2020 average of $652 to an average of $1,537 for tax year 2021. When filing tax year 2021 tax returns, taxpayers should take advantage of this and other available tax relief provisions.

The IRS’s Volunteer Income Tax Assistance and Tax Counseling for the Elderly programs offer free basic tax return preparation to qualified individuals and can help ensure that taxpayers benefit from all the credits to which they are entitled.