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The Tax Credit for Childcare Expenses

Updated: Dec 15, 2020



With summer camps able to open and more daycare centers welcoming youngsters back, a discussion about childcare expenses seems timely.


What is the credit for child and dependent care expenses?

The credit is a tax break geared towards working individuals to offset the costs of childcare or care for a dependent who is mentally or physically disabled.


Qualifiers for claiming the credit

In order to claim the credit, all of the following requirements must be satisfied.


1. You (the taxpayer) paid someone or an organization to care for your dependent child under the age of 13, spouse who is disabled, or other dependent who is unable to care for themselves and lived with you for more than half the year.


For divorced parents, only the custodial parent is able to claim the credit.


2. You must have earned income for the year. Earned income includes wages, salaries, tips, other employee taxable compensation, and net earnings from self-employment.

Social security benefits, unemployment compensation, pensions, workers’ compensation, and interest and dividends are not considered earned income.


For any month that you or your spouse is a full-time student, you are considered as having earned income.


3. To qualify for the credit, the expenses must be considered work-related. What does this mean? Because the credit is designed for working people, you must incur the expenses as a means of allowing you to work or look for work. For married taxpayers, both spouses must work or look for work.


Special rules apply if you stop working or looking for work during part of the year, or if you work part-time.


4. You make payments for the care of your child or other dependent.


Different options for providing care exist.

· Nursery school, preschool, or similar programs

· Care provided by daycare centers that comply with state and federal regulations

· Day camps, but not overnight camps.

· Even summer camps designed around a particular activity like computer engineering or fly fishing

· In-home services such as having a nanny, a babysitter, or housekeeper who provides care to qualifying dependents

· Care provided by relatives. For example, your parent (the child’s grandparent) regularly cares for the child so you can work. The relative cannot be your dependent, your child under age 19, a person who was your spouse at any point during the year, or the parent of your qualifying child.


Generally, only the cost of the paid care provider is eligible for the credit. Expenses like those for meals, lodging, or entertainment can only be included if they are incidental and cannot be separated from the cost of care.


5. Married couples must file a joint return to claim the credit. Special exceptions exist if a couple is separated or living apart and do not file a joint return.


6. You must identify the individual or organization that provided care. Form 2441 must provide the provider’s name, address, and taxpayer identification number. Make sure you do your due diligence when gathering this information. Mistakes are on you, and can cause the credit to be disallowed.


Figuring the credit

With all of the qualifiers explained, let’s now discuss how the credit is figured numerically.


· The credit has a dollar limit of the lesser of actual expenses or $3,000 for one qualifying person or $6,000 for two or more.


· If your child dependent turns 13 during the year, the expenses you paid for the part of the year the child was 12 are eligible for the credit.


· The amount of the care expenses cannot exceed the smaller of your or your spouse’s earned income for the year. For example, if your spouse earned an income of $2,000 for the year, but you paid $3,000 for childcare, the amount of expenses you can use to claim the credit is limited to $2,000.


· Full-time students are considered to have earned income of $250 a month for figuring the credit.


· The credit is reduced by benefits you may have received from your employer for childcare.


· The credit is then figured by multiplying the dollar limit by a percentage between 20% and 35% based on your adjusted gross income (AGI). The following table shows the percentages used for completing 2019 tax returns. There is no income limit.

Source: IRS Publication 503


Example:

The household adjusted gross income is $34,000. The single parent incurred childcare expenses of $7,000 for her two children, ages 7 and 8. Because the taxpayer has two dependents, the dollar limit for the credit is limited to $6,000. Based on the AGI table, the percentage used to figure the credit is 25%. Therefore, the taxpayer will receive a nonrefundable credit of $1,500. The credit covers roughly 21% of the taxpayer’s actual expenses - $7,000. ($1,500/ $7,000 = 21%)


The provide more substantial tax benefits, the credit requires serious changes

At the end of the day, the credit will not come close to covering what parents are spending on providing care for their child or dependent.


A Care.com survey from June 2020 found that 72% of surveyed parents spend more than 10% of their household income on childcare while 55% of parents spend more than $10,000 a year on childcare.


If a family is spending $10,000 a year on childcare for one child with a household income of $60,000, the maximum credit they could claim in 2019 is $600 ($3,000 x 0.20 from AGI table). Six hundred dollars is a drop in the bucket compared to the actual cost.


The credit might equate to one month of spending on childcare. Even then the credit is non-refundable, which means the credit will not increase the amount of your tax refund.


Childcare is by no means a luxury. In fact, childcare is a necessity for early childhood development. Quality care develops the emotional, social, and physical facets of young children that in turn shapes their future development into adulthood.


Affordable childcare is an issue for low income families. Research suggests that subsidies for childcare programs enables families earning less than $32,000 annually to select higher quality and stable childcare for their children. Furthermore, children being cared for outside the home, enabled parents to enter the workforce for longer periods, increased their earnings trajectory, and stabilized financial independence.


Other research shows that the childcare affordability crisis has prevented women from remaining in the workforce or furthering their careers. Affordable childcare and greater tax benefits available through the credit for child and dependent care expenses would transform the workforce.


I suggest a few changes that can be made to make the credit for child and dependent care expenses more advantageous.


1. Increase the dollar limits for the credits. The national average for spending on childcare is $10,000. The dollar limit should reflect that national average instead of limiting expenses to a mere $3,000 or $6,000.


2. The credit should be refundable, meaning that tax refunds will increase as a result of claiming the credit.


3. The fraction of the credit that can be claimed based on AGI should increase. As it stands right now, the credit can only be claimed up to 35% of the dollar limit.


In closing, the credit for child and dependent care expenses can and should be claimed by families with young children or other dependents who cannot care for themselves. That said, changes are required to increase the tax benefits of this credit to make a financial difference for taxpayers across the country.


Still have questions? Quill & Keyboard Accounting is always here for you.

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