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Enhanced Child and Dependent Care Credit

March 23, 2021

The American Rescue Plan Act of 2021, that was passed in March of 2021, provided an enhanced child and dependent care credit (CDCC) for tax year 2021.

Refundable Credit for 2021

This 2021 credit is refundable provided either the taxpayer or the spouse has a principal place of abode in the U.S. for more than one-half of the tax year.

Qualifying for the Credit

To qualify for the credit, a taxpayer must incur expenses that are for the care of qualifying individuals as listed below so that the taxpayer and or spouse can work.

  • Child, stepchild, or foster child under the age of 13.
  • Brother or sister or stepsibling (or a descendent of any of these), under the age of 13, who lives in the taxpayer’s home for over half the year and doesn’t provide over half of their own support for the year.
  • Care of a spouse or dependent who is handicapped and lives with you for over half the year.

Expenses that qualify for the credit include:

  • Day-care center
  • Nanny
  • Nursery school under the age of kindergarten
  • Before and after school programs regardless of age.
  • Household services, e.g. domestic help, can qualify as long as the cost at least in part goes towards the care of the individual.

Expenses that do not qualify for the credit include:

  • Cost of Education over the age of kindergarten.
  • Overnight camps

Payments to Relatives or Dependents

Eligible expenses can include amounts paid to relatives who aren’t a dependent of the taxpayer, even if they live in the taxpayer’s home. However the following expenses would not be eligible:

  • A person whom can be claimed as a dependent on the taxpayer’s 2021 tax return.
  • A child of the taxpayer or spouse who is under age 19 , even if they are not claimed as a dependent on the 2021 tax return.
  • A person who was the spouse of the taxpayer at any time during the year.
  • The parent of the qualifying person.

Claiming the Credit

To claim the credit, married couples must file a joint return. For purposes of this rule, a valid same-sex marriage that’s authorized under state or foreign law is recognized, but a registered domestic partnership or civil union isn’t.

The following information needs to be included on the 2021 tax return to claim the credit:

  • Caregiver’s: name, address, and social security number (or tax ID number if it’s a day-care center or nursery school.
  • Social security number of the children who received care.

Calculating the Credit

There are several limits that apply in the calculation of the credit as listed below.

  • Qualifying expenses are limited to the income the taxpayer or spouse earns from work, self-employment, of certain disability and retirement benefits. Under this limitation, if either the taxpayer of the spouse has no earned income, there will not be the ability to claim any credit. One exception to this is if the either the taxpayer of the spouse has no actual earned income, but they are a full-time student, or disabled, they are considered to have monthly income of $250 (if the couple has one qualifying individual) or $500 of monthly income (if the couple has two or more qualifying individuals).
  • The 2021 credit is capped at the first $8,000 (increased from $3,000) of qualifying expenses for one qualifying individuals, or $16,000 (increased from $6,000) of qualifying expenses for two or more qualifying individuals. If an employer of either the taxpayer or spouse has a dependent care assistance program under which benefits are received that are excluded from gross income, the qualifying expense limits ($8,000 or $16,000) are reduced by the excludable amounts received.
  • The credit is computed as a percentage of qualifying expenses based on AGI. The applicable percentage of qualifying expenses is 50% (increased from 35%) but is reduced by 1% for every $2,000 (or fraction thereof) by which AGI for 2021 exceeds $125,000. If AGI is $125,000 or less, the maximum credit amount is $4,000 ($8,000 x 50%) for taxpayers with one qualifying individual, or $8,000 ($16,000 x 50%) for taxpayers with two or more qualifying individuals.
  • New for the 2021 tax year, there is one last phaseout that targets high income individuals. This drops the applicable percentage of qualifying expenses from 50% to 20% when AGI is over $440,000. The credit is fully phased out when AGI is over $440,000.
AGI RangeApplicable Percentage of Qualifying expensesPhase Out
Below $125,00050%N/A
$125,000 – $185,00050%Applicable Percentage is reduced by 1% for every $2,000 by which AGI exceeds $125,000.
$185,000 – $400,00020%N/A
$400,000 – $440,00020%Applicable Percentage is reduced by 1% for every $2,000 by which AGI exceeds $400,000.
Over $440,000N/AThe credit is fully phased out.

Examples:

1. A taxpayer has AGI of $120,000 and has two qualifying individuals, for which a total of $9,000 was paid in qualifying employment related expenses for 2021.

The applicable percentage of qualifying expenses would be 50%

The total amount of the credit would be $4,500  ($9,000 x 50%)

2. A taxpayer has AGI of $170,000 and has two qualifying individuals, for which a total of $9,000 was paid in qualifying employment related expenses for 2021.

The applicable percentage of qualifying expenses would be 27% ($170,000 – $125,000 = $45,000 over the $125,000 limit. $45,000 / 2,000 = 22.5 Therefore the applicable percentage of 50% is reduced by 23% = 27%

The total amount of the credit would be $2,430  ($9,000 x 27%)

3. A taxpayer has AGI of $380,000 and has two qualifying individuals, for which a total of $9,000 was paid in qualifying employment related expenses for 2021.

The applicable percentage of qualifying expenses would be 20%

The total amount of the credit would be $1,800  ($9,000 x 20%)

4. A taxpayer has AGI of $420,000 and has two qualifying individuals, for which a total of $9,000 was paid in qualifying employment related expenses for 2021.

The applicable percentage of qualifying expenses would be 27%

($420,000 – $400,000 = $20,000 over the $400,000 limit. $20,000 / 2,000 = 10 Therefore the applicable percentage of 20% is reduced by 10% = 10% The total amount of the credit would be $900  ($9,000 x 10%)