2021 Tax Credits for Childcare
As Americans get back to work, childcare expenses are back in the budget. To help ease the burden following the pandemic, the IRS has announced, under the American Rescue Plan Act, new tax credits for childcare for 2021. These credits apply for the current year, for taxes that will be filed in 2022. They increase the amount of credit parents and caregivers can claim on their taxes next year, and even make the credit refundable for the first time ever. The new guidance is for the year 2021, and may have the potential to be extended into the future.
Who qualifies for child care tax credits?
Working parents with earned income are eligible to claim a tax credit for child or dependent care expenses based on criteria set by the Internal Revenue Service. The guidance allows credits to be applied to your tax bill if you paid another person or facility to care for your child, aged 13 or younger, because you were working or looking for work.
The credit is also available for caregivers you pay to attend to a spouse who is unable to care for themselves and has lived in your home for at least 6 months, or another person you claim as a dependent on your tax return, if they cannot care for themselves and have lived with you for at least 6 months.
To qualify, the caregiver must provide their name, address and taxpayer Identification number (TIN). This is either their social security number or their Employer Identification Number (EIN), if you pay a facility. If you pay cash to a caregiver and they don’t report their income, there is no tax credit available.
You can claim a tax credit for any caregiver except:
- your spouse;
- a parent of the child;
- an older sibling; or
- anyone listed as a dependent on your tax return.
Enhanced child and dependent care credits for 2021
The American Rescue Plan Act of 2021 went into effect on March 11 of this year and is scheduled to end in 2022. The Act makes several temporary changes to child and dependent care tax credits for 2021 that will greatly benefit families.
One of the most significant changes will be that, for the first time, the amount will be tax credit, rather than refundable. Unlike a deduction, that simply reduces the amount of overall tax you are required to pay, the 2021 change becomes a credit. Under the ARPA, the tax credit will be refundable for taxpayers who have lived in the US for more than half the year. In the past, tax credits that exceeded tax liability were forfeited to the government. For 2021, any overage will be sent to the taxpayer in the form of a refund. So, if you owed the IRS $500 in taxes in the past and had a $1,000 credit, you would not receive the $500 difference: for 2021 only, you will receive a refund check.
Increases in Potential Credit
For 2020 and earlier, the amount of tax credit allowed was a maximum of 35% credit of adjusted gross income (AGI) for up to $3,000 in expenses for one child; $6,000 for two or more. For 2021, the ARPA increases the tax credit and allows a maximum of 50% credit for $8,000 in expenses for one child; $16,000 for two or more. This means taxpayers could receive a credit for $4,000 for a single child; $8,000 for multiple children.
In the past, a ‘phase-out structure’ meant that the higher the family’s income, the lower the tax credit available. For 2019 and earlier, if your AGI was $15,000, you were eligible for the full 35% credit: the credit amount dropped by one percent for every additional $2,000 in AGI for the year until completely phased out. So the higher your wages, the lower the credit.
For 2021, the phase-out structure has been changed. Instead of the credit decreasing after the taxpayer’s AGI exceeds $15,000, the 50% credit will remain until AGI reaches $125,000. The credit then decreases from 50% to 20% for AGI from $125,000 to $400,000. Decreases continue to zero for families with an AGI over $440,000.
What is AGI?
AGI is income minus IRS-allowed adjustments. AGI income includes wages, business income, dividends, capital gains, retirement distributions and other income. AGI can be reduced by student loan interest, alimony payments or contributions to a retirement account.
Tax credits for business
Under federal and some state laws, tax credits are also available for businesses that assist their workforce with childcare expenses. At the federal level, employers may claim a tax credit of 25% of the amount they spend providing child care services for staffers. This includes child care expenditures and resource and referral expenses. The credit can equal up to $150,000 per year.
Eighteen states currently have additional tax credits to help employers provide child care services for their workers. These are aimed to help business provide care directly, contract within the community, help expand the supply of child care, or make it more affordable for staff members.
Child and dependent care expenses can be a significant portion of a family’s annual budget. Although they may be temporary (eventually they grow up), it’s important to take advantage of all the tax breaks and incentives available. Following the pandemic, special consideration is being given to help families recover economically with tax credits that may be expanded beyond 2021. For now, make sure to use all the credits and deductions available for the lowest tax bill or the highest refund check.