Kids are wonderful.
But as any parent can attest…they’re not cheap! And as working parents can attest, paying for someone to care for your kid so that you can work is especially not cheap. However, as we wrote last year, the cost of childcare got a little bit less onerous, at least for tax year 2021.
What follows is a quick refresher on the temporarily-beefed-up Child and Dependent Care Credit. Parents that qualify for this credit don’t want to miss out as there’s potentially substantial tax savings available here.
Who can claim the credit?
You’re eligible for the credit if you paid expenses for the care of your child (under age 13) or another qualifying individual to enable you and your spouse to work. These expenses can be paid to a daycare or parent’s day out center, an after-school program, or even to a friend or relative (with some exceptions).
How is the credit calculated?
The amount of the credit you can claim will be some percentage of the childcare expenses you incurred throughout the year. If you have one child, you can include all qualifying expenses up to $8,000. If you have two or more children, you can include all expenses up to $16,000.
One positive wrinkle concerning these expense limits—let’s say that you have more than one kid (under age 13), but you only pay childcare expenses for one of them. You can still include all expenses up to the higher limit of $16,000.
Once you have your total amount of qualifying expenses, you will multiply that number by your applicable percentage, which ranges from 0-50%. Your applicable percentage is determined by your income. See the chart below.
With income from $0-125,000 (regardless of filing status), the applicable percentage is 50%.
As income exceeds $125,000 the applicable percentage is reduced by 1% for every $2,000 of additional income, such that once income reaches $185,000, the applicable percentage has been reduced down to 20%.
From there, you see that a large amount of additional income can be added with no reduction to the applicable percentage. Income earners all the way up to $400,000 have an applicable percentage of 20%. Once income exceeds $400,000, the phaseout begins again at the same rate. 1% reduction for every $2,000 over the threshold. The credit is completely phased out once income reaches $440,000.
Let's look at some examples to see how this might play out.
Jane and Ezra are married with two children, ages 2 and 4. They are both employed and together they have household income of $120,000. Both kids are in daycare for which they spent $18,000 in 2021.
Because Jane and Ezra have two children, they can include all childcare expenses up to $16,000. This means that even though they spent $18,000, they can only use $16,000 for purposes of calculating their credit.
Since Jane and Ezra have income below $125,000, they can use the maximum applicable percentage of 50%.
Jane and Ezra calculate their credit by multiplying their applicable percentage (50%) by their qualifying expenses ($16,000) to arrive at a credit of $8,000!
Preston and Cynthia are married and have one child, George, who is 3 years old. Cynthia stopped working when their baby was born and has not begun looking for work again.
In the back half of 2021, they began sending George to a parent’s day out program three days a week for a few hours a day to give Cynthia a break for which they spent $3,000 in 2021.
Unfortunately, because the purpose of the childcare expenses for George was not to enable Cynthia to work or to look for work, the $3,000 they spent cannot be used for purposes of claiming this credit.
Travis and Lauren are married with one child. In 2021 they spent $6,000 on daycare so that they both could continue to work. Together they had household income of $165,000.
Because Travis and Lauren have only one child, they can include childcare expenses up to $8,000. They spent $6,000 on daycare, which is below the limit, so they can include all $6,000 for purposes of calculating their credit.
Since they have income above $125,000, they have to use the phaseout formula to calculate their applicable percentage (1% reduction for every $2,000 over the threshold). With income of $165,000 they are $40,000 over the threshold, which means they have to reduce their applicable percentage by 20 percentage points, taking their applicable percentage from 50% down to 30%.
Travis and Lauren calculate their credit by multiplying their applicable percentage (30%) by their qualifying expenses ($6,000) to arrive at a credit of $1,800.
Jon and Aja are married with three kids, ages 3, 6 and 8. The older two kids are in school and incurred no childcare expenses. But they spent $12,000 on daycare for their 3-year-old so that they could both continue to work. Together they had household income of $250,000.
Even though all of Jon and Aja’s childcare expenses were for one kid, because they have three qualifying individuals, they can use expenses all they way up to the higher limit of $16,000. They spent $12,000 on daycare, which is below the limit, so they can include all $12,000 for purposes of calculating their credit.
Because their income is above $185,000 but below $400,000, Jon and Aja are in the large group of income-earners whose applicable percentage is 20%.
Jon and Aja calculate their credit by multiplying their applicable percentage (20%) by their qualifying expenses ($12,000) to arrive at a credit of $2,400.
Chad and Brittany and are married with two kids that are both in daycare so that they can work. In 2021 they spent $30,000 on childcare expenses and had income of $475,000.
Unfortunately, their high income puts them over the upper threshold of $440,000 which completely phases them out of the credit.
The changes made to this credit for 2021 are going to be polarizing.
On one hand, all eligible taxpayers with income under $400,000 will qualify for a greater credit this year. And for some, that credit will not be small—potentially as high as $8,000 off your tax bill! That’s some serious payoff for taking that little bit of extra time to compile all of the spending you did on childcare.
On the other hand, taxpayers with income over the upper threshold are going to be disappointed to learn that they’re phased out of even the 20% credit they used to qualify for. If that’s you, don’t fret too much. Unless these changes become permanent, 2021 will be the only year for these new rules. We’ll be back to the old rules for this credit beginning in 2022.