The enhanced credit is a part of President Joe Biden’s American Rescue Plan Act, and it increases the existing tax benefit eligible families can receive.
The Internal Revenue Service recently announced bigger tax credits for working families to help ease the transition back to work following COVID-19. The American Rescue Plan Act (ARPA) allows for these enhanced child care tax credits for 2021 only. These credits will be for expenses made in 2021 and will apply to taxes filed in 2022.
The enhanced credits increase the tax credit amount for 2021 and make it refundable for the first time ever. They also have the potential to extend into the future.
How do you qualify for child care tax credits?
Any working parent with earned income is eligible to claim a tax credit for dependent or child care expenses.
Any working parent with earned income is eligible to claim a tax credit for dependent or child care expenses, according to the IRS. Taxpayers who have lived in the United States for more than half the year qualify. The credits should apply if you pay a caregiver or caregiving facility to care for:
- Your child, under age 13
- An adult, or
- Eligible dependent who is unable to care for themselves
The credits are available for those who are working, and those looking for work.
Eligible dependents, who are not children, include paying someone to care for a spouse who is unable to attend to themselves — providing they have lived in your home for a minimum of 6 months. Any other person you claim as a dependent on your tax return may also be eligible, providing they are unable to care for themselves and require assistance from an in-house caregiver or external facility while you are at work. Again, they will need to have lived in your household for at least 6 months.
What caregivers qualify?
In order to qualify for the tax credits, an individual caregiver must provide taxpayer identification information, including their name, address, phone, social security number, or taxpayer ID number. For care facilities to be eligible, they must provide their Employer Identification Number (EIN). Payments to caregivers will not be eligible for a credit, unless they provide the information.
You may claim a tax credit for any caregiver except a:
- Parent of the child
- Older sibling, or
- Anyone also listed as a dependent on your tax return
For the first time ever, the ARPA allows taxpayers to receive refunds for unused credit amounts. Unlike deductions that reduce the amount of taxable income, these credits reduce your final tax bill — either minimizing what you owe or prompting a refund.
Historically, tax credits are only available up to the amount you owe. For example, if you owe $500 in taxes and have a $750 tax credit you owe nothing. Because the credits previously were nonrefundable, the $750 tax credit would eliminate the $500 tax bill and you would lose the benefit of the additional $250. The ARPA allows refunds for 2021: using the same example, the taxpayer eliminates their $500 tax bill and would be eligible to receive a refund check in the amount of $250.
By the numbers
In addition to being eligible for refunds, the amount of credit has been increased for tax year 2021. In 2020 and earlier, the tax credit amount allowed was calculated based on adjusted gross income (AGI), starting at 35% and reducing down to 20% depending on how much you earned for the year. The maximum deduction in the past was $3,000 in expenses for a single child; $6,000 for 2 children or more.
Those at lower incomes were allowed to deduct 35% of their caregiver’s cost per year, with the amount of allowable deduction reduced by 1 percentage point for every $2,000 of AGI over $15,000 per year. This is called a “phase-out-structure,” allowing for less credit based on annual earnings.
In 2021, the ARPA increases the credit to a maximum of 50% of the amount spent on caregiving, to a maximum of $8,000 in expenses for one child, and $16,000 for 2 or more. The maximum deduction also increases to $4,000 for a single child; $8,000 for multiple children.
In 2021, the ARPA increases the credit to a maximum of 50% of the amount spent on caregiving, to a maximum of $8,000 in expenses for 1 child, and $16,000 for 2 or more.
The “phase-out structure” has also been changed. The amount the credit decreases will begin at $125,000 per year — not $15,000. This means for families with $125,000 or less earnings for 2021, the full 50% credit will be available. Over $125,000 and up to $400,000 the credit will decrease to 20%, and for those over $440,000 there will be no credit allowed.
AGI is adjusted gross income. These are annual earnings, from wages, business income, dividends, capital gains, retirement distributions, and other income — minus adjustments allowed by the IRS. You can reduce AGI through several things, such as:
- Interest paid on student loans
- Retirement fund contributions
- Alimony payments
Business tax credits also apply
Businesses that help their workers with child care expenses are also eligible for tax credits. According to the law in some states and on the federal level, you can claim tax credits to help offset the cost of care for your employees. Federal credits of 25% of the amount spent providing child care services for employees are allowed for business tax filings. These include child and dependent care expenditures, resources, and referral expenses. The business credit can equal up to $150,000 per year.
In 18 states, there are additional tax credits to help businesses provide child care resources for their employees. These offset the cost of:
- Providing direct care (including building and staffing an in-house child care facility) contracting within the community
- Helping expand the supply of child care locally, or
- Making care more affordable for staff members
Expenses for child and dependent care can represent a significant portion of a family’s budget for the year. While some are temporary, until children reach school age, others may be long term — like care for the elderly or infirm. Taking advantage of all the tax breaks for individuals and incentives for employers can help reduce the burden on workers and help businesses attract and retain talent.
For 2021, the ARPA is hoping to boost assistance with enhanced tax credits for families. Take full advantage for this short period of time as the country recovers from the pandemic, potentially these credits may even be extended. Make sure staff members use all the deductions and credits available for the lowest tax bill or the highest refund check.