Bigger Tax Credit for Summer Child Care

If your clients are paying a facility or person to watch their kids this summer, they may be in line for the dependent care credit, commonly called the “child care credit.” What’s more, the new tax law enacted earlier this year—the American Rescue Plan Act (ARPA)—increases the tax benefits.

But the news isn’t good for all taxpayers. For folks with income in the upper stratosphere, the credit is reduced to the point where it is no longer available.

Let’s review the basics. To qualify for the credit, clients must incur expenses to care for a child under age 13 or, in other instances, for a dependent relative (that’s why it’s often referred to as the child care credit). The list of qualified expenses is a long one ranging from daycare centers to babysitters to summer day camp—even a specialty camp for athletics or other pursuits may qualify (but not any overnight camps).  

Prior to the ARPA, the maximum credit percentage was 35 percent, but it was gradually reduced to 20 percent for most moderate-to-upper income families. This nonrefundable credit was available for the first $3,000 of qualified expenses for caring for one child or $6,000 for two or more children. Thus, your maximum credit was generally either $600 or $1,200, respectively.

Usually, if one spouse did not have any earned income, the couple wasn’t eligible for the credit. However, a credit could still be claimed if one spouse was a full-time student or disabled. In that case, the spouse was considered to have earnings of $250 a month for one child or $500 per month for two or more children.

Tax update: Under ARPA, the child care credit for most taxpayers is bigger and better for the 2021 tax year. The new law includes the following changes:

• The credit is fully refundable so, your clients can benefit completely even if they’re entitled to a refund on their 2021 return.
• The maximum credit percentage is increased from 35 percent to 50 percent, while the limit for qualified expenses jumps to $8,000 for one child and $16,000 for two or more children. As a result, the maximum credit is now $4,000 for one child or $8,000 for two or more children.
• The credit percentage is gradually reduced if your client’s adjusted gross income (AGI) exceeds $125,000 until it reaches 20 percent for an AGI above $183,000. For those taxpayers, the maximum credit is $1,600 for one child or $3,200 for two or more children—still a good deal.

However, if your client’s AGI exceeds $400,000, the credit is further reduced. It disappears for an AGI above $438,000.

How long will these changes last? As dictated by ARPA, the improvements to the child care credit expire at the end of this year. But the Biden administration supports an extension of these tax breaks or other modifications. We will wait to see how this eventually plays out.