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You may qualify for a child-care tax break on up to $16,000: Here's how to find out

"Families with children who benefit from the credit receive an average benefit of almost $2,200."

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If you're paying for someone to look after your children or dependents while you work, you could be eligible for a tax break on up to $16,000 worth of those expenses when you file your 2021 return.

The tax credit in question, known as the Child and Dependent Care Tax Credit, was temporarily expanded under the American Rescue Plan Act President Joe Biden signed into law in March.

Prior to the expansion of the CDCTC, families could claim a credit worth 20% to 35% of qualifying expenses. Those expenses were previously capped at $3,000 per year for one dependent, and $6,000 for two or more dependents. That meant the maximum potential credit was $2,100.

Under the new law, eligible taxpayers can claim expenses of as much as $8,000 in 2021 for one qualifying dependent, and as much as $16,000 for two or more qualifying dependents. It also boosted the value of the credit to as much as 50% of eligible expenses for families earning under $125,000. That increases the maximum potential credit to $8,000, according to a White House statement.

Plus, the credit is now fully refundable for 2021, which means an eligible taxpayer can receive the value as a tax refund, even if they owe no federal income tax.

The credit comes as families struggle to cover the cost of child care. The average cost for a licensed child-care center was $340 per week per child, or $17,680 per year, in 2020, according to Care.com.

With the American Rescue Plan Act changes, families should receive a much larger credit, says Elaine Maag, a principal research associate at the Urban-Brookings Tax Policy Center. "Previously, on average, families with children who received the credit could reduce their taxes by an average of about $600; under current law, families with children who benefit from the credit receive an average benefit of almost $2,200," she says.

Last week, the IRS offered more guidance on eligibility, figuring out the credit amounts, and claiming the tax benefit. Here's what you need to know.

Who qualifies as a child or dependent?

If you paid someone to look after your child or dependent so you (and your spouse if you filed jointly) could work or look for work, or even attend school, you might be able to claim some of those expenses as part of the CDCTC.

Young adults who could qualify as a dependent include your child, stepchild, foster child, brother, sister, stepsibling, or a descendant of any of those individuals. They must be under the age of 13, and must also live in your home for over half the year.

A handicapped teenage or adult dependent, such as a spouse, can also qualify, as long as they live with you for more than six months of the year. The IRS defines these individuals as "persons who can't dress, clean, or feed themselves because of physical or mental problems."

Although some older adult dependents qualify, such as a parent, they make up just a "small share of the overall total," says Maag.

What are the income requirements?

In order to qualify for the full value of the credit, you or your household must have a modified adjusted gross income of under $125,000. If you meet the income requirements, you can claim 50% of up to $8,000 worth of expenses that you have paid towards caring for one dependent (which equals a maximum credit of $4,000), or up to $16,000 of expenses you've paid towards two or more dependents (which equals a maximum credit of $8,000).

If your MAGI is higher than $125,000, but less than $438,000, you'll still be able to claim care expenses, but the share you can claim phases out.

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For workers earning between $125,000 and $183,000, the credit drops by 1 percentage point for every $2,000 or fraction thereof in additional income. So for example, if you earn $131,000 you can only claim 47% of your child or dependent care expenses.

For workers earning between $183,001 and $400,000, the credit is a flat 20% of qualifying expenses. Then it starts to phase out again, dropping by 1 percentage point for every $2,000 or fraction thereof in additional income. People who earn $438,000 or more do not qualify for the credit.

While the changes in the law mean a bigger refund for qualifying low-and middle-income Americans, the number of people who qualify doesn't change that much, says Maag: "Under prior law, Tax Policy Center estimated that about 12% of families with children benefited from the CDCTC. Under current law, that share increases to about 14%."

Families with children who benefit from the credit receive an average benefit of almost $2,200.
Elaine Maag
Urban-Brookings Tax Policy Center

What types of child-care expenses qualify?

Some of the expenses that qualify for the credit are payments to a day-care center, a nursery school, or to a nanny. Paying for a private K-12 education doesn't qualify since that's considered an education expense, and neither does overnight camp. But day camp, as well as before-school and after-school programs, do.

If you pay a family member, such as your mother or father, to watch your child, that's also a qualifying expense as long as you don't claim that parent or family member as a dependent on your taxes, according to the IRS FAQ site.

It's also important to note that if you have a dependent-care flexible spending account through your employer, you can't double dip and claim the credit for expenses paid with the FSA. 

The tax credit is only available for 2021

To claim the credit, you'll need to complete Form 2441 for Child and Dependent Care Expenses next spring. So it's best to keep a record of the expenses you pay for child or dependent care as you incur them this year.

The changes to the tax credit are only temporary, though the proposed American Families Plan seeks to make the credit permanent.

"If Congress fails to extend the CDCTC expansion, more than 6 million families could see their taxes go up at the end of the year — many by thousands of dollars," the White House said in a statement.

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