If you are fretting over the size and spending power your income tax refund this year, a sometimes overlooked tax credit might offer some reassurance — and some more money.
In a filing season where the enhanced Child Tax Credit is presenting taxpayers with new snags and potentially smaller refunds, the also-enhanced Child and Dependent Care Credit is a chance to offset those loses and get some help from Uncle Sam on the exorbitant price of day care.
The trick is first knowing about the credit that can pay up to $4,000 for a single child or adult dependent this tax season, and up to $8,000 for two or more children/adult dependents. That’s up from $1,050 and $2,100 the year before, for a credit intended to help families defray the day care costs enabling them to work, look for work or go to school.
The average annual cost of daycare for infants reached approximately $12,300 in 2020, by one count.
“ The Child Tax Credit can pay up to $4,000 for a single child or adult dependent, and up to $8,000 for two or more children/adult dependents”
Payouts might still not completely cover day-care costs, but at least for one year, “it’s a lot closer than it used to be,” said accountant John Kendeigh, a partner at Tarbell & Co., headquartered in West Des Moines, Iowa.
It’s especially important people access the Child and Dependent Care Credit this year if they are eligible, said Leigh Phillips, CEO of SaverLife, a non-profit fintech organization encouraging savings habits among its 600,000 members.
“It’s actually a very significant financial opportunity for families to really take advantage of this after a tumultuous year, when things are expensive, including child care,” said Phillips.
Six in ten SaverLife members said they’d claim the credit this tax season, according to a recent 900-person survey, Phillips said. Another 40% said they would not; that includes 21% who said they didn’t know about the credit and 11% who were unsure.
Two similar, but different tax credits
The Child Tax Credit has been on the books since 1997, while the Child and Dependent Care Credit was enacted in 1976.
The similar-sounding tax breaks apply to parents and caregivers. Congress boosted the payouts and relaxed the rules for both credits when passing the $1.9 trillion American Rescue Plan last March.
But there are differences.
For just one year, the Child Tax Credit grew from a maximum $2,000 credit to a payment up to $3,000 per child age 6 to 17, and $3,600 per child under age 6. The IRS distributed half the sum in monthly payments from July to December and it will pay the remainder in a lump sum that’s incorporated into the refund. (Taxpayers could choose to skip the advance payments.)
For this year, the credit is fully refundable and there’s no work requirement via an earned income prerequisite — a point of contention when it comes to the enhanced credit’s future.
Even though the Child Tax Credit is larger for tax year 2021, the lump sum for people who already received the monthly advances will be slightly smaller than the conventional $2,000 payout. For example, parents raising a two-year-old would be in line for a $1,800 lump sum and parents of a seven-year-old would have a $1,500.
In a recent Bankrate.com survey, it was no surprise millennials and the parents of children under age 18 were most likely to say they were worried about receiving a smaller refund, said Ted Rossman, senior industry analyst at Bankrate.com.
Enter the Child and Dependent Care Credit.
The IRS says the credit applies to expenses for eligible care of a person who is under age 13 at time the care is offered. It can also apply to the taxpayer’s spouse, so long as the spouse is not “mentally or physically able to care” his or herself and lives with the spouse for at least half the year. There are circumstances where it can apply to other dependents who are not the taxpayer’s spouse.
Potentially eligible expenses include day-care facilities, nursery schools and nannies. Before- and after-school care for kids in kindergarten and above can count, but expenses to pay for the schooling from kindergarten age and above are not eligible as care. Summer schools and tutoring don’t count as care, the IRS says. Day camps are eligible, but not overnight ones, the IRS says.
The credit pays for a percentage of the expense. For this year, the percentage is greater and the thresholds for full payment are higher. This year, the credit is fully refundable, so eligible families can get the credit even if they earn too little to owe federal income tax and more people will be able to claim it, the IRS explained.
There are requirements for earned income during the year, which mean the taxpayer and their spouse both have to work, Kendeigh said. There are exceptions for full-time students, the IRS notes.
Taxpayers start their credit determinations with up to $8,000 in eligible expenses for a single child, and $16,000 for two or more. That includes monthly attendance costs, but it can also be costs like one-time non-refundable application fees or the payments a family might make to hold a kid’s slot open while the child and family are away, Kendeigh said.
The IRS will allow half of that sum as the credit, so long as the taxpayer’s adjusted gross income is under $125,000. From there, the percentage gradually phases out and ends for households making $438,000.
(By comparison, the previous rules applied a maximum 35% credit. The phase out started for households making above $15,000 and came to 20% for incomes exceeding $43,000.)
The Bipartisan Policy Center has a calculator where user can get estimates on how much more cash they’ll receive under the enhanced Child and Dependent Care Credit.
If one trick is being aware of the credit, another is understanding how to properly claim it at a time when errors can slow refund processing inside the badly backlogged Internal Revenue Service.
To claim the credit, taxpayers need to submit Form 2441, where they have to document information including the care provider’s name, Social Security Number or Employer Identification Number.
Keep in mind, people who pay their caregiver ‘off the books’ cannot claim the credit. “If you’re taking that credit, the IRS is on notice the provider is earning income,” and it will expect to see it reported, Kendeigh said.
Going off the books has other perils, like getting on the wrong side of the IRS. “If you pay someone to come to your home and care for your dependent or spouse, you may be a household employer who has to pay employment taxes,” the IRS said. (If the person takes care of the child or spouse at their home or business, the IRS said it doesn’t regard the taxpayer as a household employer.)
Taxpayers don’t need to master all the nuances of the credit. The key point is being aware it’s an option — and a valuable one — as they prepare their own taxes or work with a professional.
“The more you know, the more you can ask those questions and make you are receiving everything you are entitled to,” Phillips said. “This is a unique opportunity for families to get more money in their pockets.”