A Valuable and Little-Known Tax Benefit – Child and Dependent Care Credit for 2021 Returns

While most families with children may be aware of the federal Child Tax Credit, as enhanced payments have been received by millions of families in 2021, many may be unaware of the far more generous Child and Dependent Care Credit which has been increased for 2021 federal tax returns (which are filed in 2022) under the American Rescue Plan Act of 2021 (“ARP”).

ARP provides up to $8,000 in tax credits and makes the credit refundable. This means that if the tax credit exceeds the taxes owed to IRS, the taxpayer gets the difference in their federal tax refund if they meet certain residency requirements. ARP also increases the percentage of employment-related expenses for qualifying care considered in calculating the credit and modifies the phaseout of the credit for higher earners.

For 2021, you may claim the credit on qualifying employment-related expenses of up to $8,000 (previously $3,000) if you had one qualifying person, or $16,000 (previously $6,000) if you had two or more qualifying persons. The maximum credit in 2021 increases to 50% of your employment-related expenses, which equals a maximum credit of $4,000 if you had one qualifying person (50% of $8,000), or $8,000 (50% of $16,000) if you had two or more qualifying persons.

The more a taxpayer earns, the lower the percentage of employment-related expenses that are considered in determining the credit. Under the ARP, the adjusted gross income level at which the credit percentage starts to phase out is raised to $125,000 for 2021. Above $125,000, the 50% credit percentage goes down as income rises.

Child of Divorced or Separated Parents or Parents Living Apart

Even if you can’t claim your child as a dependent, he or she is treated as your qualifying person if:

  1. The child was under age 13 or wasn’t physically or mentally able to care for himself or herself
  2. The child received over half of his or her support during the calendar year from one or both parents who are divorced or legally separated under a decree of divorce or separate maintenance, are separated under a written separation agreement, or lived apart at all times during the last 6 months of the calendar year
  3. The child was in the custody of one or both parents for more than half the year
  4. You were the child’s custodial parent.

The custodial parent is the parent with whom the child lived for the greater number of nights in 2021. If the child was with each parent for an equal number of nights, the custodial parent is the parent with the higher adjusted gross income. For details and an exception for a parent who works at night, see IRS Pub. 501.

Taxpayers should consult with their accountants or tax preparers to find out if they qualify for such credit and/or refund which is only available for the 2021 federal tax return. These increased amounts and refunds are not being carried over to 2022.