In many parts of the United States, it is not uncommon for child care costs to exceed $1,000.00 per month per child. Additionally, caretakers of incapacitated adults often find the costs of respite care to be extravagant compared to their wages or salary. For many families, it is a sizeable proportion of their monthly budget to expend (for lower-income populations, these kinds of costs are just unaffordable). Fortunately, the Internal Revenue Code allows a tax credit to offset some of these staggering costs.
26 U.S.C. §21 permits a taxpayer to claim a tax credit worth between 20% to 35% of the costs of child or dependent care paid during the tax year. (up to a maximum of $3,000.00 for one dependent or $6,000.00 for two or more dependents). To qualify, the taxpayer must satisfy all of the following tests:
- (A) Qualifying Person Test: A qualifying person is either one of the following –
- Your qualifying child who is your dependent and was under age 13 when the child care was provided;
- Your spouse who was physically or mentally unable to care for himself or herself and lived with you more than half of the tax year; or
- A person who was physically or mentally unable to care for himself or herself and lived with you more than half of the tax year, and EITHER is your dependent OR would otherwise be your dependent except that the person had income more than $4,000.00 during the tax year, filed a joint return or could be someone else’s dependent.
- (B) Earned Income Test: The taxpayer must have earned income during the tax year.
- Earned income includes wages, salaries, tips, self-employment income or other employee compensation.
- Earned income DOES NOT include interest, dividends, inheritances, gifts, retirement accounts and welfare benefits.
- (C) Work-Related Expense Test: Both of the following conditions are satisfied.
- EXPENSES ALLOWED TAXPAYER TO WORK OR LOOK FOR WORK – You can claim the expenses if paying for the child or dependent’s care permitted you to work full-time or part-time either for others or for your own business. If you are not working, you can claim expenses if you are actively looking for employment during the time that your child or dependent is receiving care. If you are only working part of the year, you can only claim a proportion of the annual expenses based on the number of days of the year you were working.
- EXPENSES ARE FOR QUALIFYING PERSON’S CARE – You are not required to choose the cheapest child or dependent care available. However, expenses do not include amounts paid for food, lodging, clothing, education and entertainment. If a child is in nursery school, preschool or some other program below the kindergarten level, they are considered expenses for care. If a child is in kindergarten or higher, the expenses to attend school are not expenses for care, BUT a before-school or after-school latchkey service may qualify. If the care-provider offers transportation for the qualifying person to their facility, then those expenses are allowable. This DOES NOT include expenses to transport the care provider to and from your home.
- (D) Joint Return Test: Married taxpayers must file a joint return UNLESS you are legally separated from your spouse by a judgment of divorce or separate maintenance OR you are still legally married BUT ALL OF THE FOLLOWING ARE TRUE –
- You file a separate tax return from your spouse (e.g. married filing separately or head of household)
- Your home is the home of the qualifying person for more than half the year
- You pay more than half of the costs of keeping up your home for the year
- Your spouse did not live with you during the last six months of the year
- (E) Provider Identification Test – You must identify all of the persons or entities that provided care to your qualifying person during the tax year and list the following information on the tax return –
- Taxpayer Identification Number (e.g. social security number of individuals or employer identification number for businesses)
If ALL of the tests above are satisfied, the amount of the child and dependent care credit you can claim is as follows:
- If your adjusted gross income is $15,000.00 or less, you can claim a credit of 35% of your child or dependent care expenses.
- If your adjusted gross income is higher than $15,000.00, them the percentage of the child or dependent care expenses you can claim gradually decreases on a sliding scale from 35% to a minimum of 20% at $43,000.00.
- After your gross income exceeds $43,000.00, you can still claim 20% of child or dependent care expenses no matter how much income you earned during the tax year.
- If you have one qualifying person that you have eligible child and dependent expenses for, then you are limited to $3,000.00 for the tax credit.
- If you have two or more qualifying persons that you have eligible child and dependent expenses, you are limited to $6,000.00 for the tax credit. This can be an aggregate total, meaning that one qualifying person can have zero care expenses and the other qualifying person can have $5,000.00 care expenses.
- This tax credit is not refundable, meaning the amount of credit you can get is limited to your taxes owed.
You can claim the credit if you file Form 1040, Form 1040A or Form 1040NR, but not with Form 1040-EZ. You are not required to itemize with Schedule A, but Form 2441 must be attached to the tax return to claim the credit. If you have questions about the child and dependent care credit or any other tax issue, contact the tax professionals at Kershaw, Vititoe & Jedinak PLC.