The American Rescue Plan passed last March included $1.9 trillion in economic relief for individuals and businesses affected by the Covid-19 pandemic. In addition to the popular Economic Impact Payments (stimulus checks) the Plan included tax benefits designed specifically to help families, most notably expansions of the Child Tax Credit (CTC) and the Child and Dependent Care Credit.
The Expanded Child Tax Credit
The expansion of the CTC is expected to benefit 39 million households with children. For now, the expanded credit applies only to tax year 2021, but many in Congress have expressed a desire to extend the expanded benefits through 2025 when the provisions of the Tax Cuts and Jobs Act (TCJA) expire or to make the expanded credit and the advance payments permanent.
The expanded credit increases the amount of the CTC from $2,000 per qualifying child to $3,000 per qualifying child for children ages 6 to 17 and to $3,600 per qualifying child for children under age 6. In addition to the monetary expansion, the credit has been made fully refundable (you can get the full amount even if you don’t have a federal income tax obligation) and an additional year of eligibility has been added. Before the expansion children “aged out” of the credit after age 16, under the new rules children as old as 17 are eligible.
Additionally, half of the credit is now available as a monthly payment of $250 or $300 to qualifying families. The IRS began mailing Letters 6416 and 6416-A to eligible families in June. In addition to notifying families of potential eligibility for advance payments the letters also estimate the amount of the payments. Families who do not need the advance payments have the option of electing not to receive them and instead may realize the full amount of the credit when they file their 2021 tax returns. Electing out of the advance payments can reduce the amount of tax owed or result in a larger refund.
As with most tax credits, income thresholds apply to both the expanded amount and the base CTC. The credit is phased out in two steps. First, the expanded amount ($1,000 or $1,600 depending on age) starts phasing out at an adjusted gross income (AGI) of $75,000 for a single filer, $112,500 for heads of household, and $150,000 for joint filers. The credit is reduced by $50 for each $1,000 over the threshold, but not below $2,000 (the unexpanded amount of the CTC). Consequently, the expanded credit amount is fully phased out for children age 6 to 17 at $95,000 and at $107,000 for children under age 6 (for single filers). For example, a single parent with two children ages 12 and 13 with an AGI of $80,000 would see their expanded credit reduced by $250 per child, which would reduce the amount of their six advance payments by roughly $43 per payment per child.
The second step of the phaseout uses the income thresholds that were expanded by the TCJA: $200,000 for singles, separate filers, and heads of household and $400,000 for joint filers. The phaseout calculation is the same as for the first step ($50 per additional $1,000 of income) consequently the credit is completely phased out at $240,000 and $440,000, respectively.
The Expanded Child and Dependent Care Credit
While the expansion of the the Child Tax Credit is getting most of the attention right now, the expansion of the Child and Dependent Care Credit also provides working families with additional tax benefits for 2021. The credit is claimed by attaching Form 2441, Child and Dependent Care Expenses, to your annual income tax return (Form 1040). To qualify for the credit the care expenses must be used to allow the parent or parents to work. Both parents in a two-parent household must have earned income to qualify. However, a parent is considered to have earned income for any month or part of a month if they were a full-time student at a qualifying institution or if they were unable to care for themselves. Care expenses for children under age 13 qualify as do care expenses for a disabled spouse and older qualifying dependents who require care. Daycare for working parents obviously qualifies for the credit. Before and after school programs also qualify as do summer programs and day camps. Overnight camps, however, are not qualified expenses for the purposes of the credit. Depending on the circumstances certain expenses might qualify as Schedule A (itemized deductions) medical expenses and as qualified expenses for this credit. Taxpayers should choose the option that works best for them but cannot use the same expenses to qualify for both benefits (no double dipping).
The first benefit of the expanded Child and Dependent Care Credit is that, like the expanded CTC, it is fully refundable. Taxpayers who have these expenses and qualify for the credit but who otherwise have no federal income tax obligation will receive the full amount of their credit as a refund. The amount of qualified expenses has been increased for 2021 from $3,000 to $8,000 for one qualifying child and from $6,000 to $16,000 for two or more children. Anyone familiar with the cost of daycare will appreciate this increase. Additionally, in prior years the credit was limited to 20% to 35% of the lower of qualifying expenses or earned income. For 2021 the maximum credit limit is increased to 50% of qualifying expenses or earned income (whichever is smaller) for those with an AGI of $125,000 or less. Taxpayers with AGIs higher than $125,000 will still get the credit, but the 50% limit is gradually reduced until the credit is completely phased out at an AGI of $438,000.
Taxpayers who receive employer dependent care benefits can now exclude up to $10,500 in qualified expenses (in total, not per child) from their taxable income, which more than doubles the previous exclusion amount of $5,000. Nevertheless, with the higher percentage limit and higher thresholds on qualifying expenses it may be more advantageous to choose the credit rather than the income exclusion. The decision to use an employer plan to exclude qualifying expenses from income or to elect the credit is not entirely either/or. As long as the expenses qualify and they are not double-dipped taxpayers can elect to use their employer’s qualifying plan to exclude qualified expenses and use the tax credit for amounts paid that were not already excluded from income. In other words, if you have two children who qualify and have already contributed $5,000 to an employer plan (because you were perhaps unaware of the new, higher exclusion amount) you can still elect the credit for an additional $11,000 in qualified expenses. Taxpayers who use a tax professional to prepare their returns may want to schedule a planning meeting to ensure they are optimizing the available benefits.
Additional information on claiming the Child and Dependent Care Credit can be found in the IRS FAQ on the topic and in IRS Publication 503.