What is the Child Care Tax Credit?
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The Child Care Tax Credit—officially known as the Child and Dependent Care Tax Credit (CDCTC for short)—provides taxpayers with children a much-needed tax break from childcare expenses.
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How to Claim the Child Care Tax Credit
Childcare is an expense that working parents often must pay out of pocket if they want to remain in the workforce. According to one poll conducted in 2019 by Child Care Aware of America, two-income households (that is, a family where both parents work) spent as much as 11 percent of their income on childcare. Compare this to other necessary and variable expenses, such as 8.6 percent of their income on food (according to 2020 data from the USDA), and 2.4 percent on gas (according to 2020 data from the Energy Information Association).
Childcare is expensive, and even more expensive in single-parent households, who spend, on average, around 36 percent of their income on childcare. To make matters worse, Americans of all income brackets have reported that only around 15 percent of the childcare facilities available to them are satisfactory. This puts a strain on parents when it comes to affordable child care that they feel comfortable with. The end solution for many parents is to just give up on pursuing upward career mobility.
For instance, as many as 61 percent of mothers with at least one child under the age of 6 years old said that their decision to remain out of the workforce was due to a lack of affordable and satisfactory childcare. Around 75 percent of postsecondary education dropouts (that is, from college or graduate school) said that they would have continued their educational path if not for a dearth of childcare options. Less than 28 percent of postsecondary students who are also parents complete a degree within a six year time frame.
As you can see, satisfactory childcare is a prerequisite for most parents to feel comfortable engaging in a professional career path, or even just working a service industry job to make ends meet. In most cases, if parents had the financial resources to pay for satisfactory childcare, they would be able to pursue the upward mobility afforded by education and professional development.
But working parents are not the only ones who benefit from a child care tax credit. A tax credit that incentives placing children in childcare means that children will be placed in a setting where they can develop intellectually and socially. The earliest years of a child’s life are formative, and studies have shown that children who receive quality care grow up to be healthier, earn higher wages, raise families, and avoid incarceration. Some of these studies have focused on low-income families and middle-income families; two tax brackets that certainly benefit from the added assistance of a child care tax credit.
The childcare and dependent tax credit also stimulates the childcare industry, which in recent estimates (albeit prior to Covid) had an output of almost $100 million at 695,000 small businesses (such as preschools and daycare facilities), employing 1.5 million workers. Childcare is a major industry, and economic incentives for taxpayers to send their children into childcare definitely has a trickle-down effect.
What is the Child Care Tax Credit?
What is the Child (and Dependent) Care Tax Credit? This credit allows a taxpaying household to claim a maximum credit of $8,000 for one child under 13 and $16,000 for two or more children (also under the age of 13). Remember, these are the maximum amounts. If your household adjusted gross income (or AGI) is below $125,000, you can claim 50 percent of your childcare expenses up to the maximum amount. The percentages continue to drop as the AGI increases. For example, you can only claim 20 percent of the expenses if your AGI is anywhere between $185,000 and $400,000…and you cannot claim any CDCTC if your AGI is over $400K.
If you are familiar with the Child Care Tax Credit from a past tax year, you may be surprised by these numbers. The American Rescue Plan of 2021 increased this tax credit from previous years. In 2020, for instance, the CDCTC was 20 percent to 35 percent of qualified childcare expenses. Moreover, the maximum amount a taxpayer could claim was up to $3,000 for one child and $6,000 for two or more children.
Starting in 2021, the Child and Dependent Care Tax Credit became a refundable tax credit, in contradistinction to a nonrefundable tax credit. This means that if your income is such that you actually don’t owe any taxes or because tax credits and tax breaks eliminate your tax burden, you can still claim a CDCTC and receive a refund from the IRS.
You may be wondering why the government has a vested interest in providing tax breaks to defray the cost of childcare expenses. As mentioned, childcare is a make-or-break concern for many families in terms of full participation in the workforce. Proponents of such tax reform ideologies purport that these types of tax breaks actually facilitate and stimulate economic activity, rather than just serving as free handouts for having children. Whatever the case may be, the Child Care Credit is not going away anytime soon, so if you have children and they are in childcare while you work, you should be taking advantage of this particular tax break (and all others you can get).
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Is the CDCTC the same as the Child Tax Credit?
It’s important to distinguish the CDCTC from the Child Tax Credit.
The Child Tax Credit is a tax break available to parents with children under 17, and it is not tied to childcare expenses, specifically. Rather, it is meant to defray the numerous expenses of raising children, since families with children typically end up having less disposable income and more expenses. In 2021, partially in response to the Covid pandemic, the IRS began issuing advance payments of the CTC, most often through direct deposit into taxpayer bank accounts. The Child Tax Credit, incidentally, is worth as much as $3,600 for dependents under six and $3,000 for dependents over six and under 17. Advance CTC payments are half of the credit, with the other half available for claiming when taxpayers file their 2022 tax return.
Earned Income Tax Credit
In addition to the monthly child tax credit payment that is meant to defray the cost of childcare expenses, there are additional tax deduction options for eligible families, such as the Earned Income Tax Credit. Though the income tax credit (as it’s also called) or EITC (as it’s called for short) does not specifically require a qualifying child, you can reduce your tax liability more for every qualifying person. Filers can enjoy a tax break of up to $6,728, depending on their taxable earned income and family size. The EITC also is a refundable tax credit, so if the tax deduction puts your tax liability into the negative, you will get a refund.
Education Tax Credits
If you have a dependent child, you likely know that the costs don’t stop when they turn 18. Of course, your qualifying child is no longer a child anymore, legally, but you can still get a tax benefit through education tax credits, which are also refundable for up to 40 percent of the credit. Education tax credits allow you to write off up to $4,000 from the cost of college tuition annually (up from a recent $2,500) at a qualifying educational institution.
It’s good for parents to know about all these tax breaks, whether those breaks relate to defraying the cost of childcare or how much earned income a family brings in. The monthly payment afforded by the advance child tax credit is a tax reform that will likely help a lot of struggling families pay for child care services or anything else related to running a family in the wake of the economic downturn caused by Covid-19 shutdowns. Of course, there were also stimulus payment checks issued or provided with direct deposit. Coupled with advance monthly payments by the expanded child tax credit, families will (hopefully) not see their bank account dwindle as they attempt to meet their financial obligations. Take note that the IRS has set up an online portal so that you can notify them of any additional eligible child born in 2020.
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How Do I Qualify for the Child Care Tax Credit?
Going back to the Child Care tax Credit—in order to claim the credit, you must provide care for the child you are claiming a CDCTC for. By care, we mean that the child is a dependent, not that you are the one providing the childcare of a preschool or daycare facility.
For children of divorced parents, the parent with custodial care is the one who can claim the CDCTC. You can also claim a spouse as a dependent if they are physically or mentally unable to care for themselves, so long as they live in the same residence. Remember that CDCTC stands for child?and dependent?care tax credit.
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