Anyone who has to pay for daycare for a child knows that the cost of quality child care can be crazy.
After your mortgage, it could be your biggest bill of the month.
It’s not uncommon to spend more than 15% of your income on care. To put that in perspective, the U.S. government defines “affordable care” as costing no more than 7% of family income.
Fortunately, the U.S. Tax Code offers an incentive that can offset at least a portion of those costs. Here’s what you need to know about the Child and Dependent Care Credit.
What is a Child Care Tax Credit?
The Child and Dependent Care Credit helps working families pay expenses for the care of their children, adult dependents, or an incapacitated spouse.
You calculate the credit by taking a percentage of the expenses you paid to a care provider. That rate depends on your adjusted gross income (Line 8b of your 2019 Form 1040).
However, there is a cap on the total expenses you can use to calculate the credit. If you pay for the care of one qualifying individual, you can use up to $3,000 of costs to claim the credit. If you pay for the care of two or more individuals, you can base the credit on up to $6,000 of expenses.
If your employer provides dependent care benefits that you don’t have to include in your taxable income, you have to subtract the amount of those benefits from your expenses before calculating the credit.
How to Qualify for the Child Care Tax Credits
There are several rules you need to follow to qualify for the Child and Dependent Care Credit.
Rule #1: Only for Working Individuals and Families
You must pay for the care of a child or dependent so you (and your spouse if filing jointly) can work or actively look for work. If one spouse works and the other is a stay-at-home parent, you’re not eligible to claim the credit.
To limit this credit to working families, the IRS requires the taxpayer to have “earned income.” Earned income includes wages, salaries, tips, and earnings from self-employment. If your only income comes from a pension or annuity, Social Security benefits, unemployment compensation, or investment income, you won’t be able to claim the credit. For a more in-depth discussion of what does and doesn’t count as earned income, see IRS Publication 503.
Publication 503 also explains a special rule that applies if your spouse is a full-time student or incapable of self-care.
Rule #2: Eligible Care Providers
Many different types of care arrangements qualify for the credit. Care provided in your home counts, as does care provided in the home of the caregiver, at a childcare center, nursery, or day camp. Tuition expenses at a K-12 school aren’t eligible for the credit but the cost of before- and after-school care is allowable.
The care provider can’t be your spouse, the parent of the child, another one of your children who is under the age of 19, or another dependent whom you or your spouse may claim on your tax return.
You’ll have to identify the care provider on your return by providing the person or organization’s name, address, and Social Security or Tax Identification Number.
Rule #3: Care Provided for a Qualifying Individual
People tend to think of the Child and Dependent Care Credit as a credit to offset childcare costs. But for this credit, the definition of a qualifying individual is a little broader. You can calculate the credit based on expenses for:
- Your child who was under the age of 13 when the care was provided
- Another dependent of any age, if they are physically or mentally unable to care for themselves
- Your spouse who was mentally or physically incapable of caring for themselves and lived with you for more than half the year
How Much to Expect in Tax Savings
The credit amount ranges from 20% to 35% of your allowable care expenses, depending on your adjusted gross income (AGI). The higher your income, the lower your percentage.
Those percentages appear on Line 8 of Form 2441, the form used to calculate and claim the child care credit.
The maximum percentage of 35% is only available to people with AGIs of $15,000 or below. So the maximum credit available to a person who pays care expenses for one qualifying individual is $3,000 times 35%, or $1,050. For two or more qualifying individuals, the maximum credit is $6,000 times 35%, or $2,100.
The percentage starts to decrease once your AGI goes over $15,000, but it doesn’t phase out entirely. If your AGI is above $43,000, you’ll at least get to claim 20% of your allowable expenses.
For example, say your AGI is $75,000, you have two children under the age of 13 in daycare, and your total care expenses for the year were $10,000. Since you have two qualifying individuals, you can use $6,000 of those expenses to calculate your credit. Because your AGI is above $43,000, the percentage you use to calculate the child care tax credit is 20%. So, your available tax credit would be $6,000 times 20%, or $1,200.
Another important thing to note is that this is a tax credit, as opposed to a tax deduction. Tax deductions lower your taxable income, so their value depends on your tax bracket. On the other hand, a tax credit is a dollar-for-dollar reduction in the amount of tax you owe.
Say you calculate your tax return without any credits and have taxes due of $1,600. If you apply the $1,200 Child and Dependent Care Tax Credit to your tax bill, you owe $400 instead. That makes the child care credit a valuable tax break for anyone paying for eligible care expenses.
Other Child-Related Credits and Deductions to Consider
If you can’t claim the Child and Dependent Care Credit or are looking for more ways to reduce your tax bill, consider these tax credits and deductions.
Child Tax Credit
The Child Tax Credit is worth up to $2,000 for each dependent child under the age of 17 at the end of the tax year. To qualify for the credit, your dependent must have lived with you for more than half the year, and you must have at least $2,500 of earned income.
The Child Tax Credit phases out for high-income taxpayers. If you are single with an AGI over $240,000 or married filing jointly with an AGI over $440,000, you won’t get any benefit from claiming this credit.
You can learn more about the Child Tax Credit in IRS Publication 501.
Credit for Other Dependents
If you have a dependent who doesn’t meet the requirements to claim the Child Tax Credit, such as a college student or elderly parent, you may be able to claim the Credit for Other Dependents. This credit is worth up to $500 per dependent but has the same phase-out limits as the Child Tax Credit.
Medical Expense Deduction
If you paid for health insurance and other health care costs for your dependents, you might benefit from the deduction for medical expenses.
Medical expenses are included in itemized deductions. So to get a benefit, your total itemized deductions, including health care costs, state and local taxes, mortgage interest, and charitable contributions, must be greater than the standard deduction available for your filing status.
For 2019, the available standard deductions are:
- Single and Married Filing Separately: $12,200
- Married Filing Jointly: $24,400
- Head of Household: $18,350
In addition, you only get to deduct medical expenses that exceed 7.5% of your AGI. Eligible expenses include:
- Medical, dental and vision insurance premiums
- Doctor visit co-pays
- Prescription drug costs
- Amounts paid for eyeglasses and contact lenses
- Lab fees
For a complete list of eligible expenses, check out IRS Publication 502.
If you and your family are in relatively good health and have access to employer-subsidized health insurance, that can be a difficult threshold to meet. However, parents of children with special needs may have more expenses that qualify.
Earned Income Tax Credit
The Earned Income Tax Credit (EITC) benefits low- and moderate-income workers, with larger credits available to taxpayers who have children.
Your maximum EITC depends on how many qualifying children you claim on your return. For 2019, the maximums are:
- $6,557 with three or more qualifying children
- $5,828 with two qualifying children
- $3,526 with one qualifying child
- $529 with no qualifying children
For more information on the EITC, including income limits, check out IRS Publication 596 .
If you adopt a child during the tax year, the Adoption Credit is worth up to $13,810 per child.
Qualified adoption expenses that can be used to calculate the credit include:
- Adoption fees
- Court costs and attorney fees
- Traveling expenses
The Adoption Credit phases out for taxpayers with modified AGIs between $207,140 and $247,140 in 2019.
Dealing with taxes can be tedious and frustrating, but taking advantage of the Child and Dependent Care credit and other tax breaks can help offset the high cost of raising children. Take the time to research the tax credits and deductions that apply to you so you can minimize the amount of tax you’ll owe or even increase your tax refund.