Among all the expected and unexpected expenses that parents of young children face, the biggest may be the sticker shock from daycare and after-school programs.
According to the U.S. Department of Labor, the median annual cost for full-day daycare for just one child ranged from $6,552 to $15,600 in 2022 (the most recent year for which data is available). To put that in perspective, the nationwide median cost of a full year’s rent in 2022 was $15,216.
One cost-saving tool can help: the Child and Dependent Care Tax Credit (CDCTC), a federal tax benefit designed to offset the cost of care so that parents or guardians can work. Many parents may already realize that this flexible and widely available benefit is key to family budgeting, tax savings, and longer-term financial planning (which may include life insurance for children). However, it’s crucial—and can be confusing—enough that almost anyone might benefit from refreshing their knowledge as tax season nears.
What is the child and dependent care tax credit?
As mentioned, it’s a federal benefit (although New Jersey has its own version to help reduce state taxes for residents) to assist families with care costs for eligible individuals. Besides children under 13, it can also be used to lower the cost of caring for an older dependent who is physically or mentally unable to care for themselves. In both cases, the qualifying dependent must live with you for over half the year, and the care must occur during your working hours. If you are married, you must typically file a joint return to claim the credit. However, exceptions exist for separated individuals or those living apart from their spouse.How does the credit work?
It’s calculated based on your adjusted gross income (AGI) and as a percentage of your qualifying expenses. For the tax year 2024, individuals can claim up to $3,000 of eligible expenses for one qualifying person or $6,000 for two or more, provided their expenses are high enough and/or their income is low enough to meet the cap. The percentage of expenses you can claim will vary from 20% to 35%, depending on your AGI. For instance, if your AGI is $15,000 or less, you can claim 35% of your qualifying expenses. As your income rises, the percentage decreases, but it won’t completely vanish. Therefore, even those earning significantly more than the $43,000 AGI cutoff for the minimum (20%) percentage can still claim the maximum benefit ($3,000 or $6,000) if their qualifying expenses exceed at least $15,000 (20% x $15,000 = $3,000). Remember, Adjusted Gross Income is not the same as gross income, as a long list of other expenses such as contributions to your IRA, student loan interest, and health savings account contributions reduce it. Thus, your percentage may be higher than you think.Is this the same as the Child Tax Credit or different?
Different. The Child Tax Credit is another federal benefit that provides relief for qualifying children (up to age 17 in this case) to help offset all the costs of raising children, not just work-related care costs. It’s a flat amount of $2,000 per qualifying child, which begins to phase out for single filers with an AGI above $200,000 and for joint filers with an AGI above $400,000. Another difference is that the Child Tax Credit is partially refundable, whereas the CDCTC is not, meaning the former can result in a partial refund while the latter can’t reduce your taxes by more than the amount owed. Still, it’s important to highlight that both are credits, not deductions. Many people confuse the two terms. A deduction reduces your taxable income before calculating taxes, while a credit directly reduces the taxes owed, dollar for dollar. That’s why, all things being equal, credits can be more beneficial.Eligible child and dependent care expenses
CDCTC is specifically designed to offset the costs of services that enable parents or guardians to work or look for work. Any expense that falls outside that definition, including for education, does not qualify. Here are a few instances that would qualify for CDCTC:
- A babysitter hired to care for a sick child so you can work.
- Summer camp if it’s day camp (sleepover camp does not).
- A grandparent can qualify as a paid caregiver. The IRS does not prohibit paying relatives for childcare provided that the relative is not a dependent of yours under the age of 19. Here are a few instances that would not qualify for CDCTC:Private kindergarten, as anything above preschool is considered education.After-school tutoring or lessons as they are classified as being more about education and enrichment than work-enablement.Sending a child to live with extended family abroad for care.
How to apply for the Child and Dependent Care Tax Credit
To claim the credit, you must fill out IRS Form 2441 and submit it with your federal tax return (Form 1040). You’ll need:
- Total amount paid for qualifying childcare or dependent care services.
- Provider information, including name, address, and Social Security Number (SSN) or Employer Identification Number (EIN).
- Dependent’s name, SSN, and relationship to you.
Frequently asked questions
Here are some additional common questions about CDCTC that you may want to consider.
Is the Child and Dependent Care Tax Credit refundable?
CDCTC is non-refundable. This means that while it can reduce the amount of taxes you owe, it won’t provide a refund if the credit exceeds your tax liability.
Can a non-custodial parent claim child and dependent care credit?
No, a non-custodial parent cannot claim the CDCTC. Only the custodial parent, who has physical custody of the child for the greater part of the year, can claim this credit.
Why is my child and dependent care credit so low?
There are a few reasons why your CDCCTC might be lower than you expected:
- Income level — The credit percentage decreases as your adjusted gross income (AGI) increases. Higher income levels result in a lower credit percentage.
- Eligible expenses — The credit is based on a percentage of your work-related care expenses. There is a limit of $3,000 for one qualifying individual and $6,000 for two or more qualifying individuals.
- Filing status — if your filing status is “Married Filing Separately,” you generally cannot claim the credit.
- Dependent Care benefits — If you received dependent care benefits that you excluded or deducted from your income, you must subtract the amount of those benefits from the dollar limit that applies to you.
Does the child and dependent care credit phase out?
Yes, CDCCT does phase out, but not completely. The credit percentage decreases as your adjusted gross income increases.
Are child tax credit and dependent care credit mutually exclusive?
No, they are not mutually exclusive. You can claim both credits on your tax return, but the expenses used for child and dependent care cannot be the same expenses used for the Child Tax Credit.
The Child and Dependent Care Tax Credit can be a valuable tool to reduce the burden of childcare costs. Understanding how it works can help families maximize their benefits and save money where it counts.
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