Changes to Dependent Care - 2021 only

 2021 Dependent Care Credit Update

In the last post, the 2021 changes for the child tax credit were discussed.  This post is about changes to the credit for caring for dependents, which is completely different.

In March 2021 Congress passed the American Rescue Plan Act (ARPA) which expands the dependent care credit for 2021 only.

Historically, this credit is for qualified expenses paid that allow a taxpayer and/or their spouse to work or go to school, and was based on the earned income of the lower earner (meaning a married couple must both have earned income to be eligible for the credit, or if a student the earned income is deemed to be $250 per month while a student).  The qualified expense amounts were capped at $3,000 per dependent (age 13 or younger) and up to 2 children.  Employees could elect a pre-tax deferral up to $5,000 from their paycheck for reimbursement of dependent care expenses, the amount claimed on the personal return is reduced for the pre-tax deferral or employer paid amounts.  The credit was non-refundable (could only be used to offset tax liability) and the percentage of expenses for the credit ranged from 35% down to 20%.

Changes for 2021

For 2021 (only) individual tax returns qualify this credit is greatly expanded.  The credit is eligible to be refundable (if the credit exceeds the tax liability, it may result in a larger refund), the credit rate ranges from up to 50% down to 20%, and the qualified expense amount is raised to $8,000 for 1 dependent and up to $16,000 expenses for more than 1 dependent. The pre-tax dependent care election amount has been raised to $10,500.

Action Items to consider:

• Election for pre-tax amount from paycheck: if your employer offers a dependent care Flexible Savings Account (FSA), review the option to increase the amount of the election for 2021.  The FSA provides tax savings for Federal and State income taxes, plus Social Security and Medicare taxes.  If you have 2 or more kids, the full election more be more beneficial than the credit.
• Document qualified expenses: To claim the credit, at tax time the form 2441 is used which requires listing the Care Provider's name, address, tax identification number/Social Security number, and amount paid during the year. Without that information, the tax return may not be able to claim the credit or may result in extended delays in processing the return for missing information.

As each person's situation is unique, a consultation to review your specific circumstances may be warranted and the above is intended to be educational to this topic, but not specific tax advice for all taxpayers.