The Expanded Child and Dependent Care Tax Credit Can Reduce Families’ Child Care Burden

BlogEarly ChildhoodFeb 9 2022

Over the past year, tax credits have rightly claimed the spotlight as researchers and policymakers hailed the poverty-reducing benefits of the Child Tax Credit (CTC) and Earned Income Tax Credit (EITC). With the onset of tax season, it’s time to highlight a lesser-known tax credit temporarily expanded for tax year 2021 under the American Rescue Plan (ARP)—the Child and Dependent Care Tax Credit (CDCTC). The expanded CDCTC is a critical federal investment in working families that can substantially reduce the high burden of child and dependent care, particularly among low- and moderate-income families. Family advocates, service providers, and tax preparers should work to increase awareness of the CDCTC among families with young children so that they are positioned to take full advantage.

The expanded CDCTC helps offset the cost of child and dependent care for many working families, the majority of whom pay more for child care than for any other single household expense. The credit is especially beneficial to the lowest-income working families in our country, who pay upwards of 33 percent of their income out of pocket on child care, a figure 4.5 times greater than the 7 percent benchmark for low-income working families suggested by the Department of Health and Human Services.

To benefit working families, the ARP expanded the CDCTC in three key ways:

  • The CDCTC is now fully refundable. Eligible working families receive any excess credit (the amount of credit minus any taxes owed) as a refund. This means that, in the 2021 tax year, the benefits of the CDCTC extend to the lowest-income working families—families previously unable to utilize the credit if they had no tax liability. Because the refund comes as a direct deposit or check in the mail, the CDCTC operates like a cash transfer, similar to the CTC and EITC, with a direct impact on families’ economic well-being and children’s healthy development.
  • The credit is now larger. Eligible families can now receive a credit of up to $4,000 for one dependent and up to $8,000 for two or more dependents. Families can be reimbursed for up to 50 percent of the first $8,000 of care expenses for one dependent and the first $16,000 of care expenses for two or more dependents. Previously, the credit was for up to 35 percent of the first $3,000 of care expenses for one dependent (a $1,050 credit) and the first $6,000 of care expenses for two or more (a $2,100 credit). Compared to previous years, the credit is up to $5,900 higher; however, given wider income eligibility for the 2021 tax year, it could represent as much as $8,000 back to eligible working families.
  • The full credit is now available to households with a wider range of incomes. The full credit is now available to families with adjusted gross incomes (AGIs) of $125,000 or less, acknowledging the importance of child care for workforce participation and a healthy economy. The credit percentage decreases gradually and is fully phased out for AGIs above $438,000. Previously, the credit percentage decreased when AGI exceeded $15,000 and a credit of 20 percent was available to those with AGI over $43,000.

As an example, a family with two working parents earning $50,000 annually and paying for full-time child care for two children, at a cost of $10,000, would be eligible for a credit of up to $5,000 (50% of their child care costs), with any excess tax credit issued as a refund. Previously, this same family would have been eligible for a tax credit of $1,200. As a second example, a family with one working parent earning $12,550 or less paying $3,000 a year for child care would be eligible for a credit of up to $1,500; in previous years, their credit would have been $0 because their income level carried no tax obligation.

The CDCTC can offset the cost of a wide range of child and dependent care arrangements, including informal arrangements that may provide greater flexibility and better fit the needs of parents who work nonstandard hours or who have infants and toddlers. Care expenses can include child care—including child care centers, family child care homes, preschool, day camp, and before- and after-school care for older children (up to age 13)—as well as care for a spouse or dependent who isn’t mentally or physically able to care for themselves. Qualifying care expenses include babysitters, nanny-shares, and paid family members or neighbors; however, families will need to provide information about the care provider, including their taxpayer identification number (for individuals, just their Social Security number), which may carry tax implications for both the household and the care provider.

While the future of the expanded CDCTC is unclear, the 2021 tax year expansion is a potentially important source of immediate financial relief for working families that recognizes the centrality of child and dependent care for the health of our economy. This relief may increase mothers’ participation in the workforce; allow for spending on other necessities, such as food and housing; and have positive impacts on young children’s development. This year, we should ensure that families are positioned to benefit from the substantial financial relief for which they are eligible.

For more information regarding CDCTC eligibility and filing, please visit the IRS website.