Dependent Care Credit
Posted on August 25, 2008
Filed Under Credits, Federal Income Tax
The child and dependent care credit (hereafter abbreviated as dependent care credit), a nonrefundable credit that can be taken against regular and alternative tax liability, provides relief to those able to work (or look for work) only if care, at a price, is provided for their dependents. Like other tax credits, the dependent care credit provides a 100% after-tax savings for each dollar of credit a taxpayer is able subtract from income tax liability; deductions, on the other hand, deliver an after-tax savings equal to the taxpayer’s marginal tax rate (at present, the highest marginal tax rate for individual taxpayers is 35%). In short, credits are more valuable than deductions. Unfortunately, there is no carryover for any unused dependent care credit.
Eligible taxpayers can take a credit of up to 35% of employment-related dependent care expenses (pdf file) for qualifying individuals, where the total of employment-related expenses is limited to the taxpayer’s earned income. (Note: Earned income includes wages, salaries, professional fees, tips, and other payments for personal services but not interest and dividends.) Expenses incurred during the time a taxpayer is able to secure, or search for, gainful employment only if others are paid to care for taxpayer’s dependents are classified as employment-related expenses for purposes of the dependent care credit. Gainful employment includes the obvious such as working for others part- or full-time or being self-employed but not volunteer work at nominal pay. In addition, the Internal Revenue Code is written in a way that prevents a double tax benefit, that is, payments received by a taxpayer from an employer-provided dependent care account are subtracted from the total of expenses available for the dependent care credit. Click on dependent care fsa (pdf file) for a worksheet that helps a taxpayer optimize his or her tax situation via a comparison of the dependent care credit with an employer-provided flexible spending account. (Note: IRS Form 2441–Child and Dependent Care Expenses–and related instructions, two vital documents for those investigating the dependent care credit, have been posted to my Tax Forms page on the navigation menu above.)
Dependent care expenses attributable to any part of the year in which a taxpayer is not working or looking for work are not eligible for the dependent care credit. Put differently, only dependent care expenses allocable to the time during which a taxpayer is actually employed or looking for gainful employment qualify for the credit.
Expenses do not qualify for the dependent care credit if paid to (1) a person the taxpayer can claim as a dependent, (2) taxpayer’s spouse, or (3) taxpayer’s child who is under age 19 at the end of the tax year. In addition, no credit is allowed for the cost of sending a child or other dependent to an overnight camp.
A taxpayer must file a joint return if married in order to claim the dependent care credit. (Note: A married taxpayer providing a principal place of abode for a qualifying dependent but living apart from his or her spouse for the last six months of the tax year is considered unmarried and qualifies as a head of household filer for purposes of the dependent care credit). In the case of a married couple, the total of employment-related expenses eligible for the credit can be no more than the earned income of the lower-earning spouse. More important, if one spouse is not working then the married couple cannot take the dependent care credit. However, just in case a nonworking spouse is a full-time student for at least five calendar months or disabled and the couple has one qualifying dependent, federal law, for the sole purpose of calculating the earned income of the lower-earning spouse, assigns to the nonworking spouse earned income of $250 per month each month the spouse is disabled or attends school ($500 per month if the couple has two or more qualifying dependents) thus making the couple eligible for the credit. While this exception creates earned, but not taxable, income for the unemployed spouse by statutory maneuver, it does not apply when both spouses are unemployed.
Since the credit addresses only a fraction of total dependent care costs necessary for gainful employment, the maximum amount a taxpayer can write off is $1,050 for the care of one qualifying dependent ($3,000 x 35%) and $2,100 for two or more qualifying dependents ($6,000 x 35%). The top rate of 35% is reduced by one percentage point for each $2,000 increment, or portion thereof, of adjusted gross income (AGI) above $15,000 and bottoms out at 20% for taxpayers with AGI greater than $43,000. An increment of AGI greater than $2,000 causes a two-bracket jump thereby reducing the fraction of available dependent care credit by two percentage points. For example, a taxpayer with AGI of $17,300, an AGI producing an increment $2,300 above the $15,000 threshold, jumps not one but two brackets, landing in the $17,001-to-$19,000 bracket and its smaller proportion of expenses (33% to be exact) open to the dependent care credit. (But click on childcare credit (pdf file) for a brief examination of why the dependent care credit may not work for married couples and other important shortcomings of the credit.)
To complete the list, the following percentage of allowable employment-related expenses may be claimed as a dependent care credit depending on the taxpayer’s AGI: If taxpayer’s AGI is not more than $15,000, then 35% of employment-related expenses may be claimed as a credit; $15,001 to $17,000 AGI, then 34%; $17,001 to $19,000 AGI, 33%; $19,001 to $21,000 AGI, 32%; $21,001 to $23,000 AGI, 31%; $23,001 to $25,000 AGI, 30%; $25,001 to $27,000 AGI, 29%; $27,001 to $29,000 AGI, 28%; $29,001 to $31,000 AGI, 27%; $31,001 to $33,000 AGI, 26%; $33,001 to $35,000 AGI, 25%; $35,001 to $37,000 AGI, 24%; $37,001 to $39,000 AGI, 23%; $39.001 to $41,000 AGI, 22%; $41,001 to $43,000 AGI, 21%; and, if taxpayer’s AGI is $43,001 or higher, then 20% of eligible expenses may be claimed as a credit.
An individual qualifies for the dependent care credit under the following circumstances:
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The individual is under age 13 at the end of the tax year, did not provide more than 50% of his or her support for the year, has the same principal place of abode as the taxpayer for over half the year, and is related to taxpayer as (1) a descendant of either the taxpayer or taxpayer’s child, (2) the taxpayer’s sibling, half-sibling, or step-sibling, (3) a descendant of taxpayer’s sibling, half-sibling, or step-sibling, (4) taxpayer’s stepchild, or (5) taxpayer’s legally adopted child or foster child placed with the taxpayer by an authorized adoption agency or by judgment or decree of a court with jurisdiction. If the individual reaches age 13 before the end of the tax year, the taxpayer may receive credit for expenses incurred up to the dependent’s birthday. In the case of divorce or separation, only the custodial parent (that is, the parent with custody for the greater portion of the year) can claim the credit even if the noncustodial parent provides more than 50% of the child’s support or the custodial parent releases the right to claim a dependency exemption for the child.
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The individual is a tax dependent with the same principal place of abode as taxpayer for more than one-half of the year but not capable, physically or mentally, of caring for himself or herself. Again, in the event of divorce or separation, only the custodial parent can claim the credit.
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The individual is taxpayer’s spouse with the same principal place of abode for more than one-half of the year but is not capable, physically or mentally, of caring for himself or herself.
The non-exhaustive list below identifies several employment-related expenses (to repeat: expenses necessary for gainful employment, or job search activities, of a taxpayer) that qualify for the dependent care credit:
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Wages and taxes paid in connection with household services performed by a full-time, live-in employee for the benefit of taxpayer’s qualifying dependent; in this type of arrangement, the taxpayer, as employer, may be required to pay employer’s, and withhold employee’s, share of FICA and federal and state unemployment taxes;
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Services for taxpayer’s qualifying dependent or disabled spouse at a properly licensed outside dependent care center provided the individual in question regularly spends at least eight hours a day in the taxpayer’s home;
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Payments to a babysitter, cook, housekeeper, maid, etc. for household services that benefit taxpayer’s qualifying dependent, including the cost of providing meals and lodging for any in-home provider;
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Nursery school and kindergarten costs, but any separable educational benefits must be subtracted from the total of qualifying expenses; and
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The cost of a special school program.
Refer to the list of relevant articles below for more information about the dependent care credit:
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Dependent care tax credit (pdf file)
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Tax dependent care (pdf file)
Many happy returns, Roger
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