Do you have questions about child tax credits in 2021? We break it down for you.March 10, 2021
On Wednesday, March 10th Congress passed a landmark $1.9 trillion stimulus package. This package has immediate implications for parents, specifically around child tax credits. For many households, child care is the second-largest expense. Therefore any sort of reduction would be a major relief for families. Understanding the true cost of childcare is challenging and then having to understand the tax implications can be overwhelming for any parent. We try and break down the major points to keep in mind as we get closer to April 15th, the last day to file taxes in 2021.
What is the Child Tax Credit?
According to the Tax Policy Center “The child tax credit provides a credit of up to $2,000 per child under age 17. If the credit exceeds taxes owed, families may receive up to $1,400 per child as a refund. Other dependents—including children ages 17–18 and full-time college students ages 19–24—can receive a nonrefundable credit of up to $500 each.”
It’s important to note that a tax credit differs from a tax deduction. Tax credits directly reduce the amount of tax you owe. Tax deductions reduce how much of your income is subject to taxes.
How has the Stimulus Package Affected Child Tax Credits?
The stimulus package impacts child tax credits in a few ways.
- Income Eligibility: Previously, parents had to be employed and earn an income of at least $2,500 to be eligible. Now the income requirement has been waived.
- Age Expansion: Previously the credit was capped at age 17. With the new stimulus package, it has been increased to 18.
- Higher Amount: The amount of money parents get for the credit has increased from $2,000 to $3,000 per child under 17 and $3,600 per child under 6.
- Advanced Payments: Under the new plan, parents could receive up to 50% of the credit in advance. Periodic payments would be sent starting in July 2021
- Fully Refundable: Previously only $1,400 per child could be received as a refund. Under the new plan, the credit is fully refundable meaning $3,000 per child under 17 and $3,600 per child under 6 would be eligible for a refund.
What is the Child Care and Dependent Tax Credit?
If you pay for some form of child care you may be eligible for the Child Care and Dependent Tax Credit. As explained by “The Balance,” “The Internal Revenue Service’s (IRS) child and dependent care tax credit provides a tax credit of up to 35% of the expenses you pay someone to take care of your children or adult dependents.” Children must be under the age of 13 to be eligible. The expenses can’t be payments to a spouse or a dependent (like an older sibling). These are expenses such as the payments you make to a daycare center or nanny. Also, both parents have to show some form of income unless a parent cannot take care of the child on their own. The percentage of expenses you can claim is dependent on income. These expenses are not just limited to daycares or nannies. Other things like before and after school care and summer camps may also be eligible.
What has changed about the Child Care and Dependent Tax Credit?
- Percentage of Expenses: The percentage that you use to determine the amount of credit has increased from 35% to 50%.
- Maximum Amount: Previously the maximum amount that could be expensed was capped at $2100 for two or more children. Now the cap has increased to $8,000 for two or more children.
- Income Eligibility: The percentage of expenses decreases as your income increases. Previously the decline started at a household income of $15,000 but in 2021 households with an income of less than $125,000 will be eligible for the full percentage.
- High-Income Households: For households with an income over $400,000 the percentage of expenses that can be claimed will decrease to below 20%.
What is the Dependent Care Flexible Spending Account?
According to the Federal Flexible Spending Account Program, a Dependent Care FSA (DCFSA) is a pre-tax benefit account used to pay for eligible dependent care services, such as preschool, summer day camp, before or after school programs, and child or adult daycare. This is not a credit but an account where you add pre-tax dollars, effectively reducing your overall tax burden. These accounts are set-up through your employer. Therefore they are only available to employees of companies that offer a DCFSA as a benefit. Money from your paycheck is automatically added to your account. In order to use the money, you have to pay out-of-pocket first and then apply to be reimbursed. The maximum amount you can add is $5,000. However, for 2021 the maximum amount has increased to $10,500. This change has to be approved by your employer. A few things to consider with a DCFSA:
- You typically have to opt-in with your employer prior to the beginning of the year so you have to plan ahead of time
- You need to still pay for the expenses out-of-pocket and then apply for reimbursement. This can be challenging if you are already stretching your paycheck to contribute to the account in the first place.
- It's a use or lose it account so you need to add only how much you think you will actually spend. If there’s anything leftover by the end of the year (or March 15th of the following year if your employer offers a grace period) then you lose that money. If you are a new parent you can estimate the cost by looking up the price of childcare near you on Upfront . You can also use our Daycare Calculator to see the average cost of daycares in your neighborhood. This can help you plan ahead and understand how much you should set aside in the DCFSA.
Can I use both the Childcare and Dependent Tax Credit and Dependent Care FSA?
The short answer is yes. However, you cannot use both of them for the same expense. If you have two or more children you could use the DCFSA for the first $5,000. You could then claim credit of $1,000 for expenses above that. Typically if your employer offers a DCFSA it makes more sense to take advantage of that. It really does depend on your income level and amount of expenses. It's best to discuss this with a tax expert to make sure you are maximizing the benefits in the best way possible.
Raising a child comes with large expenses. Different tax programs work to reduce the burden on parents. Do your research to determine the best programs to take advantage of and the best way to set-up expenses to help reduce costs as much as possible.
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