Most the talk about the latest COVID relief package is the stimulus payments. There were also significant changes to the child and dependent care credit. Let’s start with what the child and dependent care credit is and how it was calculated.
Generally, the child and dependent care credit is paid to taxpayers who pay for care for a child or other dependent so that the taxpayer(s) can work or look for work. So, if you are Married Filing Jointly (MFJ), both spouses must be working or looking for work when the expenses are incurred.
The tax credit is calculated as a percentage of the allowed expenses and it phases out as income increases (allowed expenses are the maximum you can claim. If you paid less, then the amount you pay is the amount used to calculate the credit). The allowed expenses for a single child or dependent is $3,000 and $6,000 for two or more children or other dependents. The maximum credit is 35% of the amount above and phases out to 20% at a relatively low amount of $15,000 of Adjusted Gross Income (AGI). So for a single child or dependent the minimum credit is $600 and for two or more children or dependents it is $1,200. It should be noted that the credit is not refundable. So if your tax bill is $1,000 even if your credit is $1,200 your tax bill will only be reduced to $0.
Changes in the New Law
The new law changed pretty much everything above for 2021 only. First of all, the allowed expenses are increased to $8,000 for a single child or dependent and to $16,000 for two or more children or dependents.
The maximum percentage is also increased to 50%. On top of that, the phase out doesn’t start until $125,000 of AGI (regardless of filing status). The credit is reduced to 20% at $185,000 and stays at that level until $400,000 of AGI. At $440,000 of AGI, the credit is phased out completely. Prior to 2021, the credit never completely phased out.
The final change is that the credit is now refundable. That means a taxpayer can get back a larger refund than taxes withheld. As an example, imagine a taxpayer with $8,000 in child care expenses, $0 taxable income and $500 of withholding. The taxpayer would get his or her $500 in withholding ($0 taxable income) plus $4,000 due to the child care credit. This, can be significant for low income taxpayers.
If you have children in child care or have a dependent in care and you’re working, you may want to consider reducing your withholding for 2021. Of course, if you know someone else this applies to, make sure they know as well.
Military Finances are Different
While this change to tax law affects all Americans, that isn't always the case. There are several places where the Tax Code treats military members and retirees differently than civilians. That is also the case with your finances in general. If you'd like to chat with a firm that focuses on those differences give us a call or click on the button below to schedule a no-cost initial consultation.
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