American Rescue Plan Act of 2021- Dependent Care Credits
Through the American Rescue Plan Act of 2021, the Federal Government has greatly expanded the tax credits for dependent care costs. The Child and Dependent Care Tax Credit is a credit allowed for a percentage of work-related expenses that a taxpayer incurs for the care of qualifying persons to enable the taxpayer to work.
Previously, the law had allowed tax credits to offset dependent care costs as follows:
Maximum allowable expense per dependent: $3,000
Allowable credit percentage (income over $43,000): 20%
As expanded under the American Rescue Plan:
Maximum allowable expenses per dependent: $8,000
Allowable credit percentage (income $125,000 or less): 50%
The 50% credit reduces as income exceeds $125,000 and is fully phased out by $440,000.
Pre-2021 tax law, a family with two qualifying children in day care earning $120,000 with $20,000 in dependent care costs would calculate their dependent care credit as follows:
Maximum allowable expense: $3,000 X 2 = $6,000
Credit Percentage Applied: 20%
Tax Credit: $1,200
According to the 2021 tax law, a family with two qualifying children in day care earning $120,000 with $20,000 in dependent care costs calculates their dependent care credit as follows:
Maximum allowable expense: $8,000 X 2 = $16,000
Credit Percentage Applied: 50%
Tax Credit: $8,000
There has been a substantial increase to the allowable amount of pre-tax withholding allowance for employees whose employer hosts a flexible spending account program through payroll. Before 2021 you would be able to withhold $5,000 from pay on a pre-tax basis to apply towards dependent care cost. That amount has been increased to $10,500 under the American Rescue Plan Act of 2021.
We are excited to see this credit expansion greatly reduce the costs for working families to take care of their children. Although there are rules and limitations in place, we expect most families to greatly benefit from these changes. We are available to navigate these opportunities with you.
Michael Zaidman, CPA | 07/19/2021