February 21, 2023

Do you pay someone to watch your young child or another qualifying dependent while you’re at work? If so, you may be entitled to claim the dependent care credit on your 2022 return, but you must file by April 18. Recent enhancements provided under the American Rescue Plan Act (ARPA) expired at the end of 2021. Nevertheless, you can still maximize generous tax benefits on your 2022 return by understanding the rules and taking full advantage of what’s allowed under current law. Here’s an overview of today’s rules.

The Basics

Generally, parents of children under age 13 are eligible for the nonrefundable dependent care credit if they incur expenses to allow them to be “gainfully employed.” The credit covers eligible expenses that you pay so you can work — or if you’re married, so both you and your spouse can work. If you’re married, you generally must file a joint Form 1040 for the tax year in question to claim the child and dependent care credit.

The percentage is based on a sliding scale, depending on your adjusted gross income (AGI), starting at 35% for AGI below $15,000. The 35% credit is gradually reduced by one percentage point for each $2,000 (or fraction thereof) of AGI above $15,000 until it reaches 20%.

Under this formula, the credit equals 20% of eligible expenses for taxpayers with an AGI above $43,000. The credit is a dollar-for-dollar reduction of your tax bill, which is more valuable than a tax deduction.

Additional Restrictions

When claiming the dependent care credit, there’s an annual dollar cap on the amount of eligible expenses. The cap is $3,000 for one qualifying dependent, and $6,000 for two or more qualifying dependents. Therefore, the maximum credit for a taxpayer with an AGI above $43,000 is $600 for one qualifying dependent ($1,200 for two or more qualifying dependents).

In addition, the eligible expenses of a married couple can’t exceed the lower of the earned income or the annual earnings of the lower-paid spouse. For example, Jack earns $5,000 annually from a part-time job, and Jill earns $100,000 annually for her full-time gig. The couple pays someone $1,000 a month to watch the kids ($12,000 for the year). The eligible expenses available for the credit are limited to $5,000 (Jack’s part-time income) — not $12,000.

Under the general limitation rule, if one spouse has no earned income, you can’t claim the child and dependent care credit. However, if your spouse has no earned income and is disabled or a full-time student, he or she is deemed to have monthly earnings of $250 if you have one qualifying individual ($500 if you have two or more qualifying individuals). Therefore, the maximum amount of eligible expenses for the year is $3,000 for one child ($6,000 for two or more children). Under this exception, you can potentially claim the child and dependent care credit even though your spouse doesn’t actually work and has no earnings.

For this purpose, a parent is considered a full-time student if he or she is enrolled full time at a school for at least five calendar months during the year. The months don’t have to be consecutive. Conversely, a part-time student who takes only several courses during the year is excluded from claiming the credit.

Current Rules – Special Situations

The current rules for the dependent care credit are relatively straightforward. But there are several nuances that you should know about. To get the most from this tax break, consider the following situations:

In-home babysitters. The credit covers both out-of-home and in-home expenses. For example, the list of eligible expenses includes day care centers and private nursery schools — as well as babysitters who come to your home. Caregivers can even be relatives, such as aunts, uncles and grandparents. However, the relative can’t be someone who qualifies as your tax dependent. So, you can’t deduct the cost of hiring your teenager to watch a younger sibling.

The credit may even be available for wages or fees paid to a nanny, maid or housekeeper who performs other services around the home. Generally, the entire cost for these services qualifies for the credit. However, no credit is allowed for services provided by a chauffeur or gardener.

After-school care. Costs for kindergarten and above don’t qualify, because they’re considered education expenses rather than care expenses. However, costs for before- and after-school programs can qualify for the credit.

Summer camps. Summer day camps also qualify for the credit. The day camp can be a specialty camp involving activities, such as sports or music, or a specific academic discipline, such as computer or math studies. But no credit is allowed for an overnight camp.

Nonchild dependents. The dependent care credit isn’t necessarily limited to expenses paid for young children. It may also be available for care given to a dependent you support, such as an elderly parent or an adult child with a disability who lives with you and requires daily assistance. The caretaker doesn’t have to be a nurse or other health care professional or have any special training.

Similarly, you can even claim the credit for expenses of caring for your spouse while you’re working. For instance, suppose your spouse is at home with a back injury for 10 weeks. The cost of an aide for your spouse during that 10-week period qualifies for the credit.

Divorced parents. The credit can be claimed by a divorced parent who provides more than half of a child’s support during the tax year. In this situation, the child must have been in the custody of one or both parents for more than half the year, and the parent claiming the credit must be the child’s custodial parent.

Claiming Your Credit

The GRF Tax Team or your tax advisor can help you navigate the federal income tax rules for this credit. Before reaching out to your advisor, make sure you have all the information needed to claim the credit on your 2022 return. This includes the provider’s name, address, and Social Security number or Employer Identification Number.

©  2023