Save on Childcare with the Child and Dependent Care Credit

child and dependent care credit

Photo courtesy of Paul Schultz

Childcare can be crazy expensive.

According to Babycenter, the average cost of daycare in the United States is $11,666 per year. Of course, that varies widely according to where you live and how you decide to do things, but the fact of the matter is that if you need it, it’s probably going to be one of the bigger items in your budget.

Luckily, the IRS recognizes that this can be a pretty big burden and has decided to give you at least a little bit of a break on those costs. It certainly won’t make them go away, but it can put some decent money back in your pocket.

So today I want to talk about the child and dependent care credit, including what it is and how you can calculate what kind of tax break you might be able to get.

What is the child and dependent care credit for?

If you paid someone to help care for your child or other dependent so that you could either work or look for work, you may be able to claim some of that expense as a tax credit.

In order to claim the credit, both you and your spouse must have some kind of earned income. In other words, you won’t get the credit if you put your child in daycare so that you can watch Netflix all day. Breaking Bad might be emotionally challenging, but as far as the IRS is concerned it doesn’t qualify as “work”.

Expenses that qualify include anything paid to someone who cared for any of the following types of people:

  1. A dependent child under the age of 13 (here is a good overview for whether someone qualifies as a dependent),
  2. A spouse who lives with you for more than 1/2 the year and is physically or mentally incapable of self-care, or
  3. Any other dependent who lives with you for more than 1/2 the year and is physically or mentally incapable of self-care.

I’m going to focus on how this works with young children, but know that the rules apply similarly for #2 and #3.

How much is the credit?

Actually figuring your exact credit is a little tricky. It’s definitely a good idea to work with a tax professional (or Turbo Tax) to figure it out for yourself, but here’s a quick overview.

First of all, the maximum possible credit in 2014 is $1,050 if you have one child, and $2,100 if you have two or more children.

But there are a few steps to take before you can get there, so here’s the rundown. The actual IRS worksheet you would use to figure all of this out yourself is Form 2441:

  1. Add up all of your childcare costs. For an overview of what qualifies and what doesn’t, go here and scroll down to the section titled “Care of a Qualifying Person”.
  2. Limit the amount from Step 1 to the smaller of either your or your spouse’s earned income. For example, if you earned $60,000 this year and your spouse earned $10,000, then you would limit your expenses to a maximum of $10,000. For some help figuring out what qualifies as “earned income”, you can go here.
  3. Limit the amount from Step 2 to either $3,000 if you have 1 child, or $6,000 if you have 2 or more children.
  4. Reduce the amount from Step 3 by any non-taxable dependent care benefits received from your employer. Basically, if your employer helped you pay for childcare, you probably aren’t going to be able to count that amount towards the credit.
  5. Multiply the amount from Step 4 by a percentage determined by your income. Here’s a link to a table showing you what percentage to use: Dependent Care Expense Percentage.

Because it’s a tax credit, as opposed to a deduction, whatever amount you end up with is subtracted directly from final tax bill. Which is great! Less money owed to the IRS is more money in your pocket.

Other important things to know

The child and dependent care credit is non-refundable, which just means that it won’t reduce your tax liability past $0. There are some credits that can actually cause the IRS to refund you more money than you paid in, but that won’t happen here.

The following additional requirements must be met in order for you to be able to claim the credit:

  1. Expenses must be for a legitimate care provider. Examples that wouldn’t count would be your spouse, your child under the age of 19 (an older sibling), or any other dependent of you or your spouse.
  2. You need to include the name, address and taxpayer identification number of the care provider. You can use this form to collect it.
  3. If you’re married, you have to file a joint return.
  4. Each child for whom you’re claiming the credit must have their Social Security Number included on your tax return.

Finally, here are some great links from the IRS that should help answer any other questions you might have:

Wrapping it up

So the next time you’re writing that daycare check and it’s just a little painful, you can take some comfort in knowing that at the very least you might be getting some of it back at tax time.

And oh yeah, hopefully they’re taking good care of your kids too!

Disclaimer: The information above is accurate, but I am not a CPA and cannot make any recommendations for your specific situation. Please consult a qualified tax professional before making any personal tax decisions.

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  • John @ Sprout Wealth May 22, 2014

    Great breakdown of the credit Matt! It doesn’t help with all of it, but it can definitely soften the blow some. We’ve used it ourselves in the past when we were both working outside of the home and possibly again if we hire someone to care for the kiddos once or twice a week so we can be more efficient with client work.

    • Matt Becker May 22, 2014

      Oh man, I don’t know how you guys work without someone watching the kids. Casey somehow manages to squeeze in a little bit of work every now and then when the kids are asleep, but it’s tough. Anyways, the thing I like about this credit is that just about anyone can use it. You might get a smaller break with a higher income, but you’re never phased out. There’s something in it for everyone.

  • Brian May 23, 2014

    Our current tax credit situation is quite a joke. I’m lucky enough to have a company that allows me to pay pretax for day care….on a whopping $5,000 per year TOTAL.

    With 2 (soon to be 3) kids in day care, this amounts to the amount of money i spend in about 3 months on child care bills. And I’m lucky! If you live in an expesive city like boston, NYC, Chicago, SF…..it can cost $2,500 per kid per month!

    Yikes!

    This is an area that needs some IRS attention……kids are fantastic, but if you have 2 parents that work, they can be quite expensive…..

    Brian

    • Matt Becker May 23, 2014

      Thanks for the input Brian. I’ll definitely agree with you that kids can be expensive, and day care is often the biggest bill of all. But I’m not sure I agree that that means the IRS should be getting more involved than it already is. We all have to make a lot of hard choices about what we spend money on and I’m always hesitant to say that the government should be incenting this vs. incenting that. Even when those decisions are well thought out, and the broad implications are carefully considered, they often have strange consequences. I would rather see push in the market to find more affordable daycare than see the IRS try to subsidize it with tax breaks.

  • femmefrugality May 24, 2014

    We haven’t claimed this specific credit before (haven’t been able to,) but I love IRS tax worksheets! And this one is a stellar one to know about for future use. I have a question: I think I’ve misunderstood some terminology in the past. I thought a credit was money that the government “owed” you, after you paid your taxes. So with a credit, if you owe $300 but have a $700 credit, not only would that wipe your taxes out but you’d actually get a return of $400. And then what is the difference between a deduction and an exemption?

    • Matt Becker May 25, 2014

      Great questions! So first of all, when the government owes you money that’s simply called a refund. A credit is something that directly reduces the tax owed. So with a credit, you calculate the tax you owe, and then you subtract your credit from that amount.

      But there are two different types of credits: refundable and non-refundable. A refundable credit works just like you’ve described. If your credit amount is greater than your tax owed, the credit actually creates a refund. A good example of this is the earned income tax credit. A non-refundable credit on the other hand will only reduce your tax owed to $0. That is, it won’t create a refund. So in your example, if it was a non-refundable credit you would only be able to use $300 of the $700 credit.

      A deduction is different in that it reduces your taxable income, which indirectly reduces the tax owed. So it’s subtracted from your taxable income BEFORE the tax owed is calculated. So if you’re in the 15% tax bracket, a $100 deduction will reduce your tax owed by $15.

      As for exemptions, there are different kinds but for individuals it’s mostly just a type of deduction. For example, personal exemptions reduce your taxable income.

      The terminology can definitely get pretty confusing. There are plenty of times I have to look these things up myself, as you pretty much need to make it a full-time job if you want to be a tax expert. But I hope that helps and definitely let me know if I can explain anything else.

  • Good to know – kids can be so expensive!!

    • Matt Becker May 27, 2014

      They certainly can be, especially when some kind of day care is involved.

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