This is article number six in our series of Tax Credits. Click here to read the previous articles.

Child and Dependent Care Credit
If you pay someone to care for your child, spouse or dependent, you may be able to claim the Child and Dependent Care Credit. This credit compensates parents and caregivers with a partial credit for costs incurred in providing care for qualifying individuals while they work or are looking for work.

The qualifying child must be under age 13 and be claimed as taxpayer’s dependent, or a spouse or individual who is mentally or physically incapable of self-care and who resided with the taxpayer for more than half the year. There are special rules for divorced or separated parents, so please see your tax specialist for details.

Taxpayers are required to provide identification numbers for all qualifying individuals and also provide the provider’s name, address, and taxpayers identification number (TIN.) Providers that are churches or schools can substitute “Tax exempt” for the TIN.

The credit can be up to 35 percent of your qualifying expenses depending on your gross income, but drops to 20 percent if your adjusted gross income is over $43,000. You may use up to $3,000 of expenses paid for one qualifying individual or $6,000 for two or more qualifying individuals to figure the credit. Qualifying expenses must be reduced by the amount of any dependent care benefits provided by your employer that you deduct or exclude from your income. Form 2441 is used to compute this credit.

A Generic Example:
Bill and Betty are married and both work outside of the home. They have two children, ages 4 and 7, that they claim as dependents. Their earned and adjusted gross income was $40,000. They paid $5,000 work-related expenses for the care of one child and $4,000 for the care of the other child. Bill had $2,000 of dependent care benefits from his employer that were excluded from his income. They must reduce their total expenses of $9,000 ($5,000 + $4,000) by the $2,000 that was excluded from Bill’s wages. They are limited to $6,000 for 2 or more children and so the credit is calculated as $6,000 times 22% based on their adjusted gross income of $40,000 or $1,320. If their income tax liability is larger than $1,320, they will receive the entire credit. If their income tax liability is less than $1,320, the credit will be limited to the amount of tax liability.

Child Tax Credit/Additional Child Tax Credit
Another important tax credit that may be worth as much as $1,000 per qualifying child, depending on your income, is the Child Tax Credit. The Child Tax Credit is nonrefundable, but if your tax liability is less than your credit, you may be eligible for the Additional Child Tax Credit which is refundable.

The qualifying child must meet all of the following:

  • Child must be related to taxpayer
  • Under age 17 at the end of 2011
  • Child cannot provide over half of his or her own support
  • Child must have lived with the taxpayer for more than half of 2011
  • Taxpayer must claim the child as a dependent on his return
  • Child must be a U.S. citizen, U.S. national or resident of the U.S.

A taxpayer must have earned income of $3,000 to qualify to use the credit. Credit is phased out for taxpayers with modified adjusted gross income in excess of $75,000 single or head of household, $110,000 married filing joint or $55,000 married filing separately. The Child Tax Credit is taken on Form 1040, Form 1040A or Form 1040NR. If your Child Tax Credit exceeds your tax liability, you need to use Form 8812 to see if you qualify for the refundable Additional Child Tax Credit.

A Generic Example:
Fred and Cindy have four children who are all qualifying children for the child tax credit. They have adjusted gross income of $100,000 and their tax liability is $3,500. They are eligible for $4,000 of child tax credits. They will receive a $3,500 child tax credit and a refundable credit of $500.

For additional information on any of the above credits, please contact us today.

Written by Shelly Toft, CPA.