If you have kids, then you know they cost a small fortune to raise. You probably also know the U.S. tax code allows you a tax deduction for each child, a tax credit for each child's college expenses, plus a $1,000 tax credit just for having the child. And low-income taxpayers can receive some of these credits in cash.
But you may not know about the Child Care Tax Credit, which allows you to reduce your income tax by a portion of the money you pay for child care that enables you (or both you and your spouse, if you file jointly) to work, look for work, or go to school. In fact, the credit becomes available when you pay for the care of a handicapped spouse or a child aged 13 or younger who has lived with you for more than half the tax year.
Depending on your income, the credit works out to between 20 % and 35 % of what you spend each year in caregiving expenses. But there are limits: First, you can only get a percentage of up $3,000 (for one dependent) or $6,000 (for two or more dependents). Second, if you get reimbursed for any of your spending, you don't get the credit on that reimbursed amount. This tax credit can therefore max out for you anywhere between $1,200 and $2,100, depending on your out-of-pocket expenses and your income level.
As a tax credit -- which is a dollar-for-dollar reduction in the amount of tax you owe -- it's more valuable than a tax deduction, which simply reduces your taxable income. Even better, this credit comes with no upper limit on your income. It gets smaller as your income goes higher, but it remains available no matter how much you earn. However, you can't claim a credit against any caregiving expenditures that exceed your earned income, and you can't receive any credit that exceeds your total tax liability.
Expenses you can accumulate toward that $3,000 or $6,000 maximum can include day (but not overnight) camp, licensed day care, after-school care, school costs attributable to child care, and in-home nursing, in-home nannies, and other in-home services related to the dependent person.
You can find more information in "IRS Publication 503, Child and Dependent Care Expenses" and "Chapter 32, IRS Publication 17, Your Federal Income Tax." You'll find them chock-full of handy details that'll help you navigate the ins and outs of this highly specific portion of the Tax Code.
How to get the biggest credit you can
Here are the most important steps you can take to maximize the credit you receive for child care and dependent expenses.
- Keep track of all your relevant caregiving expenses. You can do so by hanging on to all the invoices you pay, noting the checks you write, or maintaining a running log of what you spend. Except in the case of tax-exempt organizations, you must tell the IRS who's receiving your payments.
- Create and maintain a document that connects the hours for which your children are receiving paid care to the same hours you're working, looking for work, or attending school.
- Make sure you document your earned income, or your search for work, or your full-time attendance at school (you must be enrolled for at least five months during the tax year).
- Be precise about filing your IRS tax return in one of the proper categories (head of household, married filing jointly, qualifying widow(er) with a dependent child, or single), completing the necessary paperwork (such as IRS Form 2441), and demonstrating that you have custodial rights over each child for whom you're claiming this credit.
- Watch out if you hire people to work in your home. If doing so incurs tax obligations as an employer, be sure to comply with them.
- Document the age of each child. In most cases, the credit disappears once the child turns 13.
- Calculate the impact of accepting child care benefits from your job, or any other source. Depending on the amount and how they are structured, such benefits could cost you more than the credit you'd gain by rejecting them.
- Calculate the impact of increasing your taxable income. Up to $43,000 per year, every $2,000 of extra income reduces the credit by 1%. Once you're over that limit, the credit hits its floor of 20%, so additional income is not a factor.
Some people feel buffaloed by the intricacies of the Child Care Tax Credit's requirements. But once you dig into the details, you'll find they're fairly straightforward and logical.
If you have any qualms about claiming what you're owed under this section of the Tax Code, remember that the IRS is completely OK with taxpayers paying only as much as they owe and claiming every penny of credit to which they are entitled under the law.