This Tax Credit Is Extremely Complicated -- but It's Still Worth Claiming

Don't overlook it, even if the rules make your head spin.

For many parents, childcare is a major expense. It's also a necessary one. Without it, a lot of people would not be able to hold down a job.

The good news is that the IRS allows parents who pay for childcare so they can work recoup some of those costs in the form of the Child and Dependent Care Credit. And while the credit is a bit complex to claim, it's worth looking into if you currently spend a lot of money on childcare.

Get the tax break you deserve

If you're tired of seeing those weekly daycare center payments debited from your checking account, the good news is that a portion of your costs might serve as a tax break. As a refresher, a tax credit is a dollar for dollar reduction of your tax liability. If you owe the IRS $2,000 but claim a $2,000 credit, your tax liability becomes $0. 

Filers are often advised to seek out different credits when filing their taxes. And so if you pay for childcare, it makes sense to look at the Child and Dependent Care Credit.

Here's how it works. The Child and Dependent Care Credit lets you deduct a portion of your childcare costs, and it only applies to costs up to a certain amount. 

For 2022 (which is the tax return you're filing this year), the Child and Dependent Care Credit applies to up to $3,000 in childcare expenses for one qualifying child, or up to $6,000 in childcare expenses for two or more qualifying children. But this doesn't mean the credit itself will be worth $3,000 or $6,000. 

Rather, you can only claim a portion of up to $3,000 or $6,000, depending on your income. The more you earn, the lower the percentage you can claim.

If your income is $15,000 or less, you can claim 35% of your childcare costs of up to $3,000 or $6,000. From there, this percentage drops to 20% at an income above $43,000. So whether you make $43,000 or $88,000, you're limited to claiming 20% of your costs of up to $3,000 or $6,000. If you earn more than $15,000 but less than $43,000, you can consult this page on the IRS website to see what percentage applies to you.

Confused yet? That's understandable. But here's an example to explain how the credit might work in practice.

Let's say you earn $45,000 a year, have two children, and spend $8,000 on childcare costs. The maximum baseline cost you can claim against in this situation is $6,000. And from there, you can only claim 20% of $6,000, or $1,200. So all told, that's what your Child and Dependent Care Credit will look like.

But remember, that's $1,200 that will directly reduce your tax liability. So if you owe the IRS $2,000 and get this $1,200 credit, you'll only owe $800. 

Another thing you should know about the Child and Dependent Care Credit is that it's not refundable. That means the most it can do is knock your tax liability down to $0. 

A head-spinner for sure

Clearly, calculating the Child and Dependent Care Credit isn't easy. But it's worth going after that tax break if you're entitled to it -- especially if you spend a large portion of your income on childcare costs.