Child Tax Credits

If you have children you support, there are two different tax credits you should know about.

Children are expensive. To offset some of this expense, Congress provides two special tax credits to people who support children:

  • a child tax credit, and
  • a child and dependent care tax credit.

If you qualify, you can get both credits in the same year. In the past, the child tax credit was limited to middle and lower-income taxpayers. No longer: you can earn up to $400,000 and qualify for the full credit.

What is the Child Tax Credit?

The child tax credit is only available if you have what the IRS calls a “qualifying child.” A qualifying child is a child who qualifies as a dependent for tax purposes. A qualifying child can be your son, daughter, stepchild, adopted child, foster child, brother, sister, stepbrother, stepsister, or a descendant of any of them—for example, your grandchild, niece, or nephew. A qualifying child must:

  • live with you for over half the year
  • provide less than half of his or her own support
  • be a U.S. citizen, resident, or national, and
  • have a Social Security number which you must provide on your tax return.

Normally, the child tax credit may be claimed only if you have a qualifying child under age 17 at the end of the year. You get no credit if a child turned 17 during the year. However, for 2021 only, the age of a qualifying child is increased to children under age 18 at the end of the year.

The IRS has an online questionnaire you can complete to determine if you have a qualifying child. Visit the Does My Child/Dependent Qualify for the Child Tax Credit? page at the IRS website.

Before you get too excited about how much money Junior is going to save you on your taxes, read on. The child tax credit is subject to an income threshold and the amount of credit you can take each year goes down as your income approaches that threshold amount.

The Regular Child Tax Credit Rules

Under the regular child tax credit rules in effect during 2018 through 2025 (but not for 2021), everyone with a qualifying child starts out the tax year entitled to a $2,000 credit per child for the tax year. This credit is gradually phased out for taxpayers whose incomes rise up to and above the annual threshold amount specified for the year. Specifically, for each $1,000 that your modified adjusted gross income exceeds the income threshold level, the total child tax credit for a family (not the amount per child) is reduced by $50. If you make too much money, you won’t get any credit at all. However, the Tax Cuts and Jobs Act greatly increased the amount you can earn and still receive the credit. Indeed, only a small fraction of all taxpayers are unable to obtain the credit.

The child tax credit starts to be reduced only when your adjusted gross income reaches the following levels:

  • $400,000 for married couples filing separately, and
  • $200,000 for all other taxpayers.

For example, a married couple filing jointly with one qualifying child gets no child tax credit if their adjusted gross income exceeds $440,000. The $2,000 credit they started the tax year with would be whittled down to zero by 40 $50 reductions.

The child tax credit is partly refundable—that is, you may collect it even if you owe no taxes for the year. The maximum refundable amount is $1,400 per child. However, the actual refundable amount you can collect if you owe no tax for the year depends on your earned income (generally, wages, salary, tips, or net earnings from self-employment). The refundable amount is equal to 15% of your earned income over $2,500, up to the maximum $1,400 credit. For example, if your earned income is $10,000, your refundable credit would be 15% x ($10,000 - $2,500) = $1,125.

If you have three or more qualifying children and receive the earned income credit, you can use a different formula to figure your refundable credit. With this formula, your refundable credit is equal to the amount your Social Security taxes exceed your earned income credit. You should use this formula if it will result in a larger credit.

The TCJA also established a new $500 nonrefundable child care credit for dependents who are not qualifying children (also called the “family care credit”). For example, you may claim this credit for parents or grandparents if they are your dependents for tax purposes. Since this credit is nonrefundable, you may benefit from it only if you owe income taxes for the year.

Special Child Tax Credit Rules for 2021

To help families struggling in the wake of the COVD-19 pandemic, the child tax credit was expanded for 2021. For 2021 only, the child tax credit is increased to:

  • $3,600 for every child under age 6, and
  • $3,000 for children between the ages of 6 and 17 (one year older than the regular credit rules).
For example, a family with two children under age 6 will receive a $7,200 tax credit for 2021.
The increased credit amount is phased out for married couples with incomes over $150,000 and single parents who earn over $112,500. The credit is reduced $50 for each $1,000 your AGI exceeds these levels. For example, if you have one child over age 5, you're entitled to a $1,000 increased credit for 2021. This amount gets reduced to 0 if you have 20 $50 reductions.
Once the increased amount is phased out, the amount of the credit remains $2,000 until the $400,000/$200,000 phaseout limits under the regular rules apply.
The entire credit is refundable--you get the full amount even if you owe no taxes.
In addition, starting July 1, 2021 the IRS will pay 50% of the credit each month to eligible families by direct deposit. This will result in 50% of the credit being paid by the end of 2021. For example, if you're entitled to a $6,000 credit, you'll be paid $500 each month from July through December 2021. The IRS payments will be based on the most recently filed return.

Child and Dependent Care Tax Credit

Unlike the child tax credit (which you get simply by having a qualifying child), you can use the child and dependent care credit only if you spend money for child care so that you and your spouse, if any, can work. There is no income ceiling on the child and dependent care credit (which is also different from the child tax credit). People with higher incomes get a smaller credit than those with more modest incomes. Here’s how it works.

You qualify for the credit if:

  • you have a qualifying child or other dependent under the age of 13, or your spouse is disabled and physically or mentally incapable of caring for him or herself, or you have any disabled dependent who has income of less than $4,000 per year
  • you incur child care expenses to enable you and your spouse, if any, to earn income
  • you and your spouse file a joint tax return (applicable only if you’re married), and
  • you and your spouse, if any, both work either full or part time and have earned income for the year, unless you or your spouse is a full-time student or disabled. (Looking for work counts as being employed.)

The amount of the credit is based on a percentage of the child care expenses you incur on the days that you and/or your spouse work. Under the regular rules, the credit is equal to 35% of childcare expenses up to $3,000 for one child, or $6,000 for two or more. But the credit is reduced by 1% for every $2,000 in household income over $15,000, until reaching 20%. Thus, the credit is 20% of childcare expenses if your household income is $45,000 or more.

However, for 2021 only, the child dependent care credit is 50% of childcare expenses up to $8,000 for one child and $16,000 for two or more. Also, the credit is reduced by 1% for each $2,000 of household income over $125,000. The credit percentage is not further reduced below 20% until household income reaches $400,000 at which point the reduction of the credit percentage continues until reaching zero. Thus, when income does not exceed $125,000, the credit is usually $4,000 for taxpayers with one child ($8,000 x 50%), and $8,000 for taxpayers with two or more ($16,000 x 50%)

If you’re fortunate enough to have an employer that reimburses you for child care expenses, you must deduct the reimbursed amount from your annual child care expenses.

Starting 2021, the child and dependent care credit is fully refundable--that is, you're paid the full amount as a tax refund by the IRS even if you owe no taxes for the year. For 2020 and earlier, the credit is not refundable--it is limited to your tax liability for the year.

Obviously, you need to keep track of everything you spend on child care during the year and be sure to keep receipts and cancelled checks. Child care expenses include expenses both in and outside your home, such as:

  • babysitting
  • day care
  • nursery school, and
  • day camp (but not if the child sleeps overnight at the camp).

The costs of sending a child to school in the first grade or beyond are not included. Nor can you hire your spouse, child, or other dependent as a daycare provider. If your child turns 13 during the year, you can only include those expenses you incur before his or her 13th birthday.

To claim the credit, you’ll have to list on your tax return the name, address, and Social Security number or Employer Identification number of the people you pay for dependent care, so be sure to get this information. You must also file IRS Form 2441, Child and Dependent Care Expenses with your tax return.

The IRS has an online questionnaire you can complete to determine if you qualify for the child and dependent care credit. Visit the Am I Eligible to Claim the Child and Dependent Care Credit? page at the IRS website.

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