The Expanded Child and Dependent Care Tax Credit Can Reduce Families’ Child Care Burden

Over the past year, tax credits have rightly claimed the spotlight as researchers and policymakers hailed the poverty-reducing benefits of the Child Tax Credit (CTC) and Earned Income Tax Credit (EITC). With the onset of tax season, it’s time to highlight a lesser-known tax credit temporarily expanded for tax year 2021 under the American Rescue Plan (ARP)—the Child and Dependent Care Tax Credit (CDCTC). The expanded CDCTC is a critical federal investment in working families that can substantially reduce the high burden of child and dependent care, particularly among low- and moderate-income families. Family advocates, service providers, and tax preparers should work to increase awareness of the CDCTC among families with young children so that they are positioned to take full advantage.

The expanded CDCTC helps offset the cost of child and dependent care for many working families, the majority of whom pay more for child care than for any other single household expense. The credit is especially beneficial to the lowest-income working families in our country, who pay upwards of 33 percent of their income out of pocket on child care, a figure 4.5 times greater than the 7 percent benchmark for low-income working families suggested by the Department of Health and Human Services.

To benefit working families, the ARP expanded the CDCTC in three key ways:

• The CDCTC is now fully refundable. Eligible working families receive any excess credit (the amount of credit minus any taxes owed) as a refund. This means that, in the 2021 tax year, the benefits of the CDCTC extend to the lowest-income working families—families previously unable to utilize the credit if they had no tax liability. Because the refund comes as a direct deposit or check in the mail, the CDCTC operates like a cash transfer, similar to the CTC and EITC, with a direct impact on families’ economic well-being and children’s healthy development.
• The credit is now larger. Eligible families can now receive a credit of up to $4,000 for one dependent and up to $8,000 for two or more dependents. Families can be reimbursed for up to 50 percent of the first $8,000 of care expenses for one dependent and the first $16,000 of care expenses for two or more dependents. Previously, the credit was for up to 35 percent of the first $3,000 of care expenses for one dependent (a $1,050 credit) and the first $6,000 of care expenses for two or more (a $2,100 credit). Compared to previous years, the credit is up to $5,900 higher; however, given wider income eligibility for the 2021 tax year, it could represent as much as $8,000 back to eligible working families.
• The full credit is now available to households with a wider range of incomes. The full credit is now available to families with adjusted gross incomes (AGIs) of $125,000 or less, acknowledging the importance of child care for workforce participation and a healthy economy. The credit percentage decreases gradually and is fully phased out for AGIs above $438,000. Previously, the credit percentage decreased when AGI exceeded $15,000 and a credit of 20 percent was available to those with AGI over $43,000.