The 2nd limit is the percentage of costs that you can claim. Once you determine your allowable expense amount, your actual credit is limited to a percentage of that figure.
So, regardless of how much you pay, the potential maximum child- and dependent-care credit is $1,050 (35% of $3,000) for the care of 1 person, twice that for 2 or more. Depending upon your income, the percentage range drops from 35% to 20% of your allowable care costs.
The 35% rate is only for lower-income taxpayers. If you make more than $15,000, the credit percentage is incrementally phased down by salary range until it hits 20% for those earning more than $43,000.
And even if your care costs come up to the maximum credit amount, you may not get it all if your tax bill is less than your allowable credit. The dependent-care credit is not refundable, meaning it can only take your tax bill to zero. Any excess credit is not usable.
For example, if you claim a $1,050 maximum credit for the care of one child and owe $750, the IRS will use your credit to wipe out your tax bill, but you won't get the extra $300 as a refund.
If you pay for child care, you can claim this credit to help offset some of your costs as long as your child meets IRS guidelines.
The youngster must be younger than 13. He or she also must meet IRS' dependent requirements. Basically, this means the child must be related to you and live with you most of the time. There are exceptions in the cases of divorced or separated parents, so read the tax-filing instructions carefully or consult your tax adviser if this is your situation.
But the child- and dependent-care credit is not limited to child-care costs. It also can be claimed when you pay for care of other dependents, as they are deemed qualified by the IRS. For example, if you pay someone to look after your spouse or a dependent of any age who is incapacitated because of physical or mental limitations, you might be eligible for this tax break.
Only working taxpayers need apply
Then there's the credit's job catch. You can only claim dependent care that was necessary so that you could go to or look for work.
If you're married, the IRS requires both of you to be employed or seeking a job. The only exception is when one spouse is either a full-time student or is physically or mentally incapable of self-care.
After clearing the employment hurdle, other requirements to claim the credit include:
- A filing status of single, head of household, married filing jointly or qualifying widow or widower with a dependent child. In most cases, married taxpayers who file separate returns cannot claim the dependent-care credit.
- The payments for care cannot be made to someone you can claim as your dependent on your return, or to your child who is younger than age 19.
To claim child- and dependent-care credit, complete and attach Form 2441 to your return. You must file taxes using either Form 1040 or Form 1040A to claim the credit.
Identify your caregivers
You also must include on the tax forms the name and taxpayer identification numbers of the caregivers.
If it's a business, the operator can provide you with the employer identification number. You also can use Form W-10, Dependent Care Provider's Identification and Certification, to request this information from the care provider. For individual providers, you generally use the person's Social Security number.
You might have some additional filing duties related to this credit depending on whom you hire and how you cover the costs.
If you pay someone to come to your home to provide the care, you may be considered a household employer and have to pay employment taxes.
And while you feel most comfortable when a member of your family is taking care of your children, you cannot claim the credit if the caregiver is your spouse or, as mentioned, one of your teenage children.
Company benefit considerations
Finally, if you received any dependent-care benefits from your employer during the year, you will have to complete Part III of Form 2441 to determine the amount of your credit. These amounts are listed in box 10 of your W-2.
Company benefits include money you receive directly from your employer or that was paid by your employer to your care provider. The fair market value of a company-provided day care facility also counts, as does money you put into a dependent-care flexible spending account, or FSA, to pay care expenses.
For example, if your company provides untaxed dependent-care benefits directly to you, those amounts reduce the amount of expenses you can claim. If the company pays you $1,000 for child-care costs, you must reduce your credit amount by that payment, so a $3,000 limit now becomes $2,000 to offset the company payments.
In the case of a spending account, if you paid $10,000 for a nursery school to look after your 2 children while you were at work, $6,000 is the maximum allowable credit amount. But you used $5,000 from your workplace FSA to pay part of those costs, so the account money will reduce how much you can claim toward the child care credit -- the $6,000 maximum care expense amount is cut to $1,000.
In both of these instances, because the workplace child-care assistance is not taxable income to you, you cannot use those amounts to help further cut your tax bill.
More information on the credit is available in IRS Publication 503, Child and Dependent Care Expenses, or Chapter 32 of IRS Publication 17, Your Federal Income Tax.