While the American Rescue Plan’s changes to the Child and Dependent Care Tax Credit for 2021 will be welcome news for an overwhelming majority of taxpayers, highest earning taxpayers will find the legislation contains a rather unwelcome surprise.
As noted earlier, the ‘regular’ pre-2021 Child and Dependent Care Tax Credit rules create a minimum Applicable Percentage floor of 20%. Even the highest earners are generally able to claim a 20% × $3,000 = $600 Child and Dependent Care Tax Credit if they have one qualifying child, and a 20% × $6,000 = $1,200 Child and Dependent Care Tax Credit if they have two or more qualifying children.
That, however, won’t be the case for 2021.
In keeping with the Biden campaign promise not to increase taxes for those making less than $400,000 per year, the American Rescue Plan introduces a second phaseout point of $400,000 of AGI (for all filing statuses). Once a taxpayer’s AGI exceeds $400,000, their 20%
Applicable Percentage is decreased by 1% for every $2,000 (or portion thereof) of income that exceeds that mark.
Taxpayers with AGI exceeding $440,000 will receive no Child and Dependent Care Tax Credit in 2021, despite having been eligible for at least some credit amount in prior years.
While the American Rescue Plan limits its changes to the Child and Dependent Care Tax Credit only to 2021, like the changes made to the Child Tax Credit, these changes (and other changes that are substantially similar) are likely to be made permanent later this year when Democrats take up comprehensive tax reform.