TO FIGURE YOUR CREDIT PERCENTAGE BASED ON AGI
The amount of the credit you claim, if any, for 2021 depends on your AGI. The maximum credit of 50% of eligible expenses applies for AGI up to $125,000. The credit rate is reduced to 20% for AGI up to $185,000. The 20% rate is reduced starting with AGI of $400,000. No credit may be claimed once AGI is $440,000 or more.
Example
You have 1 qualifying child and adjusted gross income of $110,000. Your credit is 50% of your dependent care expenses up to $8,000, for a top credit of $4,000.
Conditions for the Exclusion
Benefits must be provided by your employer under a written plan that does not discriminate in favor of owners or highly compensated employees (for example, top executives cannot obtain greater benefits than you). The dollar limit on this benefit is $10,500 (or $5,250 if you are married and file separately).
The same limits apply to a flexible spending arrangement (FSA), which is an employer plan to which you contribute a portion of your pay to be used for dependent care expenses. This salary reduction amount is not currently taxable to you; it becomes tax‐free income that you withdraw from the FSA to cover eligible expenses.
Planning Tips
If you have the option of making salary reduction contributions to your company's flexible spending arrangement (FSA) for dependent care expenses, decide carefully on how much to contribute each month. You can use the funds in the FSA only for dependent care expenses; you cannot, for example, use any of the funds for your medical expenses or other costs. Any funds not used up by the end of the year (or within the first two and a half months of the next year if your employer has a grace period) are forfeited; they do not carry over. The IRS has not ruled clearly about whether virtual daycare expenses qualify for the credit. However, if it can be shown that the cost was incurred to enable a parent to work, then it seems the expenses could be taken into account.
Pitfalls
If in the same month you and your spouse both did not work and were either full‐time students or not physically or mentally capable of caring for yourselves, only one of you can be treated as having earned income ($250 or $500 as explained earlier in this chapter) in that month.
If you qualify to receive an exclusion, you must reduce the amount of eligible expenses used in figuring the credit by the amount of the exclusion.
Example
You have 1 child and receive reimbursement from your employer's plan for 2021 of $3,000. In figuring your tax credit (assuming you are eligible for the maximum credit), you can use only $1,000 of eligible expenses ($4,000 – $3,000). In essence, if your exclusion in 2021 is $4,000 for 1 child or $8,000 if you have 2 or more children, you cannot claim any tax credit.
If you participate in a dependent care FSA, distributions from the plan are treated as employer reimbursements. Like excludable benefits, distributions from FSAs reduce the amount of expenses you can use to figure the credit.
Check with the administrator of the dependent care FSA you participate in to learn about possible carryovers or using up contributions after the year is over.
If you pay someone to care for your dependent in your home, you are the worker's employer. You are responsible for employment taxes. For more information about these employment taxes, see IRS Publication 926, Household Employer's Tax Guide, at www.irs.gov.
Where to Claim the Tax Credit or Exclusion
You figure the credit and the exclusion on Form 2441, Dependent Care Expenses. The amount of the credit is entered on Schedule 3 of Form 1040 or 1040‐SR.
If you owe employment taxes for a dependent care worker, you must file Form 1040 or 1040‐SR and complete Schedule H, Household Employment Taxes, which is attached to the return. You include employment taxes you owe on Schedule 2 of Form 1040 or 1040‐SR.
Adoption Costs
One out of every 25 families in the United States has an adopted child. Each year, more than 135,000 children are adopted in the United States, with costs as much as $40,000 or more. Taxpayers who adopt a child may qualify for a tax credit. The amount of the credit may or may not fully offset actual costs for the adoption. If an employer pays for adoption costs, a worker may be able to exclude this fringe benefit from income. And, there's a waiver of the 10% early distribution penalty for withdrawals from retirement plans up to $5,000 to pay adoption expenses (but the distribution itself is taxable).
Benefits
If you adopt a child, you may be eligible to claim a tax credit for the expenses you incur. The maximum credit is $14,440 per child in 2021. The credit is 100% of eligible adoption expenses up to this dollar limit. If you adopt a child that the state has determined as having special needs (e.g., a medical condition), the credit is $14,440 without regard to your actual adoption expenses. The credit, including one for a special needs child, is subject to income limits.
Example
In 2021, your income is $100,000; you pay $9,000 in attorney's and adoption agency fees to adopt a child who is not a special needs child (the adoption becomes final in 2021). You can claim a tax credit of $9,000 (100% of your eligible costs that do not exceed $14,440). If the child adopted is a special needs child, then the credit is $14,440, even though this is greater than the amount of actual adoption expenses.
If your employer pays or reimburses you for adoption expenses, you may exclude this benefit from your income; it is tax free to you if you meet eligibility conditions. The exclusion has the same dollar limit and income limits as the credit.
If a tax‐exempt organization makes a payment to help pay adoption costs, the payment is not taxable. The payment is viewed as a gift to the recipient.
If you take withdrawals from your 401(k) plan to pay for adoption expenses, you are not subject to the 10% early distribution penalty even though you're under age 59½. However, the penalty waiver only applies to distributions up to $5,000 for the adoption of an individual (other than a child of the taxpayer's spouse) who is under age 18 or who has a physical or mental incapacity making the person incapable of self‐support. The distribution is taxable, but can be recontributed to a retirement plan so that you can recoup any taxes paid on the distribution by filing an amended return.
Conditions
To claim the adoption credit or exclusion, 2 key conditions apply:
1 You must pay qualified adoption expenses.
2 Your modified adjusted gross income cannot exceed a set amount.
There is an additional condition for married persons; they must file jointly unless they are legally
