The federal government offers a tax break of up to $2,100 for people who pay someone else to take care of their children or other dependents. This tax break comes in the form of a tax credit, rather than a deduction, though you'll sometimes hear it referred to as a "child care deduction" or "dependent care deduction."
As of 2012, the maximum credit for dependent care expenses was $2,100 a year. However, the maximum was available only to taxpayers who had paid for care for more than one dependent, had at least $6,000 in dependent care expenses during the year, and had an adjusted gross income of $15,000 or less. A look at how the credit is calculated explains where this $2,100 figure comes from.
Figuring the Credit
You don't necessarily get a tax credit for the full amount of your dependent care expenses. If you're paying for the care of one dependent, you can apply a maximum of $3,000 worth of your expenses toward the credit. If you're paying for care for two or more people, you can apply up to $6,000 worth of expenses toward the credit. Further, the tax credit you receive is only a percentage of your allowable expenses. That percentage is tied to your federal adjusted gross income, which you determine by filling out your tax return. The highest percentage, 35 percent, is available to those with incomes of $15,000 or less. (So 35 percent of the maximum $6,000 produces the maximum credit of $2,100.) As income increases, the percentage decreases. For everyone with an adjusted gross income of $43,000 or more, the percentage is 20 percent. There's no upper income limit.
Credit vs. Deduction
The dependent care tax break is a credit rather than a deduction, which actually saves you more money. A tax deduction reduces the amount of your income that the government taxes, so a $100 deduction would reduce your tax bill by at most $35, depending on your tax bracket. But a tax credit reduces your tax liability dollar for dollar. If you have a $100 tax credit, you will pay $100 less in taxes.
To qualify for the dependent care credit, you must be paying for care so that you can either work or look for work. When determining the amount of your expenses that are eligible for the credit -- which you do using Internal Revenue Service Form 2441 -- you must calculate your earned income, which is what you made from working. If you're married, you must also calculate your spouse's earned income separately. The dollar amount of dependent care expenses you apply toward the credit cannot be greater than the lowest individual earned income of you or your spouse. In other words, if you are paying for care so that you can work at a job, you can't claim expenses in excess of what you actually earned at that job.
Cam Merritt is a writer and editor specializing in business, personal finance and home design. He has contributed to USA Today, The Des Moines Register and Better Homes and Gardens"publications. Merritt has a journalism degree from Drake University and is pursuing an MBA from the University of Iowa.