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Taxation and the Family: How does the tax system subsidize child care expenses?

Working parents can utilize two primary tax benefits to offset child care costs: the child and dependent care tax credit (CDCTC) and the employer-provided child care exclusion. To receive the CDCTC, parents report up to $3,000 of expenses per child (to a maximum of $6,000) and receive a credit of between 20 and 35 percent of that amount, depending on their adjusted gross income (AGI). Higher credit rates are available to families with lower incomes. To benefit from the exclusion, employees arrange with their employer to exclude up to $5,000 from their salary, regardless of the number of children receiving care. These dollars are pre-tax. Higher-income families generally benefit more from the exclusion than from the credit, since the excluded income avoids both income and payroll taxes, but it is only available to those taxpayers whose employers offer it.

Although the same expenses cannot be used to claim both the CDCTC and the exclusion, in some cases, parents can benefit from both provisions. If a parent’s child care expenses exceed the amount excluded from income, these excess expenses may be applied to the CDCTC, provided the total expenses claimed under both provisions do not exceed the maximum eligible amount under the CDCTC. For example, families with two or more children excluding the maximum $5,000 can still claim a CDCTC for an additional $1,000 of expenses, so long as their total child care expenses are at least $6,000.

  • To benefit from the CDCTC, both parents must be working or in school. The expenses claimed may not exceed the lower-earning parent’s earnings. The exclusion, however, can be used even if only one parent is working.
  • The highest credit rate for the CDCTC (35 percent) applies to families with AGI below $15,000 and decreases by 1 percentage point for each additional $2,000 of AGI. The lowest credit rate (20 percent) applies to families with AGI greater than $43,000.
  • In 2013, TPC estimates that among families claiming the CDCTC, the largest average benefits will go to those with incomes between $100,000 and $200,000. People in the highest income quintile received the greatest share of benefits, both because their average expenses are higher than other income groups and because more people in this quintile have child care expenses (figure 1).
    Taxation-&-Family-Graphs-Distribution-of-total-May-2013-2
    Underlying Data: Download
    Taxation-&-Family-Graphs-Distribution-of-total-May-2013-2
  • Because the CDCTC is not refundable, only families who owe income taxes can benefit, and low-income families rarely qualify for the maximum benefit.
  • .
  • The exclusion applies to both payroll and income taxes; its value (that is, the actual reduction in tax) is thus the excluded income times the sum of the rates of the two taxes. Because income tax rates rise with income, the value of the employer exclusion is greater for higher-income taxpayers.
  • Maximum allowable expenses for both the CDCTC and the exclusion are not indexed for inflation. Thus each year the value of these provisions erodes.
  • Possible reforms to the CDCTC would make it refundable, so that low-income families can receive the maximum benefit regardless of their income tax liability; raise the ceiling on eligible expenses for both the credit and the exclusion, to more closely align them with actual expenses people face (or, more modestly, allowable expenses could be indexed for inflation); or extend the credit rates and allowable expenses under current law to keep them from reverting to their lower, pre-EGTRRA levels.
  • On paper, the CDCTC appears larger than it actually is.  Most taxpayers eligible for the higher rates have insufficient tax liability to benefit from the credit.  Figure 2 shows the benefit taxpayers actually receive compared to what the law suggests they could receive.
 Taxation-&-Family-Graphs-CDTC-May-2013
Underlying Data: Not Available
Taxation-&-Family-Graphs-CDTC-May-2013
 
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   Entry 5 of 8