How much earned income is needed to maximize child-related credits?
Question of the week: How can a single parent, concerned she lost her child and dependent care credit because of her low earnings, maximize the credit?
Q. How much earned income is needed for low-income taxpayers to keep their child-related credits, including the entire child and dependent care credit?
My client is a single parent with a 10-year old son. In 2019 she had earnings of $26,000 and paid $3,000 for after-school daycare. She received a refundable credit of $3,808, which was the $1,400 additional child tax credit (ACTC) and $2,408 EIC. She thinks she lost the childcare care credit because of her low income. Did she lose the child and dependent care credit? How much higher would her earnings need to be to get the full credit? What about other child-related credits? She files as head of household.
A. This credit, along with the CTC and EIC, are interdependent and there is no optimum earnings level to maximize all of the credits.
Your client lost some, but not her entire, child and dependent care credit. Slightly higher earnings would result in getting most of the credit. Generally, for taxpayers in the 10% bracket, 10% of taxable income must be the same or more than the child and dependent care credit to get the full benefit of the credit. However, credits are interdependent. In this case, higher earnings would also result in lower EIC and a lower refund.
Taxable income and nonrefundable credit ordering rules
Nonrefundable credits are applied in a specific order. For instance, the child and dependent care credit is applied before the child tax credit is applied. Here’s how it works for your client:
$ 870 child and dependent care credit ($3,000 expenses × 29%)
$2,000 child tax credit
$5,278 total available child-related credits
$7,650 taxable income ($26,000 earnings - $18,350 standard deduction for head of household)
$765 tax ($7,650 × 10%)
$0 tax after applying $765 of child and dependent care credit
$4,573 total credits received ($765 + $1,400 maximum ACTC + $2,408 EIC)
$105 unused child and dependent care credit ($870 - $765)
$600 unused child tax credit ($2,000 - $1,400)
$705 total unused credits
Note that because of this ordering rule, all credits are maximized. If the CTC had applied first, $765 (instead of $0) of the CTC would have been used up, leaving nothing available for the child and dependent care credit and only $1,235 ($2,000 - $765) for the ACTC.
How changes in earnings could impact the child-related credits
Suppose your client had earned $27,000. Her taxable income would be $8,650 ($27,000 - $18,350 standard deduction) and tax before credits would be $865 ($8,650 × 10%), which covers nearly all of the $870 child and dependent care credit. She would still receive the $1,400 ACTC. However, EIC would be reduced from $2,408 to $2,248
So, an additional $1,000 in income would allow her to get more of the child and dependent care credit, but lower her overall credits by $60. ($4,573 in credits at $26,000 vs $4,513 in credits ($865 + $1,400 + $2,248) at $27,000 in income.) Since the child and dependent care credit reduces her tax to $0 and the ACTC is $1,400 in either case, the net effect on her refund would be to lower it by $160, which represents the decreased EIC.
As earnings increase, the child and dependent care credit also decreases. If your client earned $27,001, the credit percentage would drop from 29% to 28%. The minimum 20% credit applies at earnings over $43,000. At that earnings level your client would get the full child and dependent care credit and the full CTC, but no EIC.
Conversely, the child and dependent care credit increases as earnings decrease but the client would have less taxable income and tax with which to cover it. At the same time, with decreasing earnings, the ACTC also decreases as earnings get closer to the $2,500 earned income threshold. The maximum EIC of $3,526 is available for earnings from $24,849 down to $10,350 (for unmarried filers for 2019), then it, too, decreases as earnings decrease.
As these calculations show, there is no optimum earnings level that applies to every situation. Both nonrefundable and refundable family-related credits depend on a taxpayer’s filing status, number of children, earnings, and other income.
For more information on family-related tax rules, see the Insights article, "Back to basics: Family and dependent tax rules, Part One"