The Minnesota dependent care credit is tied to the federal dependent care credit. Both of these credits allow taxpayers to claim a percentage of qualifying dependent care expenses as a credit against income tax liability. The box to the right summarizes the history of the federal and state credits. The state credit is limited to families with incomes less than $36,980, while the federal credit is available to all filers, regardless of income level.
To qualify for the dependent care credit, an individual must incur expenses related to the care of a dependent to have employment. Under federal law, four basic tests must be satisfied to qualify for the dependent care credit. By using the federal credit amount in calculating its credit, Minnesota also follows these rules.
- The taxpayer must maintain a household that includes a qualified individual. In order to maintain a home, more than half of the cost must be furnished by the individual or married couple. For example, an individual who lives with a parent and does not pay one-half or more of the costs of the home may not claim the dependent care credit for the care of his or her children.
- Qualified individuals are dependent children under age 13 or disabled spouses or dependents.6 To qualify, an adult dependent must be physically or mentally unable to perform self-care. Dependents must satisfy five conditions specified in federal law;7 one of these requires the taxpayer to provide at least one-half of the person’s support. The Minnesota credit differs from federal law in disregarding payments under the Temporary Assistance to Needy Families (TANF) program in determining whether the dependency support test is met.
- The expenses must be incurred to enable the taxpayer to be gainfully employed. Expenses must be paid to allow the taxpayer to work or look for work. For a married couple, both spouses generally must work. However, a parent who is a full-time student is considered to be working.
- The expenses must relate to the care of the qualified individual. In general, two types of expenses qualify—(1) direct care expenses, such as day care or a nanny for a qualified individual, or (2) household expenses, such as a maid or cleaning service, when performed in conjunction with dependent care. Expenses may not exceed the earned income of the lower earning spouse.8 Generally, payments to a day care center (those taking care of six or more children) qualify only if the center meets the requirements of state law. The taxpayer also must report the caregiver’s taxpayer identification number (generally a Social Security number) on the federal dependent care credit form. Credits cannot be claimed for payments made to dependents or a child of the taxpayer under age 19.
The maximum federal credit equals 35 percent of the first $3,000 of qualifying expenses ($6,000 for two or more dependents) or $1,050 for one dependent ($2,100 for two or more dependents). The maximum state credit is $720 for one dependent, and $1,440 for two or more dependents.
The federal dependent care credit allows maximum qualifying expenses of $3,000 for one dependent and $6,000 for two or more dependents, and a maximum credit rate of 35 percent. Taxpayers with adjusted gross income under $15,000 qualify for the maximum federal credit of $1,050 for one dependent, or $2,100 for two or more dependents. Before tax year 2003, the maximum federal qualifying expenses were $2,400 for one dependent and $4,800 for two or more dependents, and the maximum credit rate was 30 percent. The federal Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 increased the maximum federal credit from $720 to $1,050 for one dependent and from $1,400 to $2,100 for two or more dependents.
Like many provisions of EGTRRA, the changes to the dependent care credit will sunset after tax year 2010. Unless Congress extends the EGTRRA changes, the maximum qualifying expenses, credit rates, and maximum federal credit will return to the tax year 2002 levels in tax year 2011.
The state dependent care credit does not explicitly set maximum qualifying expenses or a credit rate, but rather allows families to claim a credit equal to the federal credit, but subject to a state maximum of $720 for one dependent and $1,440 for two or more dependents. The state credit maximum amounts are specified in statute and equal to the maximum federal credits in effect prior to enactment of EGTRRA 2001.
The maximum qualifying expenses for the federal credit have not kept pace with inflation, even with the increases under EGTRRA 2001. Qualifying expenses were set at $2,400 for one dependent and $4,800 for two or more dependents in 1982. If they had been adjusted for inflation, the maximum would be about $5,450 for one dependent and $10,900 for two or more dependents in 2008. An annual survey of dependent care expenses in family day care homes showed a range in 2006 from $8,010 for infants in the metro area to $5,750 for preschoolers in the nonmetro, both above the maximum allowable qualifying expense of $3,000 for one child.9
Dependent care expenses paid out of pre-tax accounts do not qualify for the credit, but do count against the credit maximums. Many employers allow their employees to participate in pre-tax accounts for dependent care expenses. Employees may set aside up to $5,000 of pre-tax income in these accounts to pay dependent care expenses. People who use these accounts, however, may only claim the dependent care credit if the amount paid through the pre-tax account is less than the maximum qualifying expense allowed under the credit. For example, a taxpayer who sets aside $2,000 in a pre-tax account and has actual dependent care costs of $4,000 for one child may claim a dependent care credit for $1,000 of qualifying expenses—the difference between the $3,000 maximum allowed under the credit and the $2,000 set-aside in the pre-tax account. Because annual dependent care expenses may exceed the maximum allowed under the credit, many taxpayers will either use a pre-tax account or claim the credit, but not qualify for both programs.
Dependent care expenses paid through the state’s Basic Sliding Fee child care program or through Minnesota Family Investment Program (MFIP) child care do not qualify for either the federal or state dependent care tax credit. However, any amounts families are required to contribute as “copayments” do qualify for both credits.
The federal credit rate phases down to a minimum 20 percent of qualifying expenses.
The federal credit percentage begins to phase down from 35 percent when income exceeds $15,000. The credit phases down at the rate of one percentage point for each $2,000 of income over $15,000 to a minimum credit percentage of 20 percent. Claimants with incomes of $43,000 or more are eligible for a minimum credit equal to 20 percent of qualifying expenses—$600 for one child (20 percent of the $3,000 maximum qualifying expenses) and $1,200 for two or more children.
Prior to 2003, the maximum federal credit percentage was 30 percent, maximum qualifying expenses were $2,400 per child, and the phasedown began when income exceeded $10,000. The credit was phased down to the minimum of $480 for one child and $960 for two or more children when income exceeded $28,000.
Minnesota conformed to federal changes under EGTRRA that affected the calculation of the state credit.10
Since the Minnesota credit equals the federal credit (subject to a state maximum and phaseout), some taxpayers became eligible for a larger state credit in 2003 when the federal credit rate and maximum qualifying expenses increased. For example, a single parent with one dependent, $2,000 of expenses, and $13,000 of income qualified for a state credit of $560 in 2002 (28 percent—the federal credit rate at $13,000 of income—of $2,000). When the federal credit increased to 35 percent in 2003, this taxpayer’s Minnesota credit increased to $700 (35 percent of $2,000). If the EGTRRA changes to the federal credit are not extended beyond tax year 2010, this single parent’s Minnesota credit will fall back to $560 in tax year 2011.
The Minnesota credit fully phases out; taxpayers with incomes above around $37,000 may not claim the credit.
The Minnesota phaseout begins at a higher income level than does the federal credit and uses a broader definition of income.11 When Minnesota adopted the full amount of the federal credit as the starting point for the state credit, the legislation started the phaseout at the same income level—$10,000—as the federal credit. In later sessions, the Minnesota Legislature increased the phaseout floor and indexed it for inflation, while the federal phaseout floor remained unchanged. In tax year 2009, the Minnesota credit begins to phase out for those with incomes over $23,330. The Minnesota credit decreases by $18 ($36 if the filer claims the credit for two dependents) for each $350 over the income threshold, with the credit fully phased out at $36,980.
Figure 1 shows the maximum credit amounts for married couples with two dependents and head of household filers with one dependent by income level. The figure takes into account that one must have tax liability to qualify for the federal credit, since it is not refundable. The figure assumes that taxpayers claim the standard deduction, the nonrefundable federal child credit,12 and report the maximum allowable qualifying expenses. The figure shows that the two credits serve distinct populations that have little overlap.
Low-income filers may claim the maximum state credit, because it is refundable. But because the federal credit is only available to offset net tax liability after subtracting the child credit (equal to $1,000 in 2007 through 2010 and $500 in following years),13 the married couple in the example does not receive any federal credit until their income reaches $43,000; the head of household filer, until income reaches $25,000. In effect, the figure shows that it is impossible for a head of household or married joint filer to qualify for the maximum federal credit, since the phasedown of the maximum credit begins at $15,000.14 The figure also shows the Minnesota credit fully phasing out at about $37,000 of income, while the federal credit is available to all taxpayers regardless of income.
The Minnesota credit is refundable; the federal credit is not. If a filer is eligible for a Minnesota dependent care credit that exceeds his or her tax liability, that filer receives any “leftover” credit as a refund. However, filers eligible for a federal dependent care credit that exceeds tax liability may only use the credit to offset liability; the rest is forfeited.
Many credit recipients are low income and have little or no tax liability. In 2009, the standard deduction and exemption amounts ensure that a married couple with two dependents had no federal liability until gross income exceeds $26,000. Their next $2,000 of federal liability is offset by the nonrefundable $1,000 per-child tax credit, which, unlike the dependent care credit, is not tied to any particular type of expenditure. As a result, the typical married couple with two dependents will not receive any benefits under the federal dependent care credit until their income reaches $44,900. A head of household filer with one dependent owes no tax until gross income exceeds $15,650. This filer will have the next $1,000 of liability offset by the child credit and will not benefit from the dependent care credit until income reaches $25,650. Both of these example filers will receive a state credit, however, since the state credit is refundable.
Since tax year 1992, Minnesota has allowed parents who operate licensed family day care homes to claim the dependent care credit for their own children. Parents who operate licensed family day care homes and care for their own children may claim the dependent care credit without regard to their actual out-of-pocket expenses. They may claim $3,000 of qualifying expenses for their own children under 16 months of age. For children from 16 months to seven years of age, they may claim the amount they charge to care for children of the same age. They may not claim the credit for their own children over age seven under this provision.
Since tax year 1994 the Minnesota dependent care credit has included a special young-child credit. The young-child credit allows married joint filers with a child under age one to claim a credit, regardless of whether they incurred dependent care expenses. These couples will be deemed to have paid the maximum qualifying expenses of $3,000 for the child under one and will calculate their credit for that child as though they had actually paid $3,000 in expenses. This will provide a credit to families in which one parent stays at home and to those in which both parents work but incur no out-of-pocket child expenses. Families may not claim this credit and the regular credit for the same child. They also may not claim more than one young-child credit in any year, regardless of the number of children they have under age one.
The dependent care credit is an entitlement; no limit is imposed on its funding. Unlike some direct spending programs for dependent-related expenses, such as the Basic Sliding Fee child care program, no fixed dollar appropriation or spending limit applies to either the federal or state dependent care credits. Filers receive the full credits to which they are entitled under the credit formula.
This and any related posts have been adopted from the Minnesota House of Representatives Research Department’s Information Brief, The Minnesota and Federal Dependent Care Tax Credits, written by legislative analyst Nina Manzi.
6 A nondependent child may qualify if the parent is divorced or separated, has custody, and has agreed not to claim the child as a dependent or the noncustodial parent can claim the child as a dependent.
7 Five conditions must be satisfied to claim a person (other than a child under age 13) as a dependent:
- the person must be a member of the taxpayer’s household
- the person must be a U.S. citizen or resident, or a resident of Canada or Mexico
- the person may not file a married joint return
- the person may not have gross income over the personal exemption amount—$3,150 in tax year 2005—unless the person is the taxpayer’s child and is under age 19 or age 24 and is a student
- the taxpayer must provide over half of the person’s support during the calendar year
8 A full-time student with one dependent is deemed to have $200/month in earned income ($400/month for two or more dependents).
9 Minnesota Department of Human Services, DHS Announces Maximum Child Care Provider Rates and Registration Fees effective July 1, 2006, June 26, 2006. Rates cited are the averages of 75th percentile rates for family child care in metro and nonmetro Minnesota, as of 2006; DHS based its maximum rates in 2008 on the same 2006 survey.
10 Laws 2001, 1st spec. sess., ch. 5, art. 10, sec. 6.
11 The Minnesota dependent care credit uses a broad measure of income that includes all income subject to the income tax plus most nontaxable cash income, such as welfare benefits, tax-exempt bond interest, workers’ compensation benefits, and so forth. The measure does not include noncash income that is not subject to tax, such as employee fringe benefits, Medical Assistance, and food stamps.
12 The federal child credit equaled $500 per child in 2000 and previous years. Under EGTRRA 2001, it increased to $600 in 2001, was scheduled to increase to $700 in 2005, $800 in 2009, and $1,000 in 2010. The Jobs Growth and Tax Reform Reconciliation Act (JGTRRA) of 2003 temporarily increased the child credit to $1,000 in tax years 2003 and 2004, and the Working Families Relief Act (WFTRA) of 2004 keeps the credit at $1,000 through 2010. Absent additional federal legislation, the credit will revert to $500 in 2011.
13 The federal child credit was initially implemented at $400 in the Tax Reform Act (TRA) of 1997, effective in 1998, with the credit amount increased to $500 in 1999. EGTRRA 2001 set in motion a phase-up of the credit to $1,000 in tax year 2010. JGTRRA 2003 accelerated the EGTRRA 2001 phase-up by increasing the credit to $1,000 in 2003 and 2004 only. WFTRA 2004 kept the credit at the $1,000 level through 2010. Absent further legislation it will revert to the $500 implemented under TRA 1997 in 2011.
14 The income at which the federal credit begins to phase down increased from $10,000 to $15,000 in 2003 under EGTRRA 2001. However, EGTRRA 2001 also implemented a new 10-percent rate bracket and increased the nonrefundable child credit, which is calculated before the dependent care credit. Combining these changes with the annual adjustment for inflation of the standard deduction and the personal exemption results in a steady increase over time in the tax threshold or income level at which a filer has liability. Increasing the income threshold for the dependent care credit phasedown to $15,000 was not enough to catch up to the income at which most parents begin to have liability after the child credit—$44,900 for a married family of four in 2009, and $25,650 for single parent of one.