Order Code RS21466
Updated January 6, 2004
CRS Report for Congress
Received through the CRS Web
Dependent Care: Current Tax Benefits
and Legislative Issues
Christine Scott
Specialist in Tax Economics
Domestic Social Policy Division
Summary
In the 2000 census, for over 60% of the households with children under 6, all
parents in the household worked. For families with both parents working or a single
working parent family, care for young children and individuals who are physically or
mentally unable to care for themselves is critical to maintaining participation in the
workforce. To assist these families current law provides two tax benefits related to
dependent care: the dependent care credit and the exclusion from income for employer-
provided dependent care assistance programs. Both provisions are for employment-
related expenses for the care of dependents under the age of 13, or dependents (or a
spouse) who are physically or mentally incapable of caring for themselves.
Legislation has been introduced in the 108th Congress that would clarify the tax
treatment of dependent care programs for military personnel (H.R. 878, H.R. 1307, H.R.
1664, H.R. 3365, S. 19, S. 235, S. 289, and S. 351). H.R. 3365 passed both houses and
was signed into law (P.L. 108-121) on November 11, 2003.
Other legislation introduced in the 108th Congress would eliminate the 2010 sunset
for the dependent care provisions of the Economic Growth and Tax Relief
Reconciliation Act (EGTRRA, P.L. 107-16) (H.R. 210, H.R. 407, H.R. 493, H.R. 1612,
and S. 96): make the credit refundable (H.R. 493); expand the credit (H.R. 181, H.R.
936, H.R. 3666, S. 388, S. 448, and S. 1253); simplify the calculation of the credit
(H.R. 22); or provide a uniform definition of a child (H.R. 22, H.R. 936, H.R. 2392,
H.R. 2718, S. 448, S. 755, S. 1173, S. 1174, and S. 1434). This report will be updated
as legislative activity warrants.
Current Tax Benefits for Dependent Care
There are two current law tax provisions for dependent care: the dependent care tax
credit (DCTC) and the exclusion from income for employer-provided dependent care
assistance programs (DCAP). Both provisions use the same definitions of qualified
employment related expenses and qualifying dependents.
Congressional Research Service ˜ The Library of Congress

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Qualified employment-related expenses are those expenses for household services
and care of a qualifying dependent necessary for the taxpayer to be employed. For the
purposes of qualified employment-related expenses, a qualifying dependent is a:
! dependent less than 13 years of age for whom the taxpayer can claim a
personal exemption;
! dependent of the taxpayer who is physically or mentally incapable of
caring for themself; or
! spouse of the taxpayer who is physically or mentally incapable of caring
for themself.
A family may pay either a private individual or a dependent care center for dependent
care. A dependent care center is a facility that provides care for more than six individuals
who are not residents and receives a fee or other payment for providing those services.
However, payments to a dependent care center are qualified expenses only if the center
meets all applicable state and local laws and regulations. Qualified expenses do not
include payments to a child of the taxpayer under the age of 19, or payments to an
individual the taxpayer can claim as a dependent for the personal exemption.
Dependent Care Credit (DCTC). The DCTC is calculated as a percentage (as
high as 35% beginning in tax year 2003) of qualified employment-related expenses for
qualifying dependents. In addition to meeting the requirements for employment-related
expenses and a qualifying dependent, a taxpayer must maintain the household. That is,
the taxpayer must provide more than 50% of the household expenses.
The qualified employment-related expenses for the DCTC, beginning in tax year
2003, are actual expenses capped at $3,000 for one dependent and $6,000 for two or more
dependents. If the taxpayer has two or more children, the $6,000 need not reflect $3,000
per child. The per child allocation does not matter as long as part of the $6,000 is spent
on each child. The Economic Growth and Tax Relief Reconciliation Act of 2001
(EGTRRA, P.L. 107-16) raised the expense limits from $2,400 for one child and $4,800
for two or more children, and increased the credit percentage from 30% to 35%,
beginning in tax year 2003. EGTRRA also increased the income level at which the credit
rate begins to phase down resulting in a higher credit rate for incomes between $10,000
and $43,000. The EGTRRA increases will sunset at the end of 2010, and the DCTC will
revert to tax year 2002 levels.
For married taxpayers, the qualified expenses are also limited to the lesser of the
taxpayer’s or spouse’s earned income. If the spouse is a full-time student or incapable of
caring for themself they are often not employed and earning income. A special rule exists
for this situation. Each month that the spouse is a full time student or incapable of caring
for themself, the spouse’s income for purposes of calculating the credit is assumed to be
$200 for one child, and $400 for two or more children. If the spouse is a full-time student
all year, this results in an income for purposes of the credit equal to the tax year 2002
qualified expense levels of $2,400 for one child and $4,800 for two or more children.
Married taxpayers must generally file a joint return to take the DCTC, but special
rules exists for couples who are legally separated or living apart. The 35% rate is reduced
by 1% point for each $2,000 (or fraction thereof) by which income exceeds $15,000, but

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the rate is not reduced below 20%. As shown in Table 1, the credit is 20% at incomes
above $43,000.
Table 1. Maximum Dependent Care Tax Credit by Level of Income
Maximum credit based on number of
Adjusted gross income
qualifying individuals
One
Two or more
Applicable
($3,000 in qualified
($6,000 in qualified
Over
But not over
credit rate
expenses)
expenses)
$0
$15,000
0.35
$1,050
$2,100
15,000 17,000 0.34
1020
2,040
17,000 19,000 0.33
990
1,980
19,000 21,000 0.32
960
1,920
21,000 23,000 0.31
930
1,860
23,000 25,000 0.30
900
1,800
25,000 27,000 0.29
870
1,740
27,000 29,000 0.28
840
1,680
29,000 31,000 0.27
810
1,620
31,000 33,000 0.26
780
1,560
33,000 35,000 0.25
750
1,500
35,000 37,000 0.24
720
1,440
37,000 39,000 0.23
690
1,380
39,000 41,000 0.22
660
1,320
41,000 43,000 0.21
630
1,260
43,000 No
limit 0.20
600
1,200
Source: Table prepared by the Congressional Research Service (CRS).
On the tax form, the DCTC is one of several nonrefundable tax credits1 taken against
the sum of regular and alternative minimum tax liability. In tax year 2000, a total of 26.3
million returns used the DCTC for a total credit of $19.6 billion. The nonrefundable
nature of the credit results in many lower income taxpayers not being able to fully utilize
the credit. For example, in tax year 2003, a married couple with two children, claiming
a standard deduction and qualifying expenses of $6,000, would not have taxable income
and taxes to offset with the credit until their total income was over $21,700 (the value of
personal exemptions and the standard deduction). As shown in Table 2, it is not until
income is above $35,000 that this married couple would be able to fully utilize the credit.
1 Other nonrefundable credits include those for education, retirement savings, adoption, and the
child credit (which is refundable for certain taxpayers).

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Table 2. Utilization of the DCTC by Income Level for a
Married Couple with Two Children, Tax Year 2003
Personal
exemptions and
Taxable
Tax before
Gross income
standard deduction
income
credits
DCTC
$10,000
$21,700
$ -
$ -
$ -
15,000
21,700
-
-
-
20,000
21,700
-
-
-
25,000 21,700
3,300
330
330
30,000 21,700
8,300
830
830
35,000 21,700
13,300
1,330
1,330
40,000 21,700
18,300
2,045
1,320
45,000 21,700
23,300
2,795
1,200
50,000 21,700
28,300
3,545
1,200
55,000 21,700
33,300
4,295
1,200
60,000 21,700
38,300
5,045
1,200
65,000 21,700
43,300
5,795
1,200
Source: Table prepared by the Congressional Research Service (CRS).
Employer-provided Dependent Care Assistance Programs
(DCAP)
A taxpayer can exclude from income up to $5,000 paid or incurred by an employer
for qualified dependent care expenses under an employer-provided DCAP. The DCAP
definitions for qualified dependent care expenses and qualified dependent are the same
definitions as for the DCTC. An employer can provide direct payment to child care
providers, provide on-site child care, or reimburse parents for child care they obtain.
Similar to the DCTC, payments made to a dependent of the taxpayer or a child of the
taxpayer under age 19 are not excluded from income.
These arrangements are often funded through salary reduction agreements. Under
a salary reduction agreement, the employee agrees that a specified amount be set aside for
the employer’s DCAP. The employer DCAP must be a written plan meeting certain rules
for nondiscrimination among employees, but need not be funded by the employer. By
using a salary reduction, an employee receives the benefit of the income exclusion during
the tax year rather than at year’s end. The tax savings from using a DCAP include: for
federal taxes, the income set aside times the taxpayer’s marginal tax rate;2 the payroll
taxes on the income set aside (if the taxpayer’s income exceeds the maximum amount
subject to payroll taxes there is no payroll tax savings); and any applicable state taxes on
the income set aside. Therefore, for any given amount set aside, the higher the taxpayer’s
tax brackets (at the federal and state level) the greater the potential savings from using a
DCAP.
2 The marginal tax rate is the tax rate on an additional dollar of income.

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Interaction between the DCTC and the DCAP. Although both provisions use
the same definition of employment-related expenses, the same expenses cannot be used
for both the DCTC and DCAP. Taxpayers must choose between the two tax provisions
for the same qualified dependent care expenses. For taxpayers in tax brackets higher than
the DCTC credit rate, the DCAP using a salary reduction arrangement is more
advantageous. However, because the DCTC has a higher limit ($6,000) in the case of two
or more children, a higher income taxpayer may use up to $5,000 in a DCAP with a salary
reduction, and use $1,000 of taxpayer paid employment-related expenses for the DCTC.
Current Legislative Issues
The legislative issues in the 108th Congress for the dependent care tax provisions can
be broken down into three categories:
! Clarification for military personnel. Several bills have been introduced
which would clarify that dependent care assistance programs for military
personnel qualify as a military benefit and are excluded from income.
Bills clarifying the tax treatment of military dependent care assistance
programs are H.R. 878, H.R. 1307, H.R. 1664, H.R. 3365, S. 19, S. 235,
S. 289, and S. 351. H.R. 3365 passed both houses and was signed into
law (P.L. 108-121) on November 11, 2003.
! EGTRRA . Legislation has been introduced which would eliminate the
current sunset for the changes to the credit made by EGTRRA. At the
end of 2010, the sunset would result in a lower qualified expense
limitation, and a lower credit rate, particularly for taxpayers between
$10,000 and $43,0000. Bills containing a provision to eliminate the
sunset for the EGTRRA provisions related to the credit are H.R. 210,
H.R. 407, H.R. 493, H.R. 1612, and S. 96.
! Other changes. Legislation has been introduced for a wide range of
changes including:
! making the DCTC refundable (H.R. 493, which also repeals
the sunset for the EGTRRA provisions related to the credit).
! expanding the credit by making one or more of the following
changes: raising the credit rate; the income level at which
the credit rate phases down; inclusion of non-working
taxpayers or stay-at-home parents; including respite care; or
raising the age of a dependent child (H.R. 181, H.R. 936,
H.R. 3666, S. 388, S. 448, and S. 1253)
! setting the qualified expenses at a single dollar amount and
setting one credit rate to simplify the credit (H.R. 22)
! creating a uniform definition for a child, or child dependent,
for the dependent care and other child provisions (H.R. 22,
H.R. 936, H.R. 2392, H.R. 2718, S. 448, S. 755, S. 1173,
S. 1174, and S. 1434 )

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