Order Code RS21466
Updated January 17, 2008
Dependent Care: Current Tax Benefits
and Legislative Issues
Christine Scott
Specialist in Social Policy
Domestic Social Policy Division
Summary
In the 2000 census, for more than 60% of the households with children under age
six, 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.
In the 110th Congress, legislation has been introduced that would increase the
income level at which the credit rate is reduced, increase the maximum qualified
expenses for the credit, or expand eligibility for the credit. 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. The Working Families Tax
Relief Act of 2004 (P.L. 108-311) changed the definition of a qualifying dependent
beginning in tax year 2005 to conform with changes made to the personal exemption for
a more uniform definition of a child.
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

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! dependent less than 13 years of age for whom the taxpayer can claim a
personal exemption (beginning in tax year 2005, the dependent under 13
must be a qualifying child of the taxpayer as defined for the personal
exemption);1
! dependent of the taxpayer who is physically or mentally incapable of
providing self care (beginning in tax year 2005, the dependent who is
physically or mentally incapable of providing self care must live with the
taxpayer for at least half the tax year); or
! spouse of the taxpayer who is physically or mentally incapable of
providing self care (beginning in tax year 2005, the spouse who is
physically or mentally incapable of providing self care must live with the
taxpayer for at least half the tax year).
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%) of qualified employment-related expenses for qualifying dependents. P.L.
108-311 eliminated, beginning in tax year 2005, the requirement that the taxpayer
maintain the household.
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
providing self care, 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
providing self care, the spouse’s income for purposes of calculating the credit is assumed
to be $250 for one child, and $500 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
1 For more information on the qualifying child definition see Internal Revenue Service (IRS),
Publication 501, Exemptions, Standard Deduction, and Filing Information, available at :
[http://www.irs.gov/pub/irs-pdf/p501.pdf].

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2002 qualified expense levels of $3,000 for one child and $6,000 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
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
Adjusted Gross Income
Number of 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
1,020
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 credits2 taken against
the sum of regular and alternative minimum tax liability. In tax year 2005, a total of 6.5
million returns used the DCTC for a total credit of $3.5 billion.3 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 2007, 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 more than $24,900 (the
2 Other nonrefundable credits include those for education, retirement savings, adoption, and the
child credit (which is refundable for certain taxpayers).
3 Internal Revenue Service, Individual Complete Report (Publication 1304), Table 3.3, available
at [http://www.irs.gov/pub/irs-soi/05in33ar.xls].

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value of personal exemptions and the standard deduction). As shown in Table 2, it is not
until income is near $40,000 that this married couple would be able to fully utilize the
credit.
Table 2. Utilization of the DCTC by Income Level for a
Married Couple with Two Children, Tax Year 2007
Personal
Tax Before
Gross Income
Exemptions and
Taxable Income
DCTC
Credits
Standard Deduction
10,000
24,900
—
—
—
15,000
24,900
—
—
—
20,000
24,900
—
—
—
25,000
24,900
100
10
10
30,000
24,900
5,100
510
510
35,000
24,900
10,100
1,010
1,010
40,000
24,900
15,100
1,510
1,200
45,000
24,900
20,100
2,212
1,200
50,000
24,900
25,100
2,962
1,200
55,000
24,900
30,100
3,712
1,200
60,000
24,900
35,100
4,462
1,200
65,000
24,900
40,100
5,212
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.4 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;5 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
4 The plan will then reimburse the employee from the set aside amount (employee contributions)
for dependent care expenses. This type of arrangement is also known as a flexible spending
arrangement or flexible spending account, and is often offered as part of a cafeteria benefit plan,
in which employees may choose from one or more taxable or nontaxable benefits.
5 The marginal tax rate is the tax rate on an additional dollar of income.

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tax brackets (at the federal and state level) the greater the potential savings from using a
DCAP.
The Employee Benefits Research Institute (EBRI) reports6 that in 2005, the average
employee contribution to a dependent care flexible spending plan was $2,630. The
National Compensation Survey in March 2007 by the Bureau of Labor Statistics shows
that 31% of employees had access to a dependent care reimbursement account under a
Section 125 “cafeteria” benefit plan.7
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.
Legislation in the 110th Congress
In the 110th Congress, several bills related to the dependent care tax provisions have
been introduced. H.R. 1911, H.R. 2902, and S. 614 would increase the income level at
which the credit rate begins to phase down (from $15,000 to $75,000) and expand the
credit to include care of parents and grandparents of the taxpayer not living with the
taxpayer. H.R. 1871 would establish a credit rate of 40% for taxpayers with incomes
below $100,000 and a credit rate of 20% for taxpayers with higher incomes. H.R. 1871
would also adjust the $100,000 income level for inflation and make the EGTRRA
changes to the credit permanent. H.R. 1421 and S. 816 would establish a minimum
income of $250 a month for a stay-at-home parent and alter the income level at which the
credit rate is reduced by a combination of income and number of eligible dependents.
H.R. 2021 would increase the maximum qualifying expenses from $3,000 ($6,000 for two
or more eligible dependents) to $5,000 ($10,000 for two or more eligible dependents), and
increase the income level at which the credit rate begins to phase down (from $15,000 to
$20,000). H.R. 3758 and H.R. 2906 would repeal the sunset of the EGTRRA changes,
making the changes permanent. H.R. 4039 would alter the credit by creating two credit
rates: 40% for taxpayers with incomes of less than $70,000, and 20% for taxpayers with
incomes of $70,000 or more. In addition, H.R. 4039 would adjust the expense limitation
for inflation and make the EGTRRA changes permanent. H.R. 4164 would increase the
limitation on qualified expenses, make the credit refundable, and provide a new deduction
for dependent care expenses.
6 Employee Benefit Research Institute (EBRI), Data Book on Employee Benefits, Chapter 48,
updated March 2007. Data cited by EBRI are from a study by Mercer Human Resource
Consulting.
7 U.S. Bureau of Labor Statistics, National Compensation Survey: Employee Benefits in Private
Industry in the United States, March 2007, Table 24, March 2007, p. 34. Available at
[http://www.bls.gov/ncs/ebs/sp/ebsm0006.pdf].

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