The American Rescue Plan (ARP) put some sweeping changes in place to help the U.S. tax code deal with the effects of the coronavirus pandemic. To help provide guidance to families and small business who might claim some of ARP’s major credits, the IRS has issued two sets of frequently asked questions or FAQs.

The American Rescue Plan modified the Child and Dependent Care Credit as well as the Paid Sick and Family Leave Credit to give some help to families and small-to-mid-sized businesses coping with the economic fallout of the pandemic.

The two separate sets of FAQs have information on eligibility, how to calculate the credits, and how to claim the credits.

Here’s a breakdown.

Child and Dependent Care Credit

The American Rescue Plan made some major changes to the credit for 2021, raising the cap on work-related expenses for qualifying care when the credit is figured. Eligible taxpayers in 2021 can claim qualifying work-related expenses up to:

• $8,000 for one qualifying person, up from $3,000 in prior years, or
• $16,000 for two or more qualifying persons, up from $6,000 in prior years.

The IRS notes that "taxpayers are also required to have earnings," and "the amount of qualifying work-related expenses claimed cannot exceed the taxpayer's earnings."

ARP also boosts the maximum percentage of expenses that can be applied to the credit. It also changes how the credit phases out for taxpayers with higher incomes, while making the credit refundable for those who qualify.

With a maximum credit rate of 50%, those with the maximum amount of work-related expenses would qualify for $4,000 credit for one qualifying person; $8,000 for two or more.

A qualifying person for this credit is defined as a dependent, under the age of 13 - or a dependent of any age or a spouse who’s incapable of taking care of themselves and who lives with the taxpayer for more than half the tax year.

Employer-provided benefits for dependent care have to be subtracted from total work-related expenses when calculating the credit. This would include expenses paid from a flexible pending account.

The American Rescue Plan is expected to increase the number of taxpayers who qualify for the credit.

The percentage of work-related expenses allowed when figuring the credit goes down as the taxpayer’s income goes up. This hasn’t changed from prior years. But ARP does open the door to more qualified taxpayers with its new maximum 50% credit rate.

The new law pushes the beginning of the credit’s phaseout to $125,000 in adjusted gross income. At that point, the 50% credit percentage starts to go down as income goes up, drying up altogether for those who earn more than $438,000 for the year.

This credit is fully refundable for the first time in 2021, meaning a taxpayer can get the credit even if they don’t owe any federal tax.

Eligible taxpayers must live in the United States for more than half the year, although special rules are in place for American military personnel who are stationed outside the U.S.

Form 2441, Child and Dependent Care Expenses, is used to claim the credit for 2021. Taxpayers claiming the credit will need a Social Security number or a valid taxpayer identification number (TIN) for each qualifying person.

Refer to the instructions for Form 2441 for more information.

Paid Sick and Family Leave Credits

Employers who provide paid sick and family leave to their workers related to COVID-19 circumstances can get reimbursed through the Paid Sick and Family Leave Credit. This same credit is open to self-employed individuals.

The credit qualifies employers who allow paid time off due to illness from COVID-19, time off to care for a family member with COVID-19, even time off related to receiving the COVID-19 vaccination shots.

For this credit, the American Rescue Plan stands on the shoulders of legislation that went before to give employers some help for providing benefits to their workers.

The Families First Coronavirus Response Act (FFCRA) and the COVID-related Tax Relief Act of 2020 provided the foundation that ARP amends and extends.

ARP specifically expands the existing code to allow the credit in cases where the employee is waiting for a diagnosis or test for COVID-19, getting a COVID-19 vaccine, or recovering from the effects of a vaccine.

In addition, ARP allows eligible employers to claim the credit for paid family leave wages for all the same reasons as paid sick leave wages.

The IRS FAQs help employers with information on how they can claim the paid sick and family leave credits, how to file for the credits, calculate the credit amounts—most importantly for some employers, how to get advance payments or refunds of the credits.

ARP paid leave credits are tax credits against the employer’s share of Medicare tax. The credits are refundable, meaning the employer is entitled to the full amount of the credit to the extent it exceeds the employer’s share of Medicare tax.

Eligible employers can anticipate the credits they claim by withholding the federal employment taxes they would have deposited otherwise. This includes federal income tax withheld from workers, the workers’ share of Social Security and Medicare taxes, and the employer’s share of Social Security and Medicare taxes for all employees up to the amount of their share of the credit.

If the employer doesn’t have enough federal employment taxes on deposit to cover the anticipated credits, the employer can ask for an advance of the credit using Form 7200, Advance Payment of Employer Credits due to COVID-19.

Comparable credits can be claimed by self-employed taxpayers using Form 1040, U.S. Individual Income Tax Return.

The tax provisions of the American Rescue Plan has more information. Details can be found in the other provisions to help taxpayers recover from pandemic impacts. Check out the FAQs on those and other provisions.

Source: IR-2021-128