The American Rescue Plan Act of 2021 was signed into law by President Biden on March 11, 2021. Embedded in the act is an expansion of the child tax credit, and more notably, a new method of delivery. The IRS will use its methodology for delivering stimulus money to millions of Americans to make advance payments of the credit beginning in July. The advance payments will automatically come to most taxpayers unless they opt out. Presumptively, they will be direct deposited in the way that the stimulus payments arrived in the bank accounts of American taxpayers.
Prior to the Tax Cuts and Jobs Act of 2017 (TCJA), the child tax credit was a $1,000 per child, and the phaseout for eligibility was relatively low. However, each qualifying child also typically qualified for the dependency exemption. The TJCA removed the longstanding dependency exemption and to compensate, expanded the child tax credit to $2,000 per child. In addition, the phaseout income amount was greatly increased to $400,000 for Married Filing Jointly and $200,000 to Single taxpayers.
The American Rescue Plan further extends the credit to $3,600 for children under 6, and $3,000 for children 6 to 17. This expansion, however, only fully applies to Married Filing Jointly taxpayers who make $150,000 or less, and Single taxpayers who make $75,000 or less, or Heads of Household who make $112,500) (the same phaseout range used for the third stimulus payment). However, the federal government wants to pump cash into the economy now and not next tax season. So they intend to send half of the projected child tax credit amounts to taxpayers beginning in July over the next six months.
The Child Tax Credit: A Few Examples
Let’s take, for example, a married couple that makes less than $150,000 in 2020 and 2021 with one child over six. Let’s say that they received a refund of $1,000 on their 2020 tax return. Their child tax credit in 2020 was $2,000. The credit for 2021 is projected to be $3,000. Therefore, if they take no action, the IRS will send them $250 per month for 6 months for a total of $1,500 ($3,000 divided by 2), beginning in July. This $1,500 represents half of their child tax credit that the IRS expects them to be entitled to in 2021. The couple gets the use of the cash now rather than having to wait until the Spring of 2021. However, if everything stays the same, the couple will now only receive a refund of $500 instead of $1,000 on their 2020 tax return.
Now, use the same couple with one child over six, but assume that they make $250,000 in 2020 and 2021. The couple does not qualify for any additional child tax credit in 2021. They are still at $2,000. However, the IRS is going to send them half of the credit now. The couple receives $166.67 per month for six months if the couple does not opt out. At tax time, they do not receive a refund because their $1,000 refund that they are used to receiving has already been sent to them.
What happens if the same couple makes $175,000 in 2020 and 2021? They find themselves in the middle of a phaseout range. Their projected child tax is $2,350. The IRS will send them half of $2,350 or $1,175 ($195.83 per month). Remember that their normal refund is $1,000. They will have qualified for $350 more than last year’s $2,000 child tax credit, but will have already received $1,175. Therefore, their refund will drop by $825. You can see that it starts to get a little bit messy. If the same couple makes $165,000 in 2020 but makes $185,000 in 2021, they will have received $1,175 in advance child tax credit payments (based on the 2020 income), but will only qualify for $2,000 in child tax credit on the return. Of the $2,000, they will already have received $1,175, dropping their credit to be claimed on the return (and reducing a refund or increasing amount due) to $825. If their refund would have been $1,000 before all of this, they would owe $175 after that.
The Child Tax Credit and Divorced Parents
In addition, consider the plight of divorced parents who alternate claiming the children on their tax returns. The IRS will send the parent who claimed the child in 2020 an advanced child tax credit payment. However, with no child to claim on the 2021 return, the parent will owe the entire amount of advanced payments back to the IRS.
Finally, your tax preparer will have to know exactly what you received so that they can reconcile your tax return to what’s already been sent to you. Getting this wrong will likely generate a letter from the IRS.
Due to these complications, the IRS is providing an option to opt out of the advance payments of the credit. This may be done at https://www.irs.gov/credits-deductions/child-tax-credit-update-portal. For married couples filing jointly, both spouses have to unenroll or the IRS will send you half of the credit. If you choose not to unenroll, just know that receiving part of the credit now is just a matter of timing. Ultimately, your 2021 return will determine the amount of the child tax credit.
If you have other questions about how to handle the new child tax credit, don’t hesitate to reach out to us.