Read what every fed (with kids or dependents) needs to know about the 2021 Child Tax Credit
The American Rescue Plan Act (ARPA) included changes to the existing child tax credit. The changes were made in order to benefit certain qualifying individuals. Unfortunately, these changes are causing confusion and anxiety for many individuals. This column explains the changes to the child tax credit and clarifies details associated with these changes.
Most Important Changes to the Child Tax Credit
Among the most important changes to the child tax credit associated with the ARPA are:
• The age of qualifying children for the tax credit was raised from age 16 to age 17 as of Dec. 31, 2021;
• the tax credit amount was raised for certain qualifying individuals;
• The tax credit is fully refundable. This means that an eligible individual can receive the credit even if the individual has a $0 federal tax liability for 2021; and
• Up to half of the credit will be received in monthly payments unless an individual opts out. Beginning July 15, 2021, the IRS will pay half the credit in the form of advanced monthly payments (as a prepayment of the refund individuals would normally claim as a tax credit when they file their 2021 federal income taxes in spring 2022). Individuals will then claim the other half of the tax credit when they file 2021 returns.
Amount of the 2021 Child Tax Credit
For 2021 only, the maximum child tax credit is $3,600 for each child under age six and $3,000 for children aged six through 17 as of December 31, 2021.
Without the child tax credit expansion, the credit would be $2,000 per child for children aged 16 and under as of December 31, 2021.
The IRS has sent letters notifying recipients of their prepayments and the IRS website has more details. The prepayments are based on the most recent federal income tax returns processed. For most individuals, this will be their federal income tax 2020 return, but for some individuals it will be their federal income tax 2019 return. This means that if an individual’s 2021 income is different than their 2020 income, the amount of the prepayments could be too high or too low. As will be explained below, an individual’s larger than expected 2021 income could result in the individual having to pay back some or all of the advanced child tax credit.
Income Limits Associated with the 2021 Child Tax Credit
There are income limits associated with the 2021 child tax credit and the limits can be confusing. The part of the credit that is only for 2021 – either $1,600 or $1,000 per child- (depending on the child’s age as of De. 31, 2021) begins to phase out at $75,000 of adjusted gross income for single filers and $150,000 for married couples filing jointly. Above these adjusted gross income limits an individual loses $50 of child tax credits for every $1,000 of additional income. This means that the maximum tax credit varies according to income, number of children, and filing status. The following example illustrates:
A married couple has $200,000 of adjusted gross income during 2021 and has three children ages 6, 10 and 14. The couple has $200,000 less $150,000 equals $50,000 of “excess income” for the purposes of the child tax credit. With three children between ages 6 and 17, the couple would be entitled to a total child tax credit of $3,000. With $50,000 of excess income, the couple will lose 50 times $50, or $2,500 of the $3,000 child tax credit for 2021. The couple would therefore be entitled to only $500 of the expanded child tax credit for 2021.
But this couple would still get the permanent credit of $2,000 for each child because the $2,000 per child tax credit phaseout begins at $00,000 for most married couples ($200,000 for most single filers). As a result, this family’s total child tax credits for 2021 would be equal to $6,000 plus $500, or $6,500. The couple should receive a total of $6,500/2 or $3,250 between July and December 2021, to be paid in six monthly installments of $3,250/6, or $541.67 per month.
Some Advanced Child Tax Credit Payments May Have to be Returned
Those individuals whose adjusted gross income during 2021 exceed the adjusted gross income limits will have to return the advanced child tax credit money that they received between July and December 2021. These individuals will settle up with the IRS on their 2021 federal income tax returns when they file their 2021 returns in spring 2022. Individual filers who are not eligible for some or all of their prepayments (as a result of their 2021 adjusted gross income increasing over their 2020 adjusted gross income or an ex-spouse is claiming a child as his or her dependent for 2021) could owe the IRS when they file their 2021 federal income tax returns.
It needs to be emphasized that the child tax prepayment can significantly affect an individual’s 2021 federal income taxes. This effect will be either in the form of a lower 2021 federal income tax refund or increasing the amount of federal incomes owed at the time of filing. The following example illustrates:
A married couple filing jointly has two children – one child is age 8 and the other child is age 11. The couple had $220,000 of adjusted gross income during 2020 and got a $500 refund on their 2020 federal income tax return. The couple expects that their 2021 adjusted gross income will be about $230,000. The couple is therefore not eligible to receive the additional child tax credit for 2021 – $2,000 ($1,000 per child). But the couple is still receiving the permanent child tax credit totaling $4,000 – the permanent child tax credit of $2,000 per child, or $4,000. This is because the couple’s adjusted gross income is less than $400,000. The couple will receive half of the $4,000 or $2,000 in the form of monthly prepayments, spread over six months (July – December). Their monthly prepayment will be equal to $2,000/6, or $333 per month.
Next spring when they file their 2021 federal income taxes, the $2,000 of prepayments will not be available to lower their 2021 federal income tax liability. Therefore, instead of getting a $500 refund, they could owe the IRS over $500.
How will individuals know if they are receiving payments only for the permanent child tax credit ($2,000 per child under age 17) and not the “expanded” child tax credit ($1,600 per child under age 6 or $1,000 per child aged 6 to 17 as of December 31, 2021)? A tip-off is that the monthly payments are likely to be about $167 for one child, $333 for two children, $500 for three children, and so on.
Stopping or Changing Advance Child Tax Credit Payments
It is possible to change or stop advanced child tax credit payments by going to the IRS’s “child tax credit update portal” and follow the instructions.
For individuals opting out of child tax credit prepayments, detailed information is available in Topic J of the IRS’ frequently asked questions on the child tax credit found here. This includes deadlines to disenroll. Note that each spouse of a married couple must opt out separately.
Those individuals who do not want to opt out of advanced child tax credit payments could instead adjust their net 2021 federal income tax liability by raising the amount of their paycheck federal income tax withholding or by making quarterly federal estimate tax payments. The next quarterly 2021 federal estimated tax payment is due by September 15, 2021 and the fourth and final 2021 quarterly estimated tax payment is due by January 18, 2022.
Employees who may have additional questions about the 2021 child tax credit are encouraged to contact a qualified tax professional.
Edward A. Zurndorfer is a Certified Financial Planner, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street – Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While the employees of Serving Those, Who Serve are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.