Are you familiar with the $3,000 to $3,600 child tax credits that begin in July? Some investors are not going to realize this is going to reduce the amount of credit on their 2021 taxes and could cause or increase a tax liability.
At Global View, our team of independent fiduciary financial advisors want to shed some light on these new tax changes.
The Child Tax Credit
The child tax credit is larger and friendlier in 2021, with an increase in credit amounts paid out monthly to qualifying families from July through December 2021. The credit per child consists of the regular $2,000 base amount and the special additional credit amount of $1,000 or $1,600.
The changes to the credit are complex and the additional credit amount is available to only some people. For example, high-income families now have two ways in which they’ll have their payments reduced or eliminated.
However, most children will be eligible for advance payments this year. When you file your 2021 tax return in 2022, you will have to reconcile the amount of tax credit you’re actually entitled to with the amount you received via advance payments.
The Rules for the Credit
The American Rescue Plan Act of 2021 offers a temporary expansion of the tax credit. Changes by the Act include:
- Children up to and including 17-year-olds qualify for the credit.
- The annual credit per child increased to $3,000, or $3,600 for children under age 6.
- The credit is fully refundable.
- You do not have a minimum earnings floor (which was $2,500 in 2020).
- The IRS must advance you half of your payments, from July through December 2021.
Many of the rules are unchanged:
- The child still must be a U.S. citizen, national or resident alien.
- The child must have a Social Security number.
- You must claim the child as a dependent on your 2021 tax return.
- The child must be a relative.
- The child must live with you for at least six months during the year.
Some families will earn too much to get the increased tax credit. The credit starts phasing out when you earn a specified Modified Adjusted Gross Income (MAGI). The reduction in the credit is $50 for each 1,000 of MAGI above the threshold amounts:
- Single filers: $75,000
- Head of household: $112,500
- Joint filers: $150,000.
The phase-out applies to the augmented temporary increase of $1,000 to $1,600 per child, not to the permanent $2,000 base amount.
What This Looks Like in Real Life
Example 1: John and Mary have a 4-year-old daughter, Anne. The couple files a joint return and has a MAGI of $160,000 in 2021, $10,000 more than the threshold. Therefore, their credit is cut by $50 x (($160,000 - $150,000) / $1,000), or $500, to $3,100.
The standard phase-out rules still apply to the regular $2,000 portion of the credit, depending on your income and filing status. These phase-outs begin with the following MAGIs:
- Joint filers: $400,000.
- All other filers: $200,000.
The phase-out rate is still $50 for each $1,000 of MAGI above the threshold amounts.
Example 2: James and Marie have a 7-year-old son, Jackson. They have a MAGI of $415,000 in 2021 and file jointly. Because they earn so much, they are not eligible for the special $1,000 extra credit in 2021, so their credit is initially reduced to $2,000. Furthermore, their MAGI exceeds the regular threshold of $400,000 by $15,000. Therefore, their final credit is reduced by $50 x (($415,000 - $400,000) / $1,000), or $750, giving a 2021 tax credit of ($2,000 - $750), or $1,250.
Note that the maximum qualifying age for the tax credit in 2021 is 17 instead of the regular age of 16.
If you live in the United States for more than half of 2021, your credit is fully refundable. That means, folks who qualify for the tax credit can get the full credit, even if they have a $0 tax liability. Contrast this to 2020, when your maximum credit would have been $1,400 per child, if the child credit exceeded their regular taxes. In 2020, you had to have at least $2,500 in earned income to get the tax credit, a provision swept away for 2021.
Eligibility for the American Rescue Plan children’s tax credit is based upon your previously filed tax returns. That is, the IRS first looks at your 2020 return. If that is not available, it will look at your return for 2019. The IRS also makes provisions for families who earn too little to file tax returns.
Timing of Payments
If eligible, you should have already received your first payment on or around July 15, 2021. The following dates apply to subsequent payments through the second half of 2021:
- August 13
- September 15
- October 15
- November 15
- December 15
Most likely, the payment will be direct deposited into the checking account where you receive your tax refunds. If the IRS doesn’t have your checking account information, it will write and mail you a paper check or a debit card. Generally, you do not have to do anything to get your money.
You may receive more payment money than you are entitled to. The reasons can vary.
- You may earn more in 2021 than you did in the year that form the basis of the calculation (2020 or 2019).
- Your children may reach age 18 in 2021, thereby eliminating their eligibility for tax credits.
- Your filing status or U.S. residency might have changed.
If you receive tax-credit overpayments, you will have to repay them, thereby increasing your tax liability and reducing any anticipated tax refund. You will have to report the overpayment as additional income on your tax return.
The IRS will work out a repayment plan if your overpayment exceeds your tax refund and you can’t afford to pay the balance due when filing your 2021 return in 2022.
Your overpayment may receive full repayment protection, absolving you from repaying any excess amount, if you lived in the U.S. for more than half of 2021 and your MAGI was below the following thresholds:
- $60,000 if you are married and filing a joint return or if filing as a qualifying widow or widower
- $50,000 if you are filing as head of household
- $40,000 if you are a single filer or are married and filing a separate return
You may receive partial repayment protection if your MAGI exceeds these thresholds or you live in the United States for less than half the year.
Taxes can be a complicated part of your financial plan. They can be especially difficult following 2020, when so many people were affected by the Coronavirus pandemic. (Check out our new guide: Financial Planning Post COVID-19. You may also find this recent blog post helpful: 5 Tax Planning Changes You Don’t Want to Overlook.)
At Global View, we offer family-office style services, so we can help you with this or any other tax questions you may have. Schedule a no-obligation conversation with our team of independent fiduciary financial advisors, accountant and estate planning attorney, and get the conversation started!