2021 Child Tax Credits – What to know and potential tax implications

There was a major update to the child tax credit for 2021 that you want to be aware of.  In fact, if you have dependent children under the age of 18, you’ve likely already been impacted!

This update could impact your cash flow for the rest of this year, but could also have unexpected tax consequences as well.  Let’s unpack this further, shall we?

What exactly happened?

In March of 2021, Congress passed the American Rescue Plan of 2021.  This was a $1.9 trillion stimulus bill, intended to provide American families with additional relief, stemming from the economic impact of Covid-19.

An important aspect of the plan was the expansion of the Child Tax Credit program.   The Child Tax Credit program provides parents of dependent children a tax incentive, in the form of a direct tax credit for each dependent child that they claim, under the age of 18.

In 2020, this credit was $2,000 per eligible child that you claimed on your taxes, subject to phaseouts depending on your income and filing status.

The American Rescue Plan expanded this credit to help deliver additional relief for parents.

  • For children age 6-17, the expanded child tax credit will increase from $2,000 to $3,000 for 2021 (a 50% increase).
  • And for children under the age of 6, the expanded child tax credit increases from $2,000 to $3,600 (an 80% increase).

In addition, to help accelerate the relief, the IRS has already started to deposit checks in your bank account, beginning in July 2021 and continuing as monthly payments through December 2021.

These deposits are a pre-payment of one-half (1/2) of the total tax credits that the IRS expects you to be eligible for, based on your most recent tax filing (more on this shortly).  For most filers, this will be based on your 2020 tax return, but it could also be based on your 2019 tax return if you filed an extension.

How are the credits calculated and how much can I expect to receive?

The expanded Child Tax Credit program provides qualifying families with up to $3,600 per dependent child, age 5 and under.  For each child between the ages of 6 and 17, the credit is up to $3,000.  Again this is an expansion of the program that existed prior to 2021, when then credit was $2,000 per qualifying child.

This is important to understand, because each program has its own income phase-out limits that must be taken into account separately when calculating how much you can expect to receive.

In the expanded program, the phase-out starts at much lower limits than the previous “legacy” program.

For single filers, the extra payments ($1,000 and/or $1,600) are gradually phased out starting at $75,000 in modified AGI.  For those filing jointly, the phase-out begins at $150,000 of modified AGI.

After this potential reduction is calculated for the qualifying increased amount, the phase-out limit for the pre-existing program is applied to the remaining credit amount.

In 2020, the $2,000 tax credit (per qualifying child) was phased out for single-filers at $200,000 of modified adjusted gross income (AGI).  For those filing joint returns, the phase-out limit started at $400,000 of modified AGI.

Once your estimated credit is determined, the IRS will pre-pay 50% of your total credit amount, as equal monthly payments, beginning on July 15th, 2021, continuing until December 15th, 2021.

Let’s look at a hypothetical example:

  • Bob and Sue filed a joint return in 2020 and their modified adjusted gross income was $149,999
  • They have 2 children they claim as dependents, ages 10 and 12
  • Under the expanded program, they would receive a credit of $3,000 per child for a total of $6,000
  • Because their modified adjusted gross income is under the phase-out limits for both the expanded program, and the previous program, there are no reductions to their benefits
  • 50% of their total credit amount, $3,000 ($6,000 x 1/2) will be paid out monthly between July and December of this year
  • So Bob and Sue will receive a monthly deposit from the IRS of $500 ($3,000/6) between now and the end of the year
  • The remaining credit amount will be claimed as a credit when they file their 2021 tax return

I know this can get a little confusing, but good news!  Here’s a handy calculator you can use to help you estimate what you can expect to receive.

Possible Tax Surprises to be aware of

As mentioned earlier, the IRS’s estimates are based on your last tax-return, so if you’ve had significant increases (or decreases) to your income in 2021, this could result in some potential surprises.

What if my income went up in 2021?

Let’s continue to look at Bob and Sue from our hypothetical example.

Based on their 2020 return, the IRS has estimated that they would qualify for the full, non-reduced credits for their 2 children, as we established a moment ago.

In 2021, they experienced a significant increase to their income.

Since they were already up against the phase-out limit amount, this increase in income will phase them out of at least a portion of the expanded credits they are set to receive.

As a result, when they file their 2021 tax return, they’ll be forced to pay back all or at least a portion of the credit amount that they received in 2021.

This can come as an unexpected tax surprise for those who haven’t factored this into their 2021 tax forecast.

This is particularly important to be aware of because other stimulus payments that you might have received didn’t have any income qualifications, so there was no concern for paying them back.

If you think that you are set to receive benefits that you won’t qualify for, and don’t want the added burden of having to pay these credits back when you file your taxes, you have the option to opt-out of receiving your benefits.  You can access the IRS Child Tax Credit Update Portal here for more information.

What if I had a child or my income went down in 2021?

On the flip side of the coin, it’s possible that the income you reported on your last tax return was too high, and disqualifies you from receiving any child related tax credits.  Or it’s possible that your filing status changed and you have additional dependent(s) to claim in 2021 that would potentially qualify you for additional credits.

At this time, there isn’t a way to update this information to accelerate the advanced payment of your credits (that we’re aware of), but that would be reconciled when you file your 2021 tax return.

What If I’m Preparing to Retire?

One final note on the Child Tax Credit.

We have clients who are nearing retirement, who still have dependent children that they claim.  If you find yourself in this position, you might also be incorporating proactive tax planning into your financial plan.  Perhaps you’re accelerating income by doing Roth conversions, for example.  If you have qualifying dependent children, this tax planning strategy could  potentially push you past the phase-out limits, and disqualify you from the credits, creating an unintended ripple effect.

That doesn’t mean you shouldn’t incorporate these kinds of strategies, but it’s a reminder that when it comes to tax planning (and financial planning for that matter), nothing happens in a vacuum.

Everyone’s situation is unique, so be sure to work with your financial professional and tax advisor to ensure you don’t experience any unwanted tax surprises.

If you’d like to discuss this further, we invite you to book some time with our team to help address any questions you may have.  Click here to book your complimentary Discovery Call now!

**Disclaimer:  This information is intended for educational purposes only, and is not intended to be taken as specific planning advice.  We always recommend that you discuss how these issues impact your specific plan with your professional team.

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