What is the Child Tax Credit?
The Child Tax Credit was first introduced in 1998 as a part of the Taxpayer Relief Act of 1997 as a $500-per-child non-refundable tax credit. This meant that a taxpayer could not claim the full credit amount, if their total tax liability was less than the $500-per-child credit.
In 2001 the credit was modified under the Economic Growth and Tax Relief Reconciliation Act of 2001 to increase the credit amount to $1,000-per-child. The child tax credit also became partially refundable for lower-income taxpayers. The refundable portion of the credit is known as the “Additional Child Tax Credit.” Since 2001, the credit has undergone numerous legislative changes that expanded the availability of the refundable portion of the credit. Another significant change to the credit occurred in 2017 under the Tax Cuts and Jobs Act, which increased the credit amount per child, increased the availability of the credit to higher income families, and increased the refundable portion amount. The Tax Cuts and Jobs Act also created a new “family credit” for dependents who otherwise would not be eligible for the child tax credit. The “family credit” amounts to $500-per-dependent, and is subject to the same rules and limitations as the child tax credit.
In 2020, the child tax credit reduced your income tax amount dollar-for-dollar for up to $2,000 per child. Each child must have been under the age of 17, related to you, and generally lived with you for at least half of the year. For those dependents over the age of 17, the “family credit” amount was $500-per-dependent. The child tax credit began to phase out for families if their Adjusted Gross Income (AGI) was above $400,000 ($200,000 if filing a single/head-of-household return). The credit was entirely phased out entirely for families with an AGI exceeding $440,000. The only way to claim this credit was on your tax return due May 17th.
The child tax credit has undergone more legislative changes under the American Rescue Plan Act of 2021. Here is a summary of the temporary changes effective January 1, 2021:
- There is a higher credit amount available for qualifying families
- The credit is now entirely refundable, regardless of the amount of earned income
- Half of the credit must be paid to the taxpayer in advance in the form of monthly payments from the IRS from July – December 2021.
These temporary changes are confusing, so let’s look at each bullet point separately.
Who Qualifies for the Higher Credit Amounts?
The American Rescue Plan Act increased the child tax credit amount to $3,600 for children under the age of 6, and $3,000 for children between the ages of 6 and 17 (17 year olds now qualify). In order to qualify for these higher credit amounts, the taxpayer’s AGI must fall between $150,000 – $170,000 for joint returns ($75,000-$95,000 for single; $125,000 – $145,000 for head-of-household). The credit is phased out at a rate of $50 per $1,000; and only reduces the higher credit to the $2,000 normal amount. For example, a married couple who has one three year old child, and has an AGI of $170,000 won’t get to claim the full $3,600. Since their AGI is $20,000 above the phase-out threshold for joint filers, their credit is reduced by $1,000 ($50 x 20) resulting in the final credit of $2,600.
What about the “normal” credit amount?
For families whose AGI exceeds the increased credit window ($170,000 joint; $95,000 single; $145,000 head-of-household), all is not lost. Taxpayers can still claim a portion of the “normal” $2,000 per child credit, subject to the same phase-out rules as 2020. For example, let’s assume the same married couple in the previous example now has an AGI of $425,000. They will reduce their $2,000 credit by $1,250 ($50 x 25) for a final credit amount of $750.
Fully Refundable Credit
The child tax credit is now a fully refundable tax credit for taxpayers who live in the US for more than half of the year, regardless of their earned income level. Previously, to qualify for the refundable portion ($1,400) of the credit, taxpayers had to have at least $2,500 of earned income (i.e. wages, Sch C profit, or Farming income). Starting in 2021, taxpayers can now claim the full amount of the credit they are eligible to claim, regardless of their tax liability.
Half of the Credit Must be Paid in Advance
The IRS is now required to pay half of the Child Tax Credit to taxpayers in advance of their return filing. If you look back to our first example family (married couple, one three year old child, and an AGI of $170,000), the IRS is now required to provide $1,300 (one-half of the $2,600 credit), in monthly installments of $217 starting July 15, 2021. These monthly advances will come in the form of direct deposits (like refunds and the stimulus payments), paper checks, or pre-loaded debit cards. The taxpayer will then calculate their Child Tax Credit amount on their 2021 tax return, and reduce said credit by the total amount previously received from the IRS.
The IRS will base their mandatory payments off your most recent tax returns. So if you’ve filed your 2020 tax return, the IRS will estimate your 2021 total credit amount (accounting only for the change in a child’s age), and provide payments for half of that amount. If you have not filed your 2020 tax return yet, the IRS will look at your 2019 return information.
What if 2021 looks different from 2020?
All is not lost if your financial position (or family picture) in 2021 has changed since 2020. You will still be able to calculate the total Child Tax Credit amount you are eligible for on your 2021 tax return. You will just reduce that amount by any advances received from the IRS. For example, let’s say our original example family has a child in 2021. They are now a married couple with two children under the age of 6. The total credit amount possible for them to claim is $5,200 ($2,600 x 2 children), but they received $1,300 from the IRS between July and December. The couple will now report $3,900 ($5,200 total – $1,300 received) as their Child Tax Credit on their 2021 return.
The IRS is working to create a Child Tax Credit Portal that will allow taxpayers to update their income, marital status, number of qualifying children, mailing address and bank account information. Once the portal is up and running, and you update your information, the IRS will be able to calculate new monthly installment payments that better reflect what your 2021 credit amount will be.
What if I Don’t Want to Receive the Advance Payments
You can go to the Advance Child Tax Credit Payments page on the IRS website and unenroll yourself from the advance payments. In order to unenroll yourself, you will either need an existing account with the IRS, or an ID.me account. If you have neither, you can create an account with either for free. Be sure to have a photo ID ready if you create the ID.me account. You have until July 14, 2021 to unenroll from the advance payments.
With so many changes to the Child Tax Credit in 2021, it would be a good idea to look at your 2019 and 2020 returns to see if you are eligible for the child tax credit. If you think you may be eligible, go to the Advance Child Tax Credit Payments webpage to confirm your eligibility status, and unenroll from the advance payments.
Tax laws can be tricky and confusing, so it’s always smart to reach out to your tax advisor for any specific questions you may have.