Many families have just received a payment from the IRS as a part of the expanded child tax credit that was included in the American Rescue Plan that was signed into law in March. Despite a letter that was mailed in early July explaining the payment, there is a lot of confusion around the payments especially from a tax planning perspective (and rightly so!). Below is an overview of the tax credit and the payments as well as a look at the financial planning considerations involved.
What is the Tax Credit?
The American Rescue Plan increased the amount and age restrictions around the child tax credit that already existed. The chart below outlines the annual credit amount, per child, and the following section will detail which households qualify to receive the credit.
|Child under age 6|
|Child between age 6 - 17|
The American Rescue Plan also adjusted how you will receive the credit. Normally the child tax credit is received when your taxes are filed. For example, the 2020 credit was received when the 2020 income taxes were filed in 2021. This year, half of the credit that the IRS expects you will qualify for will be paid out monthly starting in July and ending in December. It is the “expected” portion of the equation that will be discussed in the financial planning considerations below.
Who Gets the Tax Credit?
The credit amount just mentioned is for a full child tax credit. The full credit amount can be received if your income falls below the thresholds listed below:
|Single||Income below $75,000|
|Head of Household||Income below $112,500|
|Married Filing Jointly||Income below $150,000|
With the child tax credit, there is a second tier of income ranges for a smaller, $2,000 per child credit. This credit does not change based on the age of the child, but they still need to be 17 or under to qualify for the advanced monthly payments (children ages 18 or 19-24 and full-time college students may qualify for a $500 credit when filing your taxes in 2022). This reduced credit can be received if your income falls below the thresholds listed below:
|Single||Income below $200,000|
|Head of Household||Income below $200,000|
|Married Filing Jointly||Income below $400,000|
Once your income is over those amounts, the more usual phaseout begins. For the child tax credit, the phaseout reduces the credit by $50 for every $1,000 of income above the income threshold. If you would like to calculate what your credit will be, visit https://www.irs.gov/credits-deductions/advance-child-tax-credit-eligibility-assistant.
Financial Planning Considerations
While the early payments of the child tax credit are likely a welcome relief for many families, it may also create tax issues for higher income families.
The first issue to be aware of is that the IRS is calculating your expected credit based upon your 2019 or 2020 tax return. Potential issues here include children being born or moving between the ages group (especially if over age 17 but a full-time student with less than $5,000 of income).
Another consideration is that, possibly due to the pandemic, your income was lower in 2019 or 2020 than it will be in 2021. This could lead the IRS to giving you half of a larger credit than you will qualify for now based on your higher income. This has the potential of an unexpected tax burden next year since you will have to pay back the credit you should not have received.
If you are concerned that you may be receiving a credit that is too large, you can go online to irs.gov to have them change your payment (which will not impact your actual credit, it will simply adjust when you receive it). The exact page to visit can be found by first visiting childtaxcredit.gov which will also have more detailed information on the tax credit. If married filing jointly, both spouses will need to complete the process to unenroll in the early payments.
If you have any questions for your tax situation, your accountant should be able to answer any questions. If you file your own tax return, we think a sound approach would be to go online and stop the payments if you believe you will need to make a payment (not receive a refund) when you file your 2021 taxes. If you expect to be receiving a refund, we think it likely makes sense to take the monthly payments, so the IRS is not holding your money interest-free. If you’re somewhere in between, perhaps stick the payments in a high yield savings account each time you get a payment, earn a few months of interest and you’ll have the cash available if it turns out that you owe taxes.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.