Making Sense of the Child Tax Credit

If you’re like me, your head is spinning from the constant changes coming out of Washington, especially as they pertain to our finances. A lot of this news is good, but it takes some time to get my head around it … and I’m a CPA. My goal is to help you wrap your head around today’s shifting tax laws and take steps to ensure you have the most positive outcomes possible.

Recently I shared some insights into the economic stimulus payments, and shortly after I shared that piece, a third stimulus payment went out as part of the American Rescue Plan of 2021(ARP).

Also part of the ARP is a major change to the Child Tax Credit, which some experts predict could have a massive impact on child poverty. But its details are somewhat complex, so I’ll try to break it down to the basics.

Here’s a basic overview of the ARP’s new Child Tax Credit:

  1. Starting with the tax year 2021, the Child Tax Credit increases from $2,000 to $3,600 for each child 5 and under, and $3,000 for each child 6 and up.
  2. The new law extends the credit to families with children who are 17. Previously, the credit only applied to children 16 or younger.
  3. This increase will NOT apply to your 2020 tax returns, which are due May 17 this year.
  4. The full credit amount is available to Americans whose adjusted gross income (AGI) is $75,000 for individuals filing singly, or $150,000 for marrieds filing jointly. Above those thresholds, the credit begins quickly phasing out.
  5. Half of the credit will be paid in direct cash installments paid directly to families (which comes to $300 per month for each child aged 0-5, or $250 per month for each child 6-17).
  6. These payments will be distributed each month over a period of six months, in the same way your stimulus payments were made, from July through December of 2021.
  7. The remaining half of the credit will be applied on your tax return for 2021.
  8. The new law makes the credit fully refundable, meaning that even if you owe no taxes, you can have this credit refunded to you as a payment from the IRS.
  9. It remains uncertain whether this will be a one-year-only credit or will remain a permanent fixture in the tax law.

Now to some of the more complicated details. Like anything pertaining to the IRS, the rules around the Child Tax Credit are not straightforward. Here are some things to keep in mind, particularly if your AGI is higher than these income thresholds or if your children are approaching ages 6 or 18.

The age cutoff goes by calendar year. This means that if your child turns 6 any time within the calendar year 2021 (even if it’s December 31!), your tax credit for that child drops from $3,600 to $3,000 for this year. This means your monthly payment from July through December will be $250. Same goes for kids who turn 18 this year — you don’t get the credit if your child turns 18 any time in 2021.

The credit phases out above the $75,000/$150,000 AGI threshold. Although the previous $2,000 credit remains a baseline credit offered to any household whose AGI falls below $400,000, the additional $1,000 that was added this year begins phasing out after your AGI exceeds the $75,000 threshold for individuals/$150,000 for marrieds filing jointly. The phaseout occurs at a rate of $50 per $1,000 above the threshold AGIs.

In other words, let’s say a married couple has one child, and their AGI is $160,000. This puts them $10,000 above the stated threshold for the credit. The credit reduction can be calculated as follows:

$160,000 AGI

-$150,000 Credit threshold

$10,000 overage

Dividing the overage by $1,000, which is the increment used in phasing out the credit, means you would multiply 10 by $50, to arrive at a credit reduction of $500. So this family would receive $3,100 for a child aged 0-5, or $2,500 for a child 6-17.

Obviously, according to this math, once you reach an AGI of $85,000 (individuals)/$170,000 (couples), you’re only eligible to receive the baseline $2,000 credit, with your direct cash payments being $167 per month and the remaining $998 being credited on your tax return.

The $2,000 baseline credit phases out once income exceeds $400,000. Once over this second threshold, the child credit starts phasing out at the rate of $50 per $1,000 of extra income. It is completely phased at incomes of $440,000 for a married couple and $240,000 for all other filing statuses).

Credits are based on your most recent tax return. Because the current deadline for filing your 2020 tax returns is now May 17, your most recent tax return on file might be 2019, or it might be 2020. That’s the income the IRS will use to arrive at your eligible payment amount.

What if your income changed significantly in 2020 or 2021? Good question. The short answer is that it’s unclear and dependent on your particular situation. At this point, I know that if your income grows to exceed the income thresholds in the second half of 2021, you may be required to repay some of your credit, but how this will be enforced remains unclear. Some may have to repay; some won’t.

If, on the other hand, your income drops significantly in 2021 from above to below the income thresholds, you should be able to receive the proper amount as a credit on next year’s return.

Finally, all this depends on the IRS meeting its deadline. That is to say that the federal government mandated the Child Tax Credit payments to begin in July, but the question remains whether the IRS actually can do it. As you might imagine, it’s a huge undertaking, and as I write this there are less than three months to make it happen. Know, however, that if any direct payments are not received, they will be applied as a credit on your tax return.

Navigating all this new information is tricky, and your unique situation may raise questions my team and I can answer for you. If you have concerns that you’re paying too little or too much during the tax year or would like to know more about how the new Child Tax Credit will affect you, schedule a mid-year tax meeting with us for this summer to make sure you’re on track.

It looks like blue skies ahead for us all — as always, I wish you the best this month!

-Ludmila

child tax credit