Updated Child Tax Credit Rules

Our prior blog in this series outlined the rules governing stimulus payments and how they could affect your household. In addition to stimulus payments, there were many other helpful measures outlined in the recently passed American Rescue Plan Act. In addition to extending unemployment benefits, expanding paycheck protection program coverages, and allocating additional money to schools and vaccination programs, the Act increased the Child Tax Credit, albeit temporarily, for 2021. Here is the rundown on the new dollar amounts, phaseout ranges, and age limits.

Increased Child Tax Credit Amount

The Act introduces temporary increases to the Child Tax Credit for 2021. In addition to the usual $2,000 per eligible child, an additional $1,000 will be added for children ages six and over (total of $3,000 per child), and an additional $1,600 will be added for children who have not turned 6 by the end of the year (total of $3,600 per child).

Let’s look at an example:

Marcia and Clark have two children who are five and nine as of December 31, 2021. They will receive a credit of $3,000 for the nine-year-old, and $3,600 for the five-year-old, making their total credit $6,600.

Different Payment Schedule for the Child Tax Credit

It’s important to note how this credit will be paid. Unlike the usual process, where the credit is applied when the taxpayer files their yearly taxes, a portion of this tax credit will be paid in advance via check or direct deposit. It is anticipated that 50% of the credit will be paid in equal installments between the months of July and December of 2021. The eligible credit amount will be estimated using the taxpayer’s 2020 tax return. If a household’s 2020 tax return has not yet been filed when the credit is computed, the 2019 tax return will be used. The remaining 50% of the credit will be applied per the usual process when 2021 taxes are filed.

Fully Refundable Child Tax Credit

Another interesting change is that the tax credit is fully refundable for 2021. When a credit is refundable, it means it can be given back as a tax refund if inclusion of the credit in the calculation of household tax due leads to a negative tax liability for the year.  This is especially important for low-income households that may not owe income after deductions as they will still be able to receive the tax credit as a refund.

Lower Phaseout Ranges

Phaseout ranges for the temporarily increased credit amount are much stricter than the typical phaseout ranges for the Child Tax Credit. The new phaseout reduces the credit by $50 for every $1,000 a household’s Adjusted Gross Income (AGI) exceeds the threshold. The good news is these lower phaseout ranges only apply to the increased tax credit amount. In other words, only the extra $1,000 or $1,600. This does not affect the original $2,000. The phaseout ranges for the increased tax credit amount are as follows:

Married Filing Jointly: $150,000

Head of Household: $112,500

All other filers: $75,000

The original $2,000 tax credit is still subject to old phaseout thresholds, which are $400,000 for married filing jointly and $200,000 for single filers.

Let’s look at some examples:

Example 1

Marcia and Clark have two children who are five and nine. As illustrated in the example above, they would receive $6,600 in Child Tax Credits in 2021.  However, their 2021 AGI is $175,000, which is above the phaseout threshold. So, their tax credit is reduced.

$175,000 – $150,000 = $25,000.

$25,000 / $1,000 = 25

25 x 50 = $1,250 ß Their tax credit is reduced by $1,250

$6,600 – $1,250 = $5,350

Example 2

Marge and Jay have two children who are five and nine. They would receive $6,600 in tax credits for 2021, but their AGI is $225,000, which is above the increased tax credit amount threshold, but below the regular tax credit threshold.

Their reduction would be:

The amount of the temporary 2021 increase is $2,600 over the normal amount.  This dollar amount is subject to the $150,000 threshold calculation. Unfortunately, their AGI of $225,000 wipes out their $2,600 increase.

$225,000 – $150,000 = $75,000

$75,000 / $1,000 = 75

50 X 75 = $3,750

Since the $3,750 reduction due to the phaseout threshold is higher than the $2,600 increase, they will not receive any of the increased child tax credit. However, they are still eligible to receive their $4,000 credit, which comes from the original child tax credit of $2,000 for each child.

Example 3

Shelia and Greg have an AGI in 2021 of $425,000 and two children, ages three and nine. Their 2021 temporary tax credit increase is eaten up by their income in excess of the threshold, and their usual $4,000 tax credit will also be reduced by $1,250.

$425,000 – $400,000 = $25,000

$25,000 / $1,000 = 25

25 x 50 = $1,250

They will receive $2,750.

Age Limit Changes

Parents with a child, or multiple children, turning 17 during the 2021 calendar year are the biggest beneficiaries of this third change. Whereas children aged 16 and younger are usually the only kids eligible for the credit, the Act expands eligibility upwards by a year, including children who turn 17 during 2021. So, if a child is younger than 18 on December 31, 2021, they quality for the credit.

COVID-19 has brought trying times for everybody. However, it is encouraging that a potential solution has been reached in congress which can assist people in their time of need. The American Rescue Plan Act is complex and includes several additional rules regarding child tax credits such as clawback provisions, which we did not discuss here. If you would like more information or have questions about how these changes may affect your financial plan, let’s talk!