The American Rescue Plan Act (ARPA) of 2021 expands the federal Child Tax Credit (CTC) rules. These changes are temporary and only apply to the 2021 tax year. This new law is intended to help out parents; but there are some important implications you need to consider and which may require you to take action sooner rather than later.
What is the Child Tax Credit? Generally speaking, before the recent changes made by the ARPA, most taxpayers were able to claim a tax credit of $2,000 per qualifying child on their federal tax return each year. (The amount of the credit was reduced for taxpayers with higher incomes).
What changed? A lot! The ARPA expands the definition of qualifying child, increases the maximum amount of the credit, makes the credit fully refundable (for most), and directs the IRS to make advanced payments of the CTC to taxpayers. Here are some of the details
- Qualifying Children Can be 17 Years Old or Under. In order to qualify, the child must be eligible to be claimed as your dependent and be age 17 or under as of December 31, 2021. The prior rule excluded 17 year old dependents.
- The Maximum CTC Amount Has Increased (subject to income limitations). The amount of the credit is increased to $3,000 per qualifying child or $3,600 per qualifying child who is under 6 years old as of December 31, 2021. If you make too much to qualify for the new, larger credit, you may still qualify for the $2,000 credit under the "old" rules. As in the past, higher earning taxpayers will be subject to a phaseout and may not be entitled to the CTC at all.
- The CTC is Fully Refundable for Most Folks. You will get the full amount of the credit you're entitled to receive even if you have little to no taxable income in 2021. Residency restrictions and the above-mentioned income limitations apply.
- The IRS is sending the CTC Payments Out Early. The IRS is expected to start sending out monthly payments of 50% of eligible taxpayers' estimated CTC amount starting in July, 2021. This is where things get complicated. To determine if you qualify for an advanced CTC payment, the IRS will look at your 2020 tax return. If your 2020 tax return hasn't been filed or processed by the time they make this determination, they'll use your 2019 tax return.
So, what's the problem?
Since the IRS is using 2020 (or 2019) tax returns to determine eligibility for the CTC, if you alternate claiming your children as dependents with another parent, the wrong parent may end up getting the advance CTC payments. If this applies to you, we recommended that you begin communicating with the other parent about this as soon as possible.
In addition, those who receive this early tax credit payment will not see the normal Child Tax Credit on their 2021 federal tax return. The payments expected to go out starting in July are advanced payments of the credit these taxpayers would have otherwise had to wait until 2022 to receive, not extra payments. On top of that, if your income was lower in 2020 (or 2019) than in 2021 and it turns out that you don't actually qualify for as much of the CTC as the IRS estimated, then you'll have to pay it back on your 2021 tax return. This may result in a surprise balance due for some!
What now?
The IRS is creating an online portal to allow taxpayers to update changes to their number of qualifying children, marital status, income and other relevant information. Taxpayers may also use the portal to opt out of the advance payments. You might want to opt out if you would prefer to have the CTC applied in a lump sum as a credit on your 2021 federal tax return or if you want to avoid the risk of having to pay it back on your 2021 federal tax return if your 2021 income is too high.
We're still waiting to hear more from the IRS. Once the portal opens and more details become known, we'll be ready to assist our affected clients.
For more in-depth information, including income limitation amounts and other applicable restrictions, check out this notice on the IRS website.