What You Need to Know
In March 2021, Congress made changes to the Child Tax Credit. Following is a summary of the new provisions and some frequently asked questions.
What is the Child Tax Credit?
The Child Tax Credit is a tax benefit for families with children, based on the number of children in the family. In contrast to a tax deduction that lowers your taxable income, a tax credit is a dollar-for-dollar reduction of the amount of taxes you owe. For example, if you owe $5,000 in taxes and receive a $1,000 tax credit, you now owe $4,000. If you have multiple children, the Child Tax Credit can add up to significant tax savings.
What changes are happening?
Prior to 2017, the Child Tax Credit was $1,200 per child per year, subject to certain income thresholds. The Tax Cuts and Jobs Act of 2017 expanded the credit to $2,000 per child and increased the income threshold, which meant more taxpayers were eligible for the credit. In 2020, the credit remained $2,000 for children under age 17, with phase outs for single taxpayers with an adjusted gross income (AGI) greater than $200,000 ($400,000 for married couples filing jointly).
The American Rescue Plan expanded the 2021 Child Tax Credit to $3,600 for each child under age 6 and $3,000 for each child between the ages of 6 and 17. Increasing the maximum age from 16 to 17 means families with older children are eligible to receive the credit for an extra year. Although additional bills are currently making their way through Congress to make the tax credit a long-term benefit, the expanded tax credit is currently for 2021 only.
How are payments being made?
The biggest change with this year’s Child Tax Credit is how it is being paid out. Typically, the credit is available to taxpayers when they file their taxes in April following the tax year in which the credit is applied. This year, in an effort to get cash to taxpayers sooner, the IRS is sending monthly payments beginning this month (July) through December 2021.
The IRS will issue monthly payments that equal 50% of your estimated Child Tax Credit. For example, if the IRS estimates that you will be eligible for $2,000, you will receive $1,000 (50% of the total) in equal monthly installments each month from July to December. You will then receive the remaining $1,000 credit when you file your tax return.
Keep in mind that this is an advanced tax payment that will reconciled on your 2021 tax return. If you receive payments during the six-month period, and you are not eligible for the tax credit when you file your 2021 returns, you will need to repay any money received. Therefore, for some taxpayers, it may make sense to opt out of payments.
What do I need to do?
If you are eligible for payments, you will automatically receive them by direct deposit or check, based on your IRS payment method of record. The payments began on July 15, 2021, and will continue on the 15th of each month (or the preceding business day if the 15th falls on a weekend or holiday).
Although payments begin automatically, it’s wise to create an online account with the IRS for several reasons. The IRS Child Tax Credit portal allows you to:
- Opt out of payments if you don’t believe you will qualify based on your 2021 income. It’s important to note that this is a one-time election. Once you opt out (or elect to stop future payments if you’ve already received payments), you cannot opt back in.
- View any payments that have already been made to you. This can be helpful as you prepare to file your 2021 tax return.
- Update bank account information.
- Add additional children who were born in 2021.
When establishing an account on the IRS portal, there are quite a few security hoops to jump through. Be prepared with a driver’s license or passport and your phone because you will need to submit a photo of yourself with a photo ID in order to confirm your identity. In addition, if you are a married taxpayer filing jointly, your spouse will also need to create an account, following the same strict security process.
At Creative Planning, we have experience helping clients navigate a wide range of tax challenges and new regulations. If you have any questions about your eligibility for the Child Tax Credit, or for any other financial matters, please contact your wealth manager.