In this episode of The Standard Deduction (they’re certain their kids will just love it), Tax Directors Candace Varner and Ben Hake explain and discuss the nuances of the Child Tax Credit which was expanded in 2021. They tell you what you need to know about eligibility, opting out and navigating the account creation process on the IRS website.
The Standard Deduction podcast is hosted by Tax Directors Candace Varner and Ben Hake. This podcast is a thoughtful, informed discussion about ideas, trends and developments in taxes related to personal wealth management.
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Candace Varner: Hello and welcome to The Standard Deduction. I’m Candace Varner.
Ben Hake: And I am Ben Hake. As some of our longtime listeners may be aware, our children are some of our biggest fans and today’s podcast is, in many ways, dedicated to them as we are talking about the Child Tax Credit.
Candace: An exciting topic. I’m sure my kids will love this episode. The Child Tax Credit has actually existed for quite a while. Before 2017, it was $1,200 per child and there were lower thresholds. Then, as part of the Tax Cuts and Jobs Act in 2017 expanded it to $2,000 per child and increased the income threshold, making a lot more taxpayers eligible for it. Then in 2020, the credit was $2,000 still and it was per child under age 17. It phases out when your AGI is over $200,000 if you’re single or $400,000 if you’re married filing jointly. That was for 2020 returns, if anyone is still filing those or years before that.
Before we go any further, I want to clarify for everyone what a credit is versus a deduction. This is a common mix-up, I would say. A credit is dollar for dollar, reducing your tax. If before this credit, you owed $5,000 and you got a $1,000 child tax credit, now you owe $4,000. As opposed to a deduction which would lower the taxable income, which is then multiplied by your tax rate, so this is actual dollars that we’re talking about. It can add up to quite a bit, depending on your income and the number of kids you have. Ben, what’s changed for this going into 2021?
Ben: In March of this year, Congress and the President had passed the American Rescue Plan Act and that really did a bunch of things, but one of the big things that most people are going to see that’s going to really hit their pocketbook is going to be that the Child Tax Credit was expanded. Like you said earlier, it was $2,000 per child. For 2021, it is 3,000 per child if they are under 17; but, if they’re under five, it’s bumped up even slightly more to $3,600. One point of note here is that it is for 2021 only. There are some bills in front of Congress to possibly make this longer term and go into future tax years, but for now, we’re just looking at this year. Then another one is that historically, when a child had turned 17, they were no longer eligible for the credits. They did change that to make it so it’s 17 and under, so we basically got one more year where people will qualify.
Those enhanced credits, so the $3,000 and the $3,600, those have phase outs just like the normal tax credit and they’re quite a bit lower. It’s $75,000 for a single taxpayer or $150,000 for a married taxpayer. As their income goes up, so every $1,000 it goes up, the credit you receive goes down by $50. One point is that if you’re a taxpayer who’s, let’s say really close to that, so maybe you’re $155,000 of AGI, you can have some really almost outsized results by getting your income down by just $5,000 because it’ll qualify you to get a lot larger child tax credits, things of that nature. For those that next year are looking at their return and they’re in that cusp or in that range, they may consider HSA contributions, IRA contributions, things of that nature to possibly get them closer or under $150,000 to qualify for the larger credit. Candace, I know we talked about it increasing, but there’s an even bigger change, especially relative to what’s ever historically happened with this.
Candace: Correct. The big thing that people are talking about, for this credit, is that some of it’s going to be prepaid. Most people aren’t thinking about their tax credits in June or July, but they are this year. For 2021 credits, the IRS is trying to get cash to the taxpayers faster. Normally, with a tax credit, like we talked about, it would reduce your taxes due, but you don’t get that until you file your return the following April. They’re trying to get cash in people’s hands sooner than that, so the IRS is going to send out monthly payments starting in July. The payments will be July through December of 2021. A lot of the taxpayers, if they think you might be eligible, you would have recently gotten a letter from the IRS with instructions on just general information about it, but essentially this credit is going to be… They’re going to estimate what they think your child tax credits going to be for 2021. They’re going to take half of that and then they’re going to pay it monthly, July through December. If your credit was going to be $2,000, they’re going to give you $1,000 upfront in monthly installments and you get the other 50% when you file your tax return. So if you get the prepayments during this six month period, but then you go to file your 2021 tax return and it turns out you were not eligible, you will have to repay those amounts.
This is an advance of a credit that is going to be reconciled on your 2021 tax return. This is different than the stimulus payments, which were received in three different rounds over the last 15 to 18 months. Those amounts, if you got more than you were eligible for when you went to file your tax return, you did not need to repay those amounts, so this is distinctly different. This is purely an advance on a credit that will be reconciled, and if you receive too much, you will have to pay it back, so some people might want to opt out. Ben, how would I opt out if I don’t want to get these prepayments?
Ben: Well, the IRS is slowly working its way into the 21st century, so instead of having to call or do something in writing, you will be able to use a website to do it. There is an IRS portal, which we’ll put in the podcast description, but basically it’s going to be a multi-use purpose. A lot of the times, people are going to it now because they’d like to opt out. To be able to do that, the first step is for security purposes, obviously this can make a big decision in terms of how much you’re receiving. There are quite a bit of security steps involved in getting the account set up. If you’re going to do so, one note is that you’ll need a driver’s license or a passport to be able to open the account and, at some point, you’re going to need your phone, too, because you’re going to hold up your driver’s license next to your head to confirm your identity.
Once you’ve got all that in there, you’re going to be able to go on their website. There’s going to be a few different options. The first is going to be that you’ll be able to opt out if you’d like to. This isn’t an all or nothing thing. This first payment’s supposed to go out on July 15th and then it’ll be on the 15th of the month going forward. If you, after receiving the first one are like, “Hey, my income’s dramatically higher and I don’t think I’m going to qualify for this credit,” or, “I’ve set up estimated payments assuming this credit is going to be on the return and that’s going to skew those in some way,” you can stop and it basically will stop all the ones going forward. The other consideration on the opt out is that it is a one-time election. If you elect out of it, you won’t be able to elect back in to get those advanced payments.
We still have quite a few taxpayers who are like, “Hey, I want the funds now. I don’t want to necessarily wait until the end of the year.” You still may want to create an account for that because there’s going to be a few benefits to that. The first is, as a bunch of taxpayers who receive their stimulus payments, because this is going to be shown on the ’21 return and we’re going to have to reconcile it, at some point, you’re going to need to know how many payments you received. One option is you can go and add it all up from all your bank statements for the last half of the year. The other option is, through this account, they’ll show you the dollar amount deposited and the date for all six payments.
The other is going to be that say you filed your return, but that you’ve changed your bank and you don’t want it to direct deposit in the same account you used on your ’19 or ’20 return, you can go in there and change the banking information as well as add additional children if you’ve had one in 2021 that clearly wouldn’t have been reported on the 2020 return. The only oddity about this whole process is that for a married taxpayer, both spouses need to create an account. In this case, my wife will be unfortunately having to do something with the IRS she relies on me to do, so that’ll be a new experience for everyone involved, but–
Candace: I don’t think she’s going to do it, Ben.
Ben: Yeah, well, and both people will need to separately do the identity check, so she’ll need her driver’s license and a photo to be able to do that process, too. Candace, now that they’ve got the funds, they know how to track it, it should be an exciting time for all taxpayers going forward.
Candace: Exciting time might be a stretch. No one ever thinks taxes are fun, but if you have any questions on it, as always, talk to your tax advisor and make sure you’re paying attention to what’s happening over the next six months with your payments so that you don’t get any surprises when you file your tax return in the spring. Thank you very much.
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