Should you Opt Out of the Advanced Child Tax Credit?
Part of the American Rescue Plan Act (ARPA) that was passed in March allowed for an increased child tax credit for certain taxpayers and the choice to receive 50% of the child tax credit as a monthly payment starting in July 2021 and ending in December 2021. Since then, we have received the same question from many clients, Should I Take It?
How It Works
Since 2018, the Child Tax Credit was a $2000 tax credit per eligible child under 17 taken on your tax return at the end of the year. Of the $2,000, $600 was nonrefundable and $1,400 was refundable. However, to qualify for the $1,400 refundable portion, taxpayers had to have at least $2,500 of earned income.
ARPA increases the credit by $1,600 for eligible children 5 and younger, and by $1,000 for eligible children between 6 and 17. This means dependent children who are 17 in 2021 are now eligible for the credit. The below table shows the potential difference between claiming the maximum child tax credit in 2020 and 2021.
|Dependent Age||Max Credit in 2020||Max Credit in 2021|
In addition to increasing the maximum credit, ARPA made the credit fully refundable and removed the earned income requirement. This means a taxpayer with under $2,500 of earned income (i.e., W2 wages and self-employment income) would not be eligible for any child tax credit in 2020 but would be eligible for 100% of the child tax credit per eligible child in 2021.
The increased amounts only apply to eligible taxpayers under certain incomes. For taxpayers who make over the income threshold amount, the increased child tax credit will begin to phase out until it is reduced to the $2,000 per child amount allowed in prior years. The phaseout is $50 per every $1,000 of income over the phaseout threshold. Taxpayers will then be subject to another phase out range at certain income levels to determine if they are eligible for the $2,000 credit.
|Filing Status||Increased Child Tax Credit Phaseout Threshold|
|Married Filing Joint, Qualifying Widow(er)||$150,000|
|Head of Household||$112,500|
|Filing Status||$2,000 Child Tax Credit Phaseout Out Threshold|
|Married Filing Joint||$400,000|
|All Other Filing Statuses||$200,000|
When Will You Get the Advanced Payments?
ARPA directed the IRS to begin issuing the advanced payments monthly starting in July 2021. The IRS will use your 2020 tax return to determine eligibility and automatically send you payment via Direct Deposit or paper checks. If your 2020 tax return has not been filed, the IRS will use your 2019 tax return.
The IRS has released the following table on when to expect payments.
|Payment Month||Payment Date|
What If I am Not Eligible?
What were to happen if the IRS advanced you the Child Tax Credit, but you weren’t eligible for it? Generally, any excess Child Tax Credit must be repaid on your 2021 tax return. However, a safe harbor was implemented to protect low-income earners from having a potentially large tax bill. If a taxpayer’s income is under these amounts, they will be exempted from having to pay back up to $2,000 of the advance payments per child. The $2,000 safe harbor payback exemption is reduced until the taxpayer reaches twice the applicable threshold. At that point, taxpayers would be responsible for fully paying back any excess child tax credit they received.
|Filing Status||Phaseout Threshold||Full Phaseout|
|Married Filing Joint||$60,000||$120,000|
|Head of Household||$50,000||$100,000|
Example: Ex-Husband claims a dependent in even years and Ex-Wife claims the dependent in odd years. Since the increased Child Tax Credit is based on 2020 tax returns, the Ex-Husband would receive the advance payments (if eligible) and the Ex-Wife would not. When the taxpayers file their 2021 tax return, the Ex-Wife would be eligible to receive the maximum credit for the dependent. If the Ex-Husband’s income is below the phaseout threshold, he would not be responsible for paying back up to $2,000 of the advance payment. If the Ex-Husband’s income is above the Full Phaseout threshold, he would be responsible for paying back 100% of the advance payments.
What If I Do Not Want the Advance Payments?
The IRS has launched an Advance Child Tax Credit payments tool to allow taxpayers to submit information or unenroll from the payments. The default scenario is that eligible taxpayers will receive the payments. Any person choosing not to receive the advance payments must actively opt out of the program. Unenrolling from the program can be completed here.
If you share custody with an ex-spouse and that ex-spouse claimed the child in 2020, there is not a way for you to tell the IRS that you are eligible for the advance child tax credit. You will claim the full credit when you file your 2021 tax return.
How Does This Affect My 2021 Tax Return?
Since these payments are an advance of the Child Tax Credit you will claim on your 2021 tax return, they must be reconciled with the amount of credit you are eligible to take when your 2021 tax return is filed. If the IRS has sent you 50% of your eligible amount in 2021, you will claim the remaining 50% as a credit on your 2021 tax return filed in 2022. The amounts received in 2021 are not considered income and will not affect any benefits you are currently receiving.
If a married couple making less than $150,000 has two children ages 4 and 7, they would be eligible for a total child tax credit of $6,600. Of that amount, $3,300 would be advanced by the IRS during the last half of 2021 and the other $3,300 would be claimed as a credit on their 2021 tax return.
The IRS will send Letter 6419 in January 2022 advising you of the amounts you received. This letter should be kept and given to your tax preparer. It will be needed when completing your 2021 tax return.
What Do I Do Next?
We have received many questions from clients on whether to receive the advance payments or opt out of them. If the IRS has deemed you are eligible, you should have received Letter 6417 informing you of the amounts you are eligible for. In general, clients should assess their financial stability throughout the year to determine if the extra payments are needed. Clients who are dependent on the additional money each month should receive the payments so necessary living expenses can be met.
Clients whose financial situations are not dependent on the additional advance payments should strongly consider opting out of the program and receiving the full amount of eligible child tax credit when they file their 2021 tax return. Clients who alternate claiming a child with an ex-spouse and are not eligible to claim that child in 2021 should also strongly consider opting out of the program.
Why Would I Want to Opt Out?
Most of our clients with dependent children rely and plan on the child tax credit when estimating their tax burden at the end of the year. Employees will complete their W4 claiming the appropriate amount of children and self-employed business owners reduce their tax burden by the anticipated Child Tax Credit amount. By receiving these amounts as an advance, it will decrease the credits taxpayers are eligible for on their return and could potentially increase their tax liability to an amount larger than expected. For clients to keep their tax bill lower, or their refund high, opting out may be a good idea.
We have many clients who share custody of a child with their ex-spouse. Clients who are not eligible to claim their dependent in 2021, but were in 2020, could see a much larger bill than expected if they do not opt out of the payments.
The experts at Murtha & Murtha are constantly reviewing the tax revisions to be able to best advise our clients and prepare their returns accurately during tax season. If you have any questions on how the new child tax credit could affect you, please give our office a call.