Note to our readers: This is the second article of a three-part series on the new Child Tax Credit.
• Our first article detailed how the advanced monthly payments will work, which you can read here
• Today’s article will focus on how these changes will impact your 2021 tax return when you file next year
• Our final article will address how you can put the additional stimulus money to greater use (hint: 529 Educational Saving Plan or Roth IRA contributions)
The American Rescue Plan, passed by Congress back in March of this year, increased the Child Tax Credit for 2021 to $3,000 for children under the age of 18, and $3,600 for children under the age of 6. The bill also requires that half of the credit be paid out through monthly installments between July and December of this year.
Since the bill increased the amount of the credit, taxpayers may be expecting a larger refund next year. However, half of the credit will be paid out in monthly installments in 2021, and this will result in smaller refunds or greater balances due next April.
The extent of this impact will depend on how many children you have, their ages, and your Adjusted Gross Income (AGI).
Example 1: A married couple with three children under the age of 6 will see the amount of credit available on their tax return drop from $6,000 down to $5,400, resulting in a decrease of $600 on next year’s tax return.
Example 2: A married couple with 2 children ages 9 and 13 who have an AGI of $200,000 will see the credit available on their tax return drop from $4,000 down to $2,000. This is because their $200,000 AGI will phase them out of the additional credit and half of that credit will already have been paid out by the end of this year. This will result in a $2,000 reduction in their tax return or an additional $2,000 owed next April.
On average, our clients with children will see a decrease in their tax refund of $1,000 in 2021 due to the advanced payments. Those who will see the biggest impact on their refund are taxpayers with multiple children between the ages of 6 and 17 whose AGI is above the phaseout threshold for their filing status ($150,000 for married couples filing a joint return, $112,500 for head of household filers and $75,000 for single filers and married couples who file separate returns). To be clear, you are still receiving as much or more as you have in the past, you are simply receiving the payment ahead of your tax filing.
For a quick estimate on how the revised tax credit will impact your tax return you can see our 2021 Child Tax Credit Calculator.
If you prefer to not receive the advanced payments so that you can receive the full credit on your 2021 tax return, the IRS will be launching an online portal in the next few weeks where you can update your information and opt-out of the advanced payments. You may also want to opt-out of the advanced payments if you typically owe on your tax return or receive a small refund and want to avoid owing more on your 2021 return. The portal will also allow you to notify the IRS if you had a new child in 2021, if you will not be claiming a child in 2021 that you claimed in 2020 or if your bank account information has changed.
UPDATE: The IRS has now launched their online portal for you to manage your advanced payments. You can access the portal at https://www.irs.gov/credits-deductions/child-tax-credit-update-portal. At the moment the portal only allows you to check if you are eligible for advanced payments and opt out if you choose. They will be adding tools to update your information in the coming weeks. At the moment the portal may show you as ineligible even if you qualify for the advanced payments. We expect this to update as we get closer to the first payment date. If you choose to opt out of the advanced payments and file a joint tax return, each spouse will need to log in and opt out of their portion of the payments.
Quick note for divorced parents: The IRS will base your advanced payments off of your 2020 tax return (or 2019 if you haven’t filed 2020 yet). If you and your ex-spouse alternate claiming your children, you will want to access the portal when it goes live to update the IRS on which children you will be claiming on your 2021 tax return. Otherwise, you may end up receiving advanced payments for which you do not qualify and then be required to repay them on your 2021 return.
Summary
The expanded child tax credit for 2021 will provide some extra money for many parents this year. However, some parents may face an unpleasant surprise when they file their 2021 tax return if they don’t fully understand how the credit is being paid out. A comprehensive understanding how the credit is being distributed this year will help you proactively manage the advanced payments when you start receiving them next month as well as set proper expectations for your 2021 tax return.
2021 will be a year where good tax planning for middle class families will make a meaningful difference. The planning, however has to take place between now and year-end to fully optimize the additional tax credits. Feel free to reach out Monotelo Advisors to see how you can work within the current tax policy to optimize your finances by minimizing the government’s toll on your income.