Huge Changes to the Child Tax Credit: Should You Decline the Advanced Payments?

Published on Wednesday, June 23, 2021

In response to the U.S.’s continued struggles recovering from the Coronavirus Pandemic, President Biden passed the American Rescue Plan Act (ARPA) in January, which contained a major overhaul to the Child Tax Credit (Provision 9611), a credit which currently benefits nearly 39 million households across the country. Now, not only does the maximum credit per child increase, but taxpayers will no longer have to wait to file their taxes in order to reap the benefits of the credit. Thanks to the ARPA, the IRS plans on sending taxpayers monthly advances on their Child Tax Credit beginning this July. While the prospect of receiving a monthly check from the government simply for having children has been cause for excitement on morning news segments and around the office water cooler, it has also raised a number of questions. In order to provide a bit more clarity on the subject, let’s take a look at some of the frequently asked questions that we have fielded since word of the credit has spread, and how it may impact your 2021 tax return.

How much is the credit worth?

In 2020, the Child Tax Credit was a partially refundable credit worth up to $2,000 per qualifying child under the age of 17. Under the ARPA, the Child Tax Credit has increased to $3,600 for children ages 5 and under at the end of 2021, and $3,000 for children ages 6 to 17 at December 31, 2021. This amounts to additional credit amounts of $1,600 and $1,000, respectively (more on this later). It is noteworthy that not only has the credit increased, but has expanded to include 17-year-olds, and is also now fully refundable, which means that even without a tax liability, taxpayers will be refunded the full amount of the credit they qualify for.

Who qualifies for the credit?

Taxpayers must a have a “qualifying child” in order to qualify for the Child Tax Credit, which requires meeting the following standards:

Age test

A child must be 17 years old or younger at the end of the tax year for which the taxpayer claims the credit.

Relationship test

The child must be the taxpayer’s child, a stepchild, or a foster child placed with the taxpayer by a court or authorized agency. Taxpayers may also claim their brother, sister, stepbrother, or stepsister. Taxpayers may claim descendants of any of these qualifying people—such as nieces, nephews, and grandchildren—if they meet all the other tests.

Support test

The child cannot have provided more than half of his or her own financial support during the tax year.

Dependent test

The child must be claimed as a dependent on the taxpayer’s tax return.

Citizenship test

The child must be a U.S. citizen, a U.S. national or a U.S. resident alien.

Residence test

The child must have lived with the taxpayer for more than half of the tax year for which the credit is claimed. There are important exceptions, however:

• A child who was born (or died) during the tax year is considered to have lived with the taxpayer for the entire year.
• Temporary absences by the child for special circumstances, such as school, vacation, business, medical care, military services or detention in a juvenile facility, are counted as time the child lived with the taxpayer.

The credit also has two Adjusted Gross Income (AGI) based phase-outs to consider:

The first is for the additional credit amount (the $1,600/$1,000 amounts per child which are in addition to the original credit amount of $2,000). The additional amount begins to phase-out at $150,000 for married filing joint taxpayers, $112,500 for Head of Household, and $75,000 for all other filers (similar to the phase-out limits on the recent stimulus checks) at a rate of $50 for each additional $1,000 (or fraction thereof) of modified adjusted gross income above the threshold. As AGI increases, the additional credit amount eventually reduces to $0, leaving the original, prior year credit amount of $2,000 still available, yet subject to the second phase-out.

The $2,000 original credit amount is subject to the same AGI phase-out thresholds as 2020, which is $400,000 for married filing joint taxpayers, and $200,000 for all others. As AGI increases past these levels, the credit can eventually be phased-out altogether.

How do I receive the monthly advance payments, and how do I opt out?

In order to get cash into people’s hands as quickly as possible, the IRS is going to send monthly checks to taxpayers deemed to qualify on the 15th of every month, beginning in July and ending in December. The amount of these checks will be based on the IRS calculating the estimated Child Tax Credit taxpayers will qualify for in 2021, based on the number of qualifying children and AGI from the taxpayer’s most recent return on file (either 2019 or 2020). This estimated Child Tax Credit will be divided in half. The first half will then be sent to taxpayers in six, even monthly payments beginning in July and continuing through December, while the second half will be claimed by the taxpayer on their 2021 return, which will be filed in 2022. Taxpayers should receive their advance checks through the same method they received their stimulus checks, so it’s vital that the IRS has either their updated address information for physical checks, or that taxpayers keep their bank accounts active if they received their stimulus checks through direct deposit.

This obviously raises a number of issues, as the IRS is using information from as far back as 2019 to estimate a tax scenario in 2021. In that time period, taxpayers may have had another child, which would increase their credit, or potentially may have experienced a significant change in their AGI, which could swing their applicable credit in either direction. In order to mitigate this issue, the IRS has promised there will be two online portals available for taxpayers by July 1st. One will allow taxpayers to update their AGI and number of qualifying children in order for the IRS to calculate a more accurate estimate, while the other portal will be for taxpayers to completely opt out of the advance payments altogether, and simply take 100% of their credit when they file their 2021 tax return.

At this point, some may be wondering why anyone would opt out of the advanced payments. The answer is that if the IRS overestimates how much a taxpayer should receive in advanced payments, when the taxpayer files their 2021 taxes they will be required to pay back the excess amount they received. This differs from the approach taken by the IRS on stimulus payments received, whereby a taxpayer was NOT required to repay a payment received that they wouldn’t have otherwise qualified for. This being the case, we highly recommend that when the online portals are ready in July, that our clients either opt out of the advanced payments, or at the very least ensure that the IRS is working with reasonable assumptions for their AGI and number of qualifying children in order to receive the best estimate possible.

Please note that as of today, this expansion of the Child Tax Credit is only for tax year 2021. However, President Biden has stated he aims to extend these changes through the end of 2025, so this may become another wrinkle added to many of our client’s annual tax planning considerations for years to come.

If you have any further questions on this matter, please don’t hesitate to reach out to any of our tax professionals.

Aaron Lavarias, CPA, Tax Manager