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American Rescue Plan and Child Tax Credit Explained

If you have young children, you should have received some extra money from the federal government this year. If these payments were a nice surprise and you aren’t sure why you received this money, you are not alone. First, I will get you up to speed on why these payments started arriving and more importantly, what to watch out for to avoid having a nice surprise turn into a nasty shock at tax time. There have been a number of government initiatives designed to support the economy as a response to COVID-19. One of these initiatives is The American Rescue Plan, enacted in March of 2021, which included two temporary changes to the Child Tax Credit. The first change was to increase the amount of the Child Tax Credit for 2021 from $2,000 per child to $3,600 for children under age 6, and $3,000 for children between ages6 and 17. The second change allowed the federal government to send up to half of these tax credits directly to qualifying taxpayers during the year instead of applying them to your tax return at year end.

The Child Tax Credit, like all other tax credits, is typically applied to your income when you file your tax return. To qualify for the Child Tax Credit, certain conditions must apply:

    • Your child must be a U.S. citizen, national, or resident alien age 17 or younger in 2021.
    • You must be related to the child and claim him/her as a dependent on your tax return.
    • Your child must have a valid Social Security number and reside with you for more than one-half of the tax year 2021.
    • You must provide at least half of their financial support during 2021.

If these conditions are met, the amount of your Child Tax Credit depends on your income level:

    • If your modified adjust gross income exceeds $150,000 as a married couple or $75,000 as an individual, the amount new extended Child Tax Credit is reduced by $50 for every $1,000 (or fraction thereof) of income above the limit.
    • If your modified adjusted gross income exceeds $400,000 as a married couple or $200,000 as an individual, the amount of the original $2,000 Child Tax Credit is reduced by $50 for every $1,000 (or fraction thereof) of income above the limit.

For example: A married couple with one 10-year-oldchild and a combined income of $100,000 qualifies for a $3,000 Child Tax Credit for 2021 ($2,000 original credit + $1,000 extended credit). Half of this amount is $1,500. Starting in July 2021, this taxpayer would receive six monthly payments of $250.

If their combined modified adjusted gross income is instead $200,000, they no longer qualify for the $1,000 extended Child Tax Credit as their income exceeds the limit by $50,000. They do however still qualify for the original $2,000 Child Tax Credit.

To understand why these advance Child Tax Credit payments could create a nasty shock at tax time, it is helpful to understand how these credits worked before the American Rescue Plan and how taxes work in general. Most of us focus on how much of a refund we get or how big of a check we need to write at tax time. This amount is a function of the taxes we owe relative to how much we paid during the year. In previous years, any Child Tax Credit you received was considered a payment towards your tax bill at year end. Thus, it either reduced the amount of the check you had to write or increased the amount of the refund you received. By receiving a portion of the Child Tax Credit in advance this year, you will not be able to apply the credit towards your tax bill when you file. To see why this may be a problem, let’s revisit our example above:

A married couple with a 10-year-old child earning a combined $100,000 annually would normally have a $2,000 Child Tax Credit to apply towards their taxes. For this example, let’s say in the past this Child Tax credit has allowed them to get on average a $1,000 tax refund on their Federal Tax return, given how much they have deducted from their normal paychecks, and any other taxes owed or credits and deductions taken advantage of.

This year, their Child Tax Credit will be larger at$3,000 instead of $2,000. However, they already received $1,500 of this credit in advance ($250 a month from July to December). Therefore, when they file their tax returns, they will only have $1,500 remaining of the $3,000 Child Tax Credit to apply towards their taxes while they file their return. This is $500less than they have applied in the past, and therefore their refund would also be $500 less, all else remaining equal.

It is important to take a look at your personal situation and the potential tax implications.

Together, we can work to keep you on-track towards your financial goals. Request a consultation with me to learn more.

Read more articles by Matthew Jeannes