By Matthew Gaude & Shawn McGuire
With tax season officially here, many families are struggling to understand the changes to the 2021 Child Tax Credit and how it will impact their overall tax return. With everything else going on, the last thing you want is to be caught by surprise with a large tax bill, or not make the most of the credits available to you. We get it. We at Live Oak Wealth Management are here to answer your questions and provide the tools and resources you need to maximize your tax savings. In this guide, we’ll cover everything you need to know about the Child Tax Credit and how it could impact what you owe.
2021 Changes to the Child Tax Credit
The American Rescue Plan temporarily expanded the provisions of the Child Tax Credit for the 2021 tax year only. Here are some of the most important changes you should be aware of:
- More children can qualify: Children up to age 17 can qualify for the credit. Previously the credit only applied to children up to age 16.
- The credit was increased: The credit was increased to $3,000 per child over the age of 6 and $3,600 per child under age 6. This is up from the previous credit amount of $2,000 per child for all children.
- The credit is now fully refundable: This means that families who qualify for the credit can receive the entire amount as a refund even if they do not have any tax liability for the year.
- The $2,500 earnings floor was removed: You do not have to have any earned income in order to claim the credit.
- Advance payments were required: The IRS was required to send out monthly payments from July 2021 to December 2021. These payments reduce the amount of the credit that can apply to your tax return.
Keep in mind that the changes above do not apply to all taxpayers. There are some restrictions on eligibility including income limits, which will be discussed below. In addition, the child must meet requirements, including: (1) U.S. citizenship or residency, (2) a valid Social Security number, (3) must be claimed as a dependent on your 2021 tax return, (4) must be related to you, and (5) must live with you for at least 6 months of the year.
Who Qualifies for the Increased Credit?
The increased credit amount is not available for all families. Those with modified adjusted gross incomes (AGI) above $75,000 for a single taxpayer, $112,500 for head of household, and $150,000 for married filing jointly will have their credits reduced by $50 for every $1,000 above the threshold amount. This phaseout only applies to the temporarily increased credit amount.
For instance, a married couple earning $182,000 can still claim $2,000 for a child under the age of 6. The $3,600 enhanced credit is reduced by $1,600 ($50 x 32). Even if you earn $300,000 as a married couple, you will still be eligible for the $2,000 original credit amount. Note that there is a second phaseout limit that applies to the base credit amount.
Who Qualifies for the Base Credit?
The second phaseout limitation applies to families with modified AGIs above $400,000 for joint returns and $200,000 on head of household and single returns. For those earning above these thresholds, the original $2,000 credit will be reduced by $50 for every $1,000 above the limit. To understand your eligibility, you will have to apply a two-tier phaseout test.
Here’s how it works.
A married couple with a modified AGI of $425,000 and a child under age 6 will have their credit reduced twice.
- Because their modified AGI is above the $150,000 initial phaseout, the enhanced $3,600 is reduced to $2,000.
- Next, the remaining $2,000 credit will be reduced by $1,250 ($50 x 25) since their modified AGI is above the second phaseout threshold. So they are only eligible for a maximum credit of $750 per child.
A married couple with a modified AGI of $145,000 and a child under the age of 6 will qualify for the full enhanced credit of $3,600 since they are below both phaseout thresholds.
Understanding the Advance Payments
The IRS was required to send out six monthly payments from July 2021 to December 2021 to those families who qualified and didn’t opt out. Qualification was generally based on your 2020 tax return. In total, the six payments were meant to account for roughly half of your expected 2021 Child Tax Credit.
So, if your family was estimated to be eligible for the entire $3,600 credit for a child under the age of 6, then you should have received $300 per month for 6 months ($300 x 6 = $1,500). High-earning families also received advance payments, but they were reduced according to the phaseout limits discussed above. The total amount of each family’s advance payments varies depending on the number and age of your children, as well as your modified AGI.
Understanding how much you received in advance payments is crucial to filing your 2021 tax return.
This form will need to be included with your tax return. It details the amount of the advance payments you received and it should match the amount listed on IRS Letter 6419.
IRS Letter 6419
Just as you receive a W-2 or 1099 each year reporting how much you earned through your job, you will receive a document from the IRS detailing how much you received in advance Child Tax Credit payments. This document is called IRS Letter 6419 and it will be mailed to every family who qualified for payments and didn’t opt out.
This document is key to properly filing your 2021 tax return. The IRS warns that if the amount listed on Letter 6419 does not match the amount on Schedule 8812, your return could experience delays in processing. If you don’t receive your letter in the next couple weeks, you can use the online Child Tax Credit Update Portal to verify your payments. Alternatively, you could also call the IRS at 800-908-4184 if you have additional questions about your return.
Taxation of Advance Payments
The payments received were meant to be advance payments of the Child Tax Credit, meaning they are not taxable. This is easy to understand if you are below the modified AGI thresholds and your 2020 income was representative of your 2021 income. However, if you earned substantially more in 2021, or if you were at or near the thresholds in 2020, there could be differences between what you received in advance payments and what you were actually entitled to receive. In this case, you may have to pay any excess payments back to the IRS in the form of additional tax.
Reconciliation of Advance Payments With the Child Tax Credit
Reconciliation of the advance payments is necessary to calculate how much remaining credit you can apply to your 2021 return, or to determine if you were overpaid. Letter 6419 and Schedule 8812 will walk you through the process.
Most families should be able to claim excess credit on their 2021 tax return, meaning the amount of their advance payments did not exceed their eligible credit. If the amount of your payments did exceed your available credit, an AGI threshold will apply to determine if you have to pay back the excess.
Paying Back Overpayments
The American Rescue Plan included safe-harbor AGI thresholds for cases where lower-income and moderate-income families may have received overpayments.
- No repayment required: Taxpayers with modified AGIs at or below $40,000 for single returns, $50,000 for head of household, and $60,000 for joint returns will not have to repay any excess payments received.
- Full repayment required: Taxpayers with modified AGIs at or above $80,000 for single returns, $100,000 for head of household, and $120,000 for joint returns will have to repay the entire amount of excess payments received.
If your modified AGI falls between the thresholds listed above, and you received overpayments from the IRS, you will only have to repay a portion of the excess payments according to Part III of Schedule 8812.
Future Child Tax Credits
All the changes mentioned in this guide were temporary in nature and officially expired on December 31, 2021. Congressional Democrats have proposed including permanent Child Tax Credit changes in the Build Back Better Act, but it is unlikely that this bill will pass. For now, it is best to assume that in the 2022 tax year and beyond, the Child Tax Credit will revert back to its pre-2021 rules.
Learn More About Your Options
If you are confused or overwhelmed by all the changes to the 2021 Child Tax Credit, you are not alone. Our Live Oak Wealth Management team can walk you through the process, helping to reconcile your payments and make the most of your return. To learn more about your options, call our office at 770-552-5968 or email firstname.lastname@example.org. Or, if you prefer, you can simply click here to schedule an appointment online.
Matthew Gaude is an *investment advisor representative and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. Working first as a commodity broker and then as a Business Development Manager for a national broker-dealer in previous jobs, he has the insight and experience to help clients understand the complexities of the market and implement strategies to minimize risk. To learn more about Matthew, connect with him on LinkedIn or visit www.liveoakwm.com.
Shawn McGuire is a financial advisor and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. He has worked in financial services since 2002 in positions ranging from financial advisor to stock broker and portfolio manager. As a CERTIFIED FINANCIAL PLANNER™ professional, he is trained to help clients with virtually all their financial needs. To learn more about Shawn, connect with him on LinkedIn or visit www.liveoakwm.com.
Securities offered through American Portfolios Financial Services, Inc., member FINRA/SIPC. Investment advisory services offered through *American Portfolio Advisors, Inc., a SEC Registered Investment Advisor. Live Oak Wealth Management, LLC is independently owned and not affiliated with APFS or APA.
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