Dear Valued Client:
The American Rescue Plan Act (the Act), which President Biden signed into law on March 11, 2021, is loaded with tax benefits for taxpayers with children. For 2021, the Act increases the amount of the child tax credit, increases the refundable portion of the credit, increases the age at which a child qualifies for the credit, and provides a program for distributing the credit monthly. The Act also enhances the child and dependent care tax credit in 2021 by making it refundable, increasing the expenses eligible for the credit, increasing the maximum rate of the credit, and increasing the applicable percentage of expenses eligible for the credit. Finally, the Act increases the exclusion from income for employer-provided dependent care assistance. Here is a brief summary of these changes.
Child Tax Credit Changes
Maximum Child Tax Credit Amount: The amount of the child tax credit is increased from $2,000 in 2020 to $3,000 for 2021. However, if the child is under age 6, the credit is further increased to $3,600.
Increase in Refundable Portion of the Child Tax Credit: The refundable portion of the child tax credit is important because that means money in your pocket when the amount of the credit exceeds your tax liability. For years other than 2021, the refundable portion of the child tax credit is based on a calculation involving an earned income formula. The Act gets rid of the earned income formula and increases the refundable amount so that it equals the entire credit.
Increase in Age of Children Qualifying for the Child Tax Credit: While the child tax credit generally only applies to children under age 17, for 2021 only, it also applies to children who are age 17.
Phaseout of Child Tax Credit: The child tax credit is phased out for taxpayers with income above a certain amount. Generally, the threshold amounts for beginning a phaseout of the credit is $400,000 for married taxpayers filing jointly and $200,000 for all other taxpayers. For 2021, modified phase-out rules apply to the increase in the credit for 2021. The modified adjusted gross income threshold is reduced to $150,000 in the case of a joint return or surviving spouse, $112,500 in the case of a head of household, and $75,000 in any other case. This special phase-out reduction is limited to the lesser of the applicable credit increase amount (i.e., either $1,000 or $1,600) or 5 percent of the applicable phase-out threshold range.
Monthly Payments of Credit May Be Available: The Act provides a special program under which individuals with refundable child tax credits for 2021 can receive advance payments equal to one-twelfth of the annual advance amount, thus potentially receiving up to $300 per month for children under 6 and $250 per month for children 6 years and older. However, these payments would only be made from July 2021 through December 2021. In essence, if you qualify for this program, you can receive one-half of your total child tax credit in the last six months of 2021 and the other half of the credit after filing your 2021 tax return. In addition, the advance child tax credit payments are generally excepted from reduction or offset, including situations where you may owe federal taxes that would otherwise be subject to levy or collection.
Changes to Dependent Care Assistance Tax Benefits
Refundable Credit: Generally, you are allowed a nonrefundable child and dependent care tax credit (CDCTC) for up to 35 percent of the expenses you pay to someone to care for a child or dependent so that you can work or look for work. The Act makes the CDCTC refundable for 2021 as long as you live in the United States for more than one-half of the tax year.
Increased Dollar Limit on Creditable Expenses: The Act increases the amount of child and dependent care expenses that are eligible for the credit from $3,000 to $8,000 for one qualifying individual and from $6,000 to $16,000 for two or more qualifying individuals.
Increase in Maximum Credit Rate, Applicable Percentage, and Phase-out Thresholds: For 2020, the CDCTC is an amount equal to the applicable percentage of the employment-related expenses that you paid during the tax year, with the applicable percentage being 35 percent reduced (but not below 20 percent) by 1 percentage point for each $2,000 (or fraction thereof) by which your adjusted gross income for the tax year exceeds $15,000. For 2021, the maximum credit rate is increased from 35 to 50 percent and the phase-out thresholds are amended so they begin at $125,000 instead of $15,000. At $125,000, the credit percentage begins to phase out, and plateaus at 20 percent. This 20-percent credit rate phases out if your adjusted gross income is in excess of $400,000. If your income is in excess of $500,000, you are not eligible for the credit.
Increase in Exclusion for Employer-Provided Dependent Care Assistance: The Act increases the amount that may be excluded from income for employer-provided dependent care assistance. For years before 2021, the maximum exclusion was $5,000 ($2,500 in the case of a separate return filed by a married individual). For 2021, the exclusion is increased to $10,500 ($5,250 in the case of a separate return filed by a married individual).
Unenrolling from Advance Child Tax Credit Payments: There may be reasons why a taxpayer may prefer to opt out of receiving advance Child Tax Credit payments. Among them are if you expect the amount of tax you owe to be greater than your expected refund when you file your 2021 tax return. The payments you receive are an advance of the Child Tax Credit that you would normally get when you file your 2021 tax return. Because these credits are paid in advance, every dollar you receive will reduce the amount of Child Tax Credit you will claim on your 2021 tax return. This means that by accepting advance child tax credit payments, the amount of your refund may be reduced or the amount of tax you owe may increase.
Also, if you receive advance child tax credit payments in 2021, you should keep track of exactly how many payments were direct deposited into your account in calendar year 2021. Your 2021 tax return preparer will require that information to accurately prepare your 2021 tax return. For tax year 2020, some of our clients experienced refund delays, IRS tax Notices and/or corrected tax returns due to incorrect information concerning the amount of the recovery rebates that they received in April 2020 and January 2021.
Below are the deadlines to unenroll or make changes to bank information for the Advance payments. You must do this on the Child Tax Credit Update Portal: https://www.irs.gov/credits-deductions/child-tax-credit-update-portal
|Payment Month||Deadline to Update Information||Payment Date|
Finally, if you are married filing a joint return, you and your spouse must EACH unenroll. If only one of you unenrolls, you will get half of the joint payment you were supposed to receive with your spouse.
As you can see, the Act contains a number of changes, some of which may benefit you. Please call us at your earliest convenience so we may discuss how these changes impact you personally. Thank you very much for the opportunity to be of service to you!
Very truly yours,
Steve Mazur, CPA, CGMA, MBA
Mazur and Associates, CPAs and Business Advisors, PC