The advanced payments of the enhanced child tax credit are being mailed out this week, so next week you may be standing in your kitchen wondering why you received a check and if you should be spending it.
For some parents, including most of the parents reading this blog, the answer is probably no, do not rush out to spend it. These prepayments are not like the previously issued stimulus checks. If you qualified for these prepayments because your 2020 income was lower due to COVID or changing job conditions and now your 2021 income has improved, the IRS will be adding these prepayments to your 2021 tax bill due in April 2022.
KEY TAKEAWAYS:
- The tax act this year increased the child tax credit and made 50% of it prepaid.
- The IRS is scheduled to start cutting monthly checks beginning in July.
- Complex phaseout rules will determine qualification for the credit and will eliminate most high earners.
- Unlike the stimulus payments, if the IRS sends you a check and your income increases in 2021 such that you no longer qualify, you will be required to pay the tax credit back with your return in April.
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Where did these payments come from?
The child tax credit was originally introduced as part of the Taxpayer Relief Act of 1997, which provided $400 credit for each child under the age of 17. It has gone through several revisions throughout the years, mostly increasing the annual credit amount to keep pace with inflation.
The American Rescue Plan passed earlier this year increased the amount again, but for the first time added a monthly prepaid component. For the 2021 tax year the Child Tax Credit was increased from $2,000 to $3,000 per qualifying child, with a further enhancement to $3,600 for children under the age of 6. The prepaid component is the most significant change though. For 2021, 50% of the credit will be paid in advance, with monthly payments of up to $250 per school-age child and up to $300 per child under age 6 from July through December 2021. The first payment is in mid-July, and subsequent payments follow this schedule:
- July 15
- August 13
- September 15
- October 15
- November 15
- December 15
The remaining 50%, if you qualify, will be a credit on your 2021 tax return when filed.
However, not everyone will get the credit. And some families will not quality for credit (or monthly payment) because the credit is reduced – and possibly eliminated – based on income. In fact, there are two “phase-out” rules in play – one for the extra $1,000 (or $1,600) amount and one for the remaining credit. The lower of these phaseouts starts for individuals earning more than $75,000 a year or $150,000 for those married filing jointly.
It is a tricky calculation, but if you want to try to estimate the payment you’ll receive, the IRS has built an online calculator to check your eligibility and estimate your credit amount.
What do I need to do to receive payments?
Most qualifying filers will not have to do anything to receive the Child Tax Credit payments. If you filed 2020 taxes, or filed taxes in 2019, or if you signed up for Economic Impact Payments using the IRS’s Non-Filer tool last year, the IRS will automatically send you monthly payments.
If you did not file or use the non-filer tool last year, you will need to use the Child Tax Credit Non-filer Sign-up Tool on the IRS website to register for your credit payments. If you do nothing and don’t receive any checks, but still qualify for the credits, you will receive the credits when your 2021 taxes are filed.
Is this just more “stimmies”? I love stimmies!
No, these payments are different in a pretty meaningful way. The previous stimulus payments were calculated using the prior year’s tax returns and checks were cut. If your income increased beyond the stimulus threshold due to a new job or working full time compared to part, the money was still yours to keep and did not need to be returned.
The prepayments of the Child Tax Credit are different. If you receive prepayments and your income increases in 2021, lowering the credit or disqualifying you from the credit completely, you will owe money to the government. When you file your current year taxes, 2021, this money due will be added to your tax bill.
Does anyone need to be concerned?
Anyone who’s income increased significantly, even temporarily, in 2021 needs to be concerned. This includes taxpayers who:
- Changed to a higher paying job.
- Were unemployed in 2020 but worked the entire year in 2021.
- Sold property or investments and realized large gains (looking at you meme stockholders).
An additional forgotten group is divorced parents or families whose custody has changed. The IRS will send the advance payments to the parent who claimed the child on their tax return in 2020. This will affect divorced parents who rotate years claiming the dependents. You will need to verify that the payment goes to the correct parent or the one without the dependents on the 2021 tax return could be facing a bill.
What should I do?
Start with your prior year tax return. If you owed money last year, if your income did not change, or if did you didn’t update your 2021 withholding or make additional payments to the IRS, there is a good chance you will owe money again in 2021. The best thing you can do is save any credit payments you receive to pay your bill in April because your tax bill will probably be larger than normal due to these payments.
Even better is to save the credit money and have a professional tax forecast done in the fourth quarter. This will ensure you are prepared for the April taxman and will give you a chance to make any potential tax savings moves.
Until next time, spend less than you make, invest the difference in low-cost index funds, be kind to your neighbors, and you will succeed in reaching your financial goals and in making the world around you a happier place.
If you feel you could use some assistance along the way, please feel free to reach out to us.