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How Did the American Rescue Plan Affect your Child Tax Credits?

By: Aimee Reavling, CPA, Director & Andy Arnold, CPA, Senior Accountant

The American Rescue Plan Act of 2021 was passed by Congress in March 2021 to aid economic recovery from the COVID-19 pandemic. Amongst the most important provisions of the American Rescue Plan were the changes made to the Child and Dependent Care Tax Credit and the Child Tax Credit which impacts only the 2021 tax year.

Child and Dependent Care Tax Credit

Taxpayers are eligible to receive a credit for care and household services if they pay someone to care for one or more qualifying persons to allow the taxpayer to work or look for work.

Qualifying persons include:

  • dependents that are a qualifying child under the age of 13 when care is provided,
  • spouse if they aren’t mentally or physically able to care for himself or herself and lives with you for more than half the year, or
  • person who isn’t mentally or physically able to care for himself or herself, lives with you for more than half the year, and is either your dependent or would have been your dependent except they exceed the gross income limit or can be claimed as a dependent on someone else’s return.

To calculate this credit, the essential elements are the eligible expenses and the applicable percentage to multiply by those expenses. For most years, the maximum amount of work-related expenses that could be considered for the credit was $3,000 for one qualifying person and $6,000 for two or more qualifying persons. However, the American Rescue Plan increased these maximum amounts for 2021 to $8,000 for one qualifying person, and $16,000 for two or more qualifying persons.

The next element of the credit is the applicable percentage. This is the percentage of expenses eligible as a credit but is subject to phaseouts for taxpayers who have an adjusted gross income (AGI) above a specified limit. For most years, the maximum applicable percentage begins at 35% of expenses and phases out incrementally as the taxpayer’s adjusted gross income (AGI) exceeds $15,000. The applicable percentage is reduced to a floor percentage of 20% for all taxpayers with AGI in excess of $43,000.

The American Rescue Plan increased the applicable percentage for 2021 to 50%, which would result in a maximum child and dependent care credit for 2021 of $4,000 for one qualifying person and $8,000 for two or more qualifying persons. The new bill also increased the AGI phaseout to begin at $125,000. However, unlike the previous phaseout limits, the rules for 2021 do not provide for a floor on this reduction. Therefore, the applicable percentage would be phased out to 0% once AGI is more than $438,000.

Example: A taxpayer has AGI of $120,000 and pays $16,000 in dependent care expenses each year for 2 children under age 13. In 2020, the taxpayer is eligible for a child and dependent care credit of $1,200. In 2021, the taxpayer would be eligible for a credit of $8,000.

Finally, while the child and dependent care credit is generally nonrefundable, the American Rescue Plan has made the credit fully refundable in 2021 for eligible taxpayers. While all these changes to the credit have endeavored to provide relief to taxpayers, it remains very important for taxpayers to document their dependent care expenses throughout the year, to ensure they are able to claim the maximum child and dependent care credit.

Child Tax Credits

Before the American Rescue Plan was passed, the Child Tax Credit was a $2,000 tax credit per qualifying child, until the child reached age 16. To aid working families, the American Rescue Plan raised this credit to $3,000 per qualifying child ages six or older and $3,600 per child for those under six for the year 2021. The American Rescue Plan raised the maximum age from 16 to 17 years old for qualifying children.

The Child Tax Credit is also subject to income phaseout limits. The credit prior to the American Rescue Plan, decreased by 5% of the excess adjusted gross income over $200,000 for single filers and $400,000 for married filing jointly. The American Rescue Plan phases out the additional $1,000 of credit for children ages six or over and additional $1,600 for children under six by $50 for each $1,000 of adjusted gross income above $75,000 for single filers and $150,000 for married filing jointly. For taxpayers whose AGI is too high to receive the additional $1,000 or $1,600 of credit for 2021, they are still eligible to apply the 2020 rules and higher phaseout limits to determine their Child Tax Credit of up to $2,000 per qualifying child.

In addition to the increase in the credit amounts, the American Rescue Plan set forth that the credit is fully refundable for 2021 and that all eligible taxpayers would automatically receive half of their Child Tax Credit in the form of monthly payments from July through the end of 2021. All taxpayers that filed 2019 or 2020 tax returns, or applied for stimulus payments, are automatically enrolled to receive the monthly payments. The amount of the credit is determined based upon the taxpayer’s prior year tax return.

You can check your monthly payment status by using the IRS Child Tax Credit Update Portal found here: https://www.irs.gov/credits-deductions/child-tax-credit-update-portal

Opting out of the Child Tax Credit Payments

As mentioned above, the Child Tax Credit payments are distributed automatically to all eligible taxpayers. Some taxpayers may find they prefer to receive the entire credit when they file their 2021 return, rather than receive half of it before the end of the year through the monthly payments.

Example: The best example of this is where the amount of tax that you expect to owe for 2021 will be greater than your credit. In this instance, taxpayers do have the ability to opt out of receiving the payments going forward.

Although it is too late to opt out of the July or August payments, taxpayers can opt out of the September payment and the remainder of the 2021 payments by August 30, 2021, at the Tax Credit Update Portal linked above.

If a taxpayer receives more advance payments of the Child Tax Credit than they are eligible for in 2021, the excess will become an increase to their federal income tax liability for 2021.

If you have any questions regarding the Child and Dependent Care Credit, or the Child Tax Credit, please contact your local Blue & Co. advisor for assistance.

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