Understanding the Advance Child Tax Credit: Should You Say No to Free Money?

The child tax credit doubled in value back in 2018 with the Tax Cuts and Jobs Act, and now in 2021, your kids might be making your taxes look even sweeter.  As part of the March 2021 economic stimulus package, Congress increased the amount of the child tax credit for 2021 only— from $2,000 per child to $3,600 for children under age 6 and $3,000 for children ages 6 to 17.  To enable parents to benefit from this child tax credit even sooner, Congress included a provision in the stimulus package to make “advance child tax credit payments” on a monthly basis from July to December 2021.  Parents can then claim the remainder of the credit when they file their 2021 tax returns next year.

So Congress wants to give parents more money and put the money in their pockets sooner?  What can go wrong?  In short, many recipients of the advance child tax credit payments may end up owing money when they file their 2021 taxes— because they received a higher estimated credit than they qualify for and/or because a portion of the child tax credit that they expected to receive on their 2021 tax return was already paid out as part of the advance payments.  

Receiving Benefits Earlier Than Expected.  Many taxpayers use their prior year taxes to gauge whether they are withholding enough (or making high enough estimated tax payments) to cover their tax liability for the current year.  For 2021, if parents receive monthly child tax credit payments, a portion of the credit that they have received on their tax return the past few years will be paid out in advance.  Through the monthly payments, the IRS is planning to dole out by December half of the total credit for 2021.  For parents who qualify for the additional tax credit, half of the total credit is $1,800 for children under age 6 and $1,500 for children ages 6 to 17.  For those who only qualify for the original $2,000 credit, parents will receive $1,000 in monthly payments and $1,000 on their tax return.  In each of these cases, parents receive less benefit from the child tax credit on their tax returns as compared with the prior year’s return, which may lead to a tax liability when they file their returns.

Consider, for example, Joe and Jane Doe, who have two feisty toddlers and had AGI of $250,000 in 2020.  Based on their 2020 income, the IRS has begun sending them monthly payments of $333 per month.  By December, they will have received $2,000 of advance payments, and they will receive the other $2,000 on their tax return.  Joe and Jane have exactly $250,000 of income again in 2021.  Unfortunately, they have calculated their federal tax withholdings from their paychecks assuming $4,000 of child tax credit, so they owe the IRS $2,000 when they file their return.  

Higher Estimated Child Tax Credit Payments.  The estimated monthly payments are also based on parents’ most recent tax return on file— either 2020 or 2019 (if one filed for extension).  This is significant because the credit phases out at certain income levels.  The regular portion of the child tax credit ($2,000) begins to phase out when your adjusted gross income (AGI) reaches $200,000 for single filers or $400,000 for married filing jointly.  The additional child tax credit amount for 2021 begins to phase out much sooner— when income reaches $75,000 for single filers or $150,000 for married filing jointly.  (Once you hit either of these limits, the total amount of your child tax credit is reduced by $50 for each $1,000 that your income is above the limit.)  If your income is higher in 2021 than in the year used to calculate the estimated monthly payments (and your income falls in the phase out range for the credit), you may be receiving a higher child tax credit amount than you should. 

Let’s return to the example of Joe and Jane Doe.  Imagine that Jane had stayed home to take care of the kids for a few years and then returned to the workforce in 2021.  As a result, their adjusted gross income was $145,000 in 2020, but it will jump to $250,000 in 2021.  Based on their 2020 income, the IRS has begun sending them monthly payments of $600 per month ($300 for each child under age 6).  By December, they will have received $3,600 of advance payments.  However, given the increase in their income in 2021, they only qualify for the basic child tax credit (of $2,000 per child).  Since they already received $3,600 in advance child tax credit payments, they will only receive a $400 child tax credit on their tax return.  Again, they calculated the withholdings from their paychecks assuming $4,000 of child tax credit, so they now owe the IRS $3,600 when they file their return.

Repayments to the IRS.  You may have heard that if the IRS made errors when distributing the stimulus payments last year, recipients who were accidentally overpaid generally did not have to pay the money back.  (If so, you are correct.)  However, that is not the case with the advance child tax credit.  The IRS knows that your income (and possibly the number of qualifying children or your filing status) may change from 2020 to 2021, but it is planning to square up when you file your tax return.  If you received more than you should have in advance payments, in most cases, it will just reduce the amount of the child tax credit you can claim— and therefore will affect your tax liability— on your 2021 tax return.  In some cases, the change in income or other circumstances will be so significant that the taxpayer may owe some of the monthly payments back to the IRS.  If one’s 2021 income is above $80,000 for single filers or $120,000 for married filing jointly, the taxpayer will have to repay the IRS in full.  If one’s income is less than $40,000 for single filers or $60,000 for married filing jointly, the taxpayer will not have to repay the IRS at all.  In between those levels, the taxpayer will have to repay a portion of the payments back to the IRS.

Whether and How to Take Action.  If you like the idea of getting money in your pocket now—even if that means possibly owing money when you file your tax return—then there is no need to take action.  If, however, you want to avoid any unpleasant surprises next April and/or you know that changes in your income or filing status may negatively impact the amount of your child tax credit for 2021, you can unenroll from the monthly advance payments on the IRS website.  Please note that it will take about 15 minutes to unenroll.  You will need to upload photos of the front and back of your driver’s license and take a picture of yourself for biometric identification.  Note also that if your filing status is married filing jointly and only one spouse unenrolls, the other spouse will continue to receive half of the monthly payment.  The deadline to unenroll prior to the August payment distribution is today, August 2^nd. 

If you have questions about what to do considering your particular financial situation and would like to discuss further, please feel free to call or email us any time.