An expanded child tax credit for 2021 is about to become law. After some procedural wrangling, the Senate narrowly approved President Biden's stimulus package to help tackle the coronavirus pandemic and stimulate the economy. Because the Senate made some changes to the House-crafted bill, titled the American Rescue Plan Act of 2021 ("American Rescue Plan"), the House will have to revote on the revised bill before sending it to Biden's desk for his signature. We expect that will happen next week. One provision in the American Rescue Plan would, for one year, expand the child tax credit and make it fully refundable.
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Presently, the child tax credit is worth $2,000 per kid under the age of 17 whom you claim as a dependent and who has a Social Security number. To qualify, the child must be related to you and generally live with you for at least six months during the year. The credit begins to phase out if your adjusted gross income (AGI) is above $400,000 on a joint return, or over $200,000 on a single or head-of-household return. Up to $1,400 of the child credit is refundable for some lower-income individuals with children, but these people must also have earned income of at least $2,500 to get a refund.
The American Rescue Plan would temporarily expand the child tax credit for 2021. First, the plan would allow 17-year-old children to qualify. Second, it would increase the credit to $3,000 per child ($3,600 per child under age 6) for many families. Third, it would remove the $2,500 earnings floor. Fourth, it would make the credit fully refundable. And fifth, it would allow half of the credit to be paid in advance by having the IRS send periodic payments to families from July 2021 to December 2021.
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Phase-Out for Wealthier Parents
Not all families with children would get the higher child credit. The enhanced tax break would begin to phase out at AGIs of $75,000 on single returns, $112,500 on head-of-household returns and $150,000 on joint returns. Under the proposal, the IRS would look to the 2020 return to determine eligibility for the credit. If a 2020 return has not yet been filed, the IRS would look to 2019 returns. Families who aren't eligible for the higher child credit would claim the regular credit of $2,000 per child, less the amount of any monthly payments they got, provided their AGI is below the current thresholds of $400,000 on joint returns and $200,000 on other returns.
Periodic Payments in 2021
Regarding the advance payments, the plan calls for the IRS to send out a check (mainly in the form of direct deposits) periodically from July through December to families. These periodic payments would account for half of the family's 2021 child tax credit. For example, if monthly payments were made, this would result in payments of up to $250 per child ($300 per child under age 6) for six months and would be a nice windfall for many families. Take a family of five with three children ages 12, 7 and 5. Assuming the family qualifies for the higher child credit and doesn't opt out of the advance payments, they could get $800 per month from the IRS from July through December, for a total of $4,800. They would then claim the additional $4,800 in child tax credits when they file their 2021 return next year. (Use our 2021 Child Tax Credit Calculator to see how much you would get per month under the current plan.)
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Democratic lawmakers want the IRS to start making the payments to eligible Americans in July, giving the agency just a few months' lead time to set up its computer systems to handle such a massive, but temporary, new payment program. The American Rescue Plan also calls for the IRS to develop an online portal so that individuals could update their income, marital status and the number of qualifying children. People who want to opt out of the advance payments and instead take the full child credit on their 2021 return could do so through the portal.
Some Overpayments Would Not Have to Be Paid Back
With advanced payments of the child tax credit, there will sure to be instances in which families receive more in advanced child tax credit payments from the IRS than they are otherwise entitled to. And the American Rescue Plan contemplates this by providing a safe harbor for lower- and moderate-income taxpayers.
Families with 2021 adjusted gross income below $40,000 on a single return, $50,000 on a head-of-household return and $60,000 on a joint return would not have to repay any credit overpayments that they get. On the other hand, families with 2021 adjusted gross incomes of at least $80,000 on a single return, $100,000 on a head-of-household return and $120,000 on a joint return would need to repay the entire amount of any overpayment when they file their 2021 tax return next year. And families with 2021 adjusted gross incomes between these thresholds would need to repay a portion of the overpayment.
Is the IRS Up for the Challenge?
Many tax experts and some lawmakers question whether the IRS, with its out-of-date computer systems, shrunken work force and its myriad of other duties, would be fully able to deliver periodic child credit payments, especially if the expanded child tax credit and advance payments are eventually made permanent, which could very well happen. Some Senate and House Democrats are already talking about making this permanent, touting the potential impact that a fully refundable, expanded child tax credit would have on reducing child poverty.
Setting up a new program to deliver regular payments to taxpayers who must meet complex eligibility requirements to qualify for the child credit will be a challenge for an agency that is not used to sending out periodic payments. The IRS would need more funding for such a big undertaking. The House bill authorizes an additional $400 million for the IRS to take on the additional work, but some experts question whether this is enough. The IRS says that to facilitate advanced payments of the credit, it would have to build a system to compute and recompute payments as taxpayers provide new information. Such a system must also be able to issue and track payments, as well as to reconcile all payments sent out to each taxpayer during the year with the taxpayer's credit taken on the tax return. The agency would also need to develop a program that would flag returns that don't accurately include all advance payments received during the year.
Another issue that the IRS will have to deal with is how to minimize the potential for fraud when it comes to refundable child tax credits. For example, the IRS estimates that in 2019 it improperly paid $7.2 billion in such refundable credits.