Later this month more than 39 million households are set to receive advance payments of the Child Tax Credit (CTC)The federal child tax credit (CTC) is a partially refundable credit that allows low- and moderate-income families to reduce their tax liability dollar-for-dollar by up to ,000 for each qualifying child. The credit phases out depending on the modified adjusted gross income amounts for single filers or joint filers. that was expanded in the March 2021 American Rescue Plan. Many households are uncertain about how the advance payments will affect their refunds or taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. es owed when they file next year, and some questions about specific taxpayer situations have yet to be answered by the Internal Revenue Service (IRS)The Internal Revenue Service (IRS) is part of the U.S. Department of the Treasury and is responsible for enforcing and administering federal tax laws, processing tax returns, performing audits, and offering assistance for American taxpayers. .
The American Rescue Plan temporarily expanded the Child Tax Credit for tax year 2021 from its current $2,000 maximum to $3,600 for children under age 6 and $3,000 for children age 6 to 17. For one year only, the credit no longer phases in with income but is instead fully refundable. Half of the expanded amount will be paid out in monthly installments to eligible households, meaning they do not have to wait until they file taxes to receive some of the Child Tax CreditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. benefits.
The extra amount of the credit—$1,600 for younger children, $1,000 for older children—phases out at $50 for every $1,000 in income earned over $112,500 for head of household filers and $150,000 for joint filers until the credit reaches what beneficiaries would receive under prior law. That means no one will see tax increases relative to prior law as the extra credit amount phases out.
While there are no tax increases, some households may experience surprises when they file their taxes next year. A dollar of Child Tax Credit received in advance is a dollar less received at filing time. While some households may prefer receiving their Child Tax Credit earlier, it is important they are fully aware of the trade-offs.
For example, consider a married filing jointly household with a 10-year-old child. Prior to the expansion, let’s assume they received a $2,000 Child Tax Credit at filing time, and had adjusted their paycheck withholdingWithholding is the income an employer takes out of an employee’s paycheck and remits to the federal, state, and/or local government. It is calculated based on the amount of income earned, the taxpayer’s filing status, the number of allowances claimed, and any additional amount of the employee requests. to receive the entire $2,000 as a refund. Under the expanded Child Tax Credit, they are now eligible for a $3,000 credit—$1,500 to be received in advance monthly payments of $250 starting this July.
Keeping everything else the same, if the household makes no adjustments to their withholding, when they file their taxes next year they may only receive $1,500 of Child Tax Credit at filing time. That is $500 less at tax time even though they received $1,000 more than the previous year when including the advanced payments.
The situation may be even more complicated for other households. For example, some filers with children have split custody arrangements, in which separated parents take turns claiming the Child Tax Credit from year to year. The IRS has not yet provided guidance for how such situations will be handled even as the opt out date for the first payment has passed, but it is likely that the advanced payment will be sent to the parent who claimed the credit on the most recent tax return—meaning one parent may receive the credit two years in a row.
And for taxpayers whose income or family situation has changed since they last filed taxes, they will not be able to provide updated information to the IRS until September, when a new tool will be available on the IRS website.
If the advance monthly payments a taxpayer receives exceed the amount of Child Tax Credit they are eligible for, they may need to repay the excess when they file their taxes next year. The American Rescue Plan did allow for a safe harbor “repayment protection” for certain taxpayers. Joint filers with under $60,000 in modified adjusted gross income (MAGI), head of household filers under $50,000, and single filers under $40,000 whose main home was in the U.S. for more than half the year would be protected from repaying $2,000 per “excess qualifying child.”
For example, suppose the IRS calculated advanced payments for a joint filer with $40,000 in income based on their previous tax return that correctly claimed three qualifying children, but when they file taxes next year, they will only claim two children. In that case, the filer would receive $2,000 in repayment protection for their one excess qualifying child. The repayment protection phases out for taxpayers with income above the specified thresholds.
For taxpayers who do not want to receive their payment in advance, the IRS has provided a portal that allows taxpayers to opt out—but the deadline to make that choice has already passed for the first payment. It is important to note that both spouses must opt out of receiving the advance payments. If only one joint filer opts out, that choice only applies to that filer’s share of the advance payment and not their spouse’s share.
Amidst the outstanding questions, potential confusion over how advanced payments will affect tax refundA tax refund is a reimbursement to taxpayers who have overpaid their taxes, often due to having employers withhold too much from paychecks. The U.S. Treasury estimates that nearly three-fourths of taxpayers are over-withheld, resulting in a tax refund for millions. Overpaying taxes can be viewed as an interest-free loan to the government. On the other hand, approximately one-fifth of taxpayers underwithhold; this can occur if a person works multiple jobs and does not appropriately adjust their W-4 to account for additional income, or if spousal income is not appropriately accounted for on W-4s. s, and an incomplete portal to update taxpayer information, the IRS will begin sending payments to millions of households this month. It is important that taxpayers fully understand the trade-offs of receiving their refundable Child Tax Credit in advance to avoid surprises next year. It will also be important for policymakers to closely monitor the administration of advance payments and evaluate the experience before deciding to extend, or make permanent, the policy.
Stay informed on the tax policies impacting you.
Subscribe to get insights from our trusted experts delivered straight to your inbox.Subscribe