By Ryan Furtwangler, CFP®, Principal, Senior Financial Advisor and Richard P. Mishock, CPA, HBK Principal
The American Rescue Plan included meaningful changes to the Child Tax Credit. Specifically, the credit was increased from $2,000 to $3,000 per child over the age of six and $2,000 to $3,600 for children under the age of six. The age to qualify as a child was also raised, from 16 to 17. All working families will get the full credit if they make up to $150,000 for a couple or $112,500 for a family with a single parent.
As part of the effort to get funds into families’ hands as quickly as possible to help with their current expenses, the federal government started “pre-refunding” up to 50 percent of their qualifying amounts. The payments started in July 2021 and are being made through direct deposit or by check through the mail. To receive payment, the head of household has to have filed a 2019 or 2020 tax return and claimed the credit, or through the Economic Impact Payment with Non-Filers for people who do not normally file a tax return but qualify for the credit. There are other qualifiers, but these are the major factors.
It is estimated that 39 million families were to receive their first checks back in July. Still as odd as it might seem, you might be better off opting out.
Tax credit vs. tax deduction
While a tax deduction reduces the income your tax is calculated on, a tax credit is a dollar-for-dollar reduction in the actual tax you owe. As such, you would always prefer a dollar credit over a dollar deduction as the latter will save you only a fraction of the credit. Some credits, like the Child Tax Credit, are also refundable, meaning that even if you didn’t owe or pay any taxes, or if you have paid precisely the correct amount, the credit could create a refund.
While tax credits are generally welcome, the Child Tax Credit could be problematic for some taxpayers as they approach the April 2022 tax filing deadline. Many people rely on their annual refund from the IRS, say, for vacation money, money they require to meet certain needs, or money they bank as “extra savings” for future, unforeseen needs. If part of the refund they’re counting on is the refundable tax credit, they could be in for an unpleasant surprise as their refund could be less or even exhausted by the monthly Child Tax Credit payments.
For example, for a single parent with $50,000 in income and two children over six years old, the tax credit is $6,000, which they anticipate receiving as a refund. But $3,000 is being distributed monthly, leaving $3,000 to be refunded. Under the earlier version of the program, they would have received all $4,000 with their tax refund. While they are getting $2,000 more overall, the $1,000 less in refund could be an unwelcome surprise, particularly if the family was expecting and had needs to address with the full $4,000 refund.
On a more positive note for families, however, lawmakers did include a clause in the Plan declaring that taxpayers with an income of under $60,000 and filing jointly, and single filers with an income of less than $50,000, will not have to repay any excess credits they might receive.
Ramifications of an increased income
A change in income could also be problematic. For example, the adjusted gross income of a married couple with two children aged 4 and 10 is $140,000 for 2021. As such, they qualify for the full $6,600 credit and will receive $550 per month and a $3,330 credit on their 2021 taxes. But if a job change boosts their income to $200,000, they are only eligible for $4,000 in credit. If they are receiving that $550 per month based on their prior year’s return, they will only receive a $700 credit on their 2021 tax return. Not only might they be surprised by the smaller credit, but they also might not have withheld enough tax to accommodate the higher income, which might mean that instead of a refund they will owe more taxes.
Even when such unexpected changes are not substantially damaging, they can still impact families by increasing their tax liability or reducing the refund they had anticipated. In any case, the monthly payments will have an impact on tax liability at tax time. As such it’s important for taxpayers to understand how they will be affected by the Child Tax Credit, and to work with their CPAs to make informed choices. You can review your payments, and even turn off the payments, at IRS.gov.
It is important to be aware of how the modified Child Tax Credit program will affect you, and prepared with an action plan so you are not blindsided. Your refund might not be as much as you expected; you could owe money when you thought you were getting a refund, or you might owe more than you were planning. One option to consider: If you are receiving the payments and don’t need them to live on, consider saving them for your children in a 529, under the Uniform Transfer to Minors Act, or another account set aside for your children’s futures. The burden for much of our nation’s debt and deficits will likely fall on our future generations; having a few dollars tucked away for their benefit from the money that is creating some of that debt might be a wise idea.
About the author:
Ryan Furtwangler, CFP, is a principal and senior financial advisor in the Stuart, Florida, offices of HBKS. He enjoys working with the complexities relating to multi-generational wealth and estate planning, as well as income replacement strategies for people transitioning into retirement. Ryan can be reached at 772-287-4110, or by email at firstname.lastname@example.org.
Richard Mishock is a CPA and Principal in the HBK office in Stuart, Fla., and is licensed to practice in Florida and Pennsylvania. He has extensive experience in the areas of financial reporting, taxation, business consulting, and audit and assurance. He provides accounting, tax, and consulting services to individuals as well as a wide range of industries, including construction, real estate, manufacturing, wholesale distribution, professional firms, and nonprofit organizations. For more information contact Rich at (772) 287-4480 or by email at email@example.com.
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