With a price tag of nearly $2 trillion, the American Rescue Plan Act (ARPA) is one of the biggest economic stimulus measures in U.S. history. The legislation offers some significant tax benefits for parents in 2021, including temporary increases in the child tax credit (CTC) and the child and dependent care credit (CDCC) for eligible families. It also provides for monthly advance payments of a portion of the child tax credit starting in July and allows parents to claim the credit for 17-year-olds (previously the cut-off age was 16).
Child tax credit
Ordinarily, the CTC is $2,000 per dependent child under the age of 17 (as of the last day of the tax year). The CTC is partially refundable — if your credit exceeds your tax liability, the IRS will send you a check for the difference (up to $1,400), provided your earned income is at least $2,500.
The CTC begins to phase out when a parent’s modified adjusted gross income (MAGI) reaches $200,000 ($400,000 for joint filers). It’s reduced by $50 for each $1,000 (or fraction thereof) by which your MAGI exceeds the applicable threshold. So, for example, if you have one qualifying child, the $2,000 credit drops to zero when your MAGI tops $239,000 ($439,000 for joint filers). If you have two qualifying children — for a total credit of $4,000 — those thresholds increase to $279,000 and $479,000, respectively.
For 2021 only, the ARPA increases the CTC to $3,600 for each child under the age of six and $3,000 for each child age six through 17 as of the last day of the tax year (ordinarily, 17-year-olds are ineligible). It also makes the credit fully refundable (for most U.S. residents) and eliminates the $2,500 earned income requirement.
The ARPA establishes two sets of phase-out thresholds for 2021:
- The additional credit amount — $1,000 per qualifying child ($1,600 per qualifying child under age six) — begins to phase out when MAGI reaches $75,000 ($150,000 for joint filers). For example, if you have two qualifying children over age six, the additional credit would be completely phased out at MAGI of $115,000 ($190,000 for joint filers).
- The remaining $2,000 in credit begins to phase out at the pre-ARPA income levels outlined above (MAGI of $200,000; $400,000 for joint filers).
If you’re eligible for the CTC in 2021, the ARPA allows you to enjoy the benefits during the year, rather than waiting until you file your return in 2022. (See “Advance CTC payments start in July” at X.)
Child and dependent care credit
You’re eligible for the CDCC if you pay someone to care for your children (under age 13) or certain other dependents so you (or your spouse) can work or look for work. Ordinarily, the maximum nonrefundable credit is 35% of up to $3,000 in qualifying expenses ($6,000 for two or more qualifying dependents).
But that percentage is gradually reduced (to a minimum of 20%) if your adjusted gross income (AGI) exceeds $15,000. In other words, except for those with modest incomes, the maximum credit is $600 (20% x $3,000) for one qualifying dependent and $1,200 (20% x $6,000) for two or more qualifying dependents.
For 2021 only, the ARPA makes several modifications to the CDCC, including:
- Increasing the expense limits to $8,000 for one qualifying dependent and $16,000 for two or more.
- Increasing the maximum credit rate to 50% (from 35%) of those expenses.
- Increasing the AGI threshold at which the credit rate is reduced to $125,000 (from $15,000). The rate is reduced by 1% for each $2,000 (or fraction thereof) in excess of the threshold. Thus, the rate drops from 50% to 20% when AGI exceeds $183,000.
- Phasing out the 20% credit by 1% for each $2,000 (or fraction thereof) by which AGI exceeds $400,000, thereby reducing the credit to zero when AGI exceeds $438,000.
To summarize: If your AGI is $125,000 or less, your maximum CDCC is $4,000 for one qualifying dependent or $8,000 for two or more qualifying dependents. The maximum credits gradually drop to $1,600/$3,200 for AGI of $185,001 to $400,000, then gradually drop to zero when AGI exceeds $438,000.
Advance CTC payments start in July
Ordinarily, you claim the child tax credit (CTC) on your tax return and apply it toward reducing your tax liability or increasing your refund. But for 2021 only, families eligible for the CTC can start receiving its benefits during the year. The American Rescue Plan Act provides for six monthly advance credit payments from July through December 2021.
The monthly amount is calculated by taking your estimated credit amount (based on your 2019 or 2020 tax return) and dividing it by 12. So, unless you opt out of advance payments, you’ll receive roughly half of the credit amount during the second half of 2021 and claim the remaining credit on your 2021 return (subject to adjustment if your 2021 MAGI is different than the amount used to estimate the credit).
Why would you opt out of advance payments? Perhaps you’d prefer to take the full credit on your 2021 return to maximize your refund. Or perhaps you expect your 2021 income to affect your eligibility for the credit, and you wish to avoid having to repay some or all of the advances.
Remember, the enhanced CTC and CDCC are available only in 2021. However, it’s possible that Congress will extend these benefits to 2022 or beyond. Keep in touch with us for the latest information.