For the 2021 tax year only, the new American Rescue Plan Act (ARPA) makes big, taxpayer-friendly changes to the federal income tax child tax credit (CTC).
Here’s what you need to know, starting with some necessary background information.
For 2018-2020 and 2022-2025, the maximum annual CTC is $2,000 per qualifying child.
A qualifying child is an under-age-17 child who could be claimed as your dependent for the year. Basically, that means the child lived with you for more than half the year; did not provide more than half of his or her own support; and is a U.S. citizen, U.S. national, or U.S. resident.
The maximum $2,000 CTC is phased out (reduced) if your modified adjusted gross income (MAGI) for the year exceeds $200,000, or $400,000 for a married joint-filing couple. The credit is phased out by $50 per $1,000 (or fraction of $1,000) of MAGI in excess of the applicable phaseout threshold.
For 2018-2020 and 2022-2025, the CTC is partially refundable.
You can collect the refundable amount even if you have no federal income tax liability for the year. So, the refundable amount is free money.
The refundable amount generally equals 15 percent of your earned income above $2,500.
An alternative formula for determining the refundable amount applies if you have three or more qualifying children. In any case, the maximum refundable amount for 2018-2020 and 2022-2025 is limited to $1,400 per qualifying child.
(If you have a 2020 tax liability, the CTC can offset up to $2,000.)
More Generous CTC Rules for 2021
For your 2021 tax year only, ARPA makes the following taxpayer-friendly changes.
Qualifying Children Can Be Up to 17 Years Old
The definition of a qualifying child is broadened to include children who are age 17 or younger as of December 31, 2021.
Bigger Maximum CTC with Separate Phaseout Rule for the Increase
ARPA increased the maximum CTC to $3,000 per qualifying child, or $3,600 for a qualifying child who is age 5 or younger as of December 31, 2021. But the increased 2021 credit amounts are subject to two phaseout rules:
- The increased CTC amount—$1,000 or $1,600, whichever applies—is phased out for single taxpayers with MAGI above $75,000, for heads of household with MAGI above $112,500, and for married joint-filing couples with MAGI above $150,000. The increased amount is phased out by $50 per $1,000 (or fraction of $1,000) of MAGI in excess of the applicable phaseout threshold.
- The “regular” $2,000 CTC amount is subject to the “regular” phaseout rule explained earlier.
Key point. If you’re not eligible for the increased CTC amount for 2021 because your income is too high, you can still claim the regular CTC of up to $2,000, subject to the regular phaseout rule.
Example 1. You file as a head of household for 2021. You have one qualifying child, who will be age 12 as of December 31, 2021.
- You will have $140,000 of MAGI for 2021.
- Unfortunately, you don’t qualify for the increased CTC, because your income is too high. That’s because the increased CTC is phased out at the rate of $50 for each $1,000 of MAGI over the $112,500 phaseout threshold for a head-of-household filer.
- Proof: $140,000 – $112,500 = $27,500 of excess MAGI, which is rounded up to $28,000 of excess MAGI. The increased credit amount of up to $1,000 is reduced, but not below zero, by $1,400 ($50 x 28). So, the phaseout rule wipes out the increased credit for you. Sorry!
- But all is not lost. Because your MAGI is under the $200,000 phaseout threshold for the regular CTC, you can claim the maximum $2,000 regular CTC when you file your 2021 Form 1040, sometime in 2022.
Example 2. Same as Example 1, except this time your 2021 MAGI is $110,000. Because that’s below the $112,500 phaseout threshold for the increased CTC, you collect the full increased CTC of $1,000 for a 12-year-old qualifying child on top of the full regular CTC, for a total of $3,000.
- If your child is age 5 or younger as of December 31, 2021, you would collect the full increased CTC of $1,600 on top of the regular CTC, for a total of $3,600. That helps!
CTC Is Fully Refundable for Most Folks
For the 2021 tax year, the CTC is fully refundable if you (or, if married, you and your joint-filing spouse) have a principal residence in the U.S. for more than half the year. If you are a member of the U.S. Armed Forces who is stationed outside the U.S. while serving on extended active duty, you’re treated as having a principal residence in the U.S.
For 2021, the CTC is fully refundable even if you have no earned income for the year.
The MAGI phaseout rules explained earlier apply in calculating your allowable, fully refundable CTC for 2021.
Example 3. Your allowable 2021 CTC in the earlier examples is fully refundable if your principal residence is in the U.S. for more than half the year.
- If so, you can collect the full allowable CTC even if you have no 2021 federal income tax liability due to low MAGI and/or other federal income tax breaks for which you are eligible.
IRS Will Make Advance CTC Payments (We Hope)
Another ARPA provision directs the IRS to establish a program to make monthly advance payments of CTCs (generally via direct deposits).
Such advance payments will equal 50 percent of the IRS’s estimate of your allowable CTC for 2021. The advance payments will be made in the form of equal monthly installments from July through December 2021. To estimate your advance CTC payments, the IRS will look at the information shown on your 2020 Form 1040 (or on your 2019 return if you have not yet filed your 2020 return).
But if the IRS in its wisdom decides that it’s not feasible to make monthly advance CTC payments, the IRS can make advance payments based on a longer interval and adjust the payment amounts accordingly.
If you receive advance CTC payments in excess of your allowable CTC for the 2021 tax year, you’ll generally have to repay the excess in the form of an increase in the federal income tax liability shown on your 2021 Form 1040.
But under a safe-harbor rule, taxpayers with MAGI below $80,000, or $100,000 for heads of household, or $120,000 for married joint-filing couples may be allowed to keep some or all of the excess payments.
Example 4. This time let’s say that you are entitled to a CTC of $6,000 for 2021, based on two qualifying children.
- Under the advance CTC payment deal, the IRS would advance you a total of $3,000 (50 percent of your allowable CTC) via monthly payments of $500 each for July through December 2021. You would collect your remaining CTC of $3,000 after filing your 2021 Form 1040.
Key point. To facilitate the advance payment deal, the IRS is supposed to create an online portal that will allow taxpayers to change the number of their qualifying children, change their marital status, reflect significant changes in income, and update other factors as determined by the IRS.
(Assuming this task is not farmed out to the Small Business Administration, the portal might actually work. Fingers crossed!)
Child ID Requirements
As was the case before ARPA, you must include a qualifying child’s name and Social Security number (SSN) on your 2021 Form 1040 to claim a CTC for the child.
In addition, the SSN must have been issued before the due date for filing your 2021 return. If you can’t meet these ID requirements for a qualifying child, you can claim the smaller $500 credit explained below.
Smaller $500 Credit
For 2018-2025, you can claim a $500 nonrefundable credit for a dependent who does not meet the definition of a qualifying child.
For 2021, the most common situation when this smaller credit will be available is when you have a dependent child who will be age 18 or older as of December 31, 2021. But you can also claim the smaller credit for other qualifying relatives, as defined. The MAGI phaseout rule for this smaller credit is the same as the regular CTC phaseout rule explained at the beginning of this article.
For 2021, the temporary changes made by ARPA will make the CTC more widely available and worth more for many families.
Thanks to the 2021 advance CTC payment deal, you can start collecting some of the resulting cash in July, assuming the IRS can get its act together by then. Again, fingers crossed!
For 2021, ARPA also made the federal income tax child and dependent care credit more lucrative for many families, as explained in ARPA Adds Dollars to the Child and Dependent Care Tax Credit. You may be eligible for both credits, which could amount to a nice windfall.