In March, the latest round of relief legislation—the American Rescue Plan—was passed by congress and signed into law by President Biden. Note, this is not to be confused with the American Jobs Plan or the American Families Plan—two additional pieces of legislation that have been proposed since the American Rescue Plan passed.
The big highlight of the American Rescue Plan was the third round of stimulus relief payments, which we wrote in detail about previously, addressing the financial planning considerations of that portion of the bill. In this post, our focus is the next most significant part of the package—tax credits for parents—what they are, how they’ve changed, who can claim them, and more.
Which Tax Credits Changed?
The tax credits involved here are specifically aimed at helping parents with dependent children: the Child Tax Credit and the Child and Dependent Care Credit.
It’s important to note that currently these changes are not permanent but are for tax year 2021 only. There’s a strong chance that one or both changes become permanent, but as of now, they are not.
The Child Tax Credit
What It Was
The Child Tax Credit provided a credit (reduction of taxes owed) of $2,000 for each eligible child—for the most part, kids under 17. The credit begins to phase out for single filers when they reach AGI of $200,000 and married filers at $400,000.
The amount increased. The credit is now $3,000 per child for kids 6 or older and $3,600 per child for kids under six. That extra amount (everything above $2,000 per child) begins phasing out for single filers at $75,000 of income and married filers at $150,000. The credit is reduced $50 for every $1,000 of AGI over the threshold. That phaseout only applies to the additional credit. The previous credit of $2,000 per child is still available to those who would have received it under the old rules.
17-year-olds became eligible. Parents whose kids are 17 years old are now eligible to receive the credit.
It’s now refundable. That means that even if the credit completely wipes out a tax liability and there is still credit more to claim, the taxpayer can receive that remaining amount back as a refund.
Part of it will be paid in advance. 50% of the estimated credit will be paid in advance, rather than claimed when you file your 2021 taxes next year. The payments will be made in equal installments from July 1st to December 1st of 2021.
Example 1. Teddy and Jane are married filers with AGI of $200,000. They have three dependent children, ages 17, 12 and 5.
Under the old rules, they would have been eligible for a Child Tax Credit totaling $4,000. This is made up of $2,000 each for their 12-year-old and 5-year-old, but nothing for their 17-year-old.
Under the new rules, the maximum credit they would have been eligible for is $9,600. This is made up of $3,600 (for the 5-year-old) and $3,000 each (for the 12-year-old and 17-year-old). However, because Teddy and Jan’s AGI of $200,000 exceeds the $150,000 threshold, their credit gets reduced. They are $50,000 over the threshold, which equals 50 increments of $1,000, so their credit gets reduced by $2,500 ($50 for each of those 50 increments), making the credit they’ll receive under the new rules $7,100.
Additionally, they will receive half of that $7,100 credit—so, $3,550—in equal payments of ~$591.67 per month from July 1st to December 1st.
The Child and Dependent Care Credit
What It Was
The Child and Dependent Care Credit provided a credit of 20% - 35% for all expenses up to $3,000 for one child and up to $6,000 for two or more children.
The amount of eligible expenses more than doubled. You can now apply the applicable percentage to all expenses up to $8,000 for one child and up to $16,000 for two or more children.
The applicable percentage increased. Previously, the maximum applicable percentage was 35%, but even that high end quickly phased down to 20% such that any households earning more than $45,000 (regardless of filing status) their applicable percentage was 20%. Now, the applicable percentage begins at 50% of expenses and doesn’t phase out until AGI reaches $125,000 (regardless of filing status).
It’s now refundable. Similar to the Child Tax Credit, taxpayers can claim the Dependent Care Credit even if it wipes out their total tax liability resulting in a refund.
High income-earners may be phased out of the credit entirely. Previously, even high-income taxpayers could claim the 20% applicable percentage on childcare expenses. Now, taxpayers (regardless of filing status) making over $400,000 will begin to get phased out and will be completely phased out at $440,000.
Example 2. Anna and TJ are married filers with AGI of $120,000. They have two children, ages 2 and 4 for which they pay childcare expenses throughout the year totaling $10,000.
Under the old rules, they would have been eligible for a Dependent Care Credit totaling $1,200. This is calculated by taking their applicable percentage of 20% multiplied by the total amount of eligible expenses, which were capped at $6,000.
Under the new rules, the maximum credit they’re eligible for is increased to $5,000. This is calculated by taking their higher applicable percentage of 50% multiplied by their total expenses of $10,000, which were no longer capped given the higher hurdle of $16,000.
These tax credits won’t benefit everyone. Just like the stimulus payments, they’re really targeting single taxpayers with income under $75,000 and married filers under $150,000, and little or no benefits for taxpayers above that range.
For those parents well over that range, there aren’t any actionable takeaways.
For those parents under that range, or in the phaseout range, it’s worth taking note. These credits reduce the costs associated with children. You can use the advance child tax care payments later this year to pay towards childcare costs. You can reduce withholding on your paycheck to increase your net take-home, knowing that these credits will lower your tax liability at the end of the year. If you’re in the phaseout range, you can look for ways to defer income to 2022 to maximize these temporary 2021 credits that you’re eligible for.
If you’re interested in discussing what actions you should consider taking, let us know! We’re happy to help.