Tax 101: The Expanded 2021 Child Tax Credit

I’m Stephanie Morris, CPA. Today, I’ll be walking you through the expanded 2021 Child Tax Credit so you can help your clients understand the new credit, and how the tax credit is calculated. Let’s get started!

Have your clients noticed deposits into their checking accounts that they were not expecting? It could be advance payments from the expanded 2021 Child Tax Credit. The American Rescue Plan Act (ARPA) of 2021 increases the amount of the tax credit, changes phaseout thresholds, makes the credit fully refundable and allows for advance payments to certain taxpayers. All of these changes make understanding how much will be received a bit complicated. Let’s look at some more details of the enhanced Child Tax Credit.

How much is the tax credit? For tax year 2021, the Code section 24 Child Tax Credit (before considering any phaseout) is the $2,000 credit plus an additional:

• $1,600 per child ages 5 and below (Total tax credit = $3,600)
• $1,000 per child ages 6-17 (Total tax credit = $3,000)

The age of the child is determined at the end of 2021.

How do phaseouts work? The Child Tax Credit phases out in two steps based on modified adjusted gross income (AGI) in 2021. 

Phaseout 1

Phaseout one applies to the additional $1,600 (for children ages 5 and under) or $1,000 (for children ages 6 -17) amount of the credit. This first phaseout reduces the Child Tax Credit by $50 for each $1,000 by which modified AGI exceeds $150,000 (married filing jointly), $112,500 (head of household), or $75,000 (single).  The additional credit amounts are fully phased out, resulting in a maximum credit of $2,000, when modified AGI is in excess of:

• $1,600:  $182,000 (MFJ), $144,500 (head of household), or $107,000 (single)
• $1,000:  $170,000 (married filing jointly), $132,500 (head of household), or $95,000 (single)

For example, let’s say a couple with a twelve-year-old child files a joint return with modified AGI of $162,000. Because their modified AGI is $12,000 over the $150,000 phaseout threshold, the additional tax credit is reduced by $600, resulting in a 2021 Child Tax Credit of $2,400:

Taxpayer 1 Example

Married Filing Jointly with $162,000 modified AGI with one 12-year-old child

$162,000 - $150,000= $12,000/$1,000= $12 x $50 = $600 phaseout

$1,000 additional credit - $600 phase out = $400 additional credit

Child Tax Credit = $2,000 base + 400 additional credit = $2,400

Phaseout 2

Phaseout two reduces the 2021 Child Tax Credit below $2,000 per child if modified AGI exceeds $400,000 (married filing jointly) or $200,000 (all other filing statuses). The calculation for the reduction is the same as phaseout one. The $2,000 credit is fully phased out, resulting in $0 credit, when modified AGI is $440,000 (married filing jointly) or $240,000 (all other filing statuses).

For example, a couple with a four-year-old child files a joint return with modified AGI of $411,000. Because the modified AGI is $11,000 over the $400,000 phaseout threshold, the credit is reduced by $550 (11 x $50) resulting in a 2021 credit of $1,450 ($2,000 - $550).

Taxpayer 2 Example

Married Filing Jointly with $411,000 modified AGI with one 4-year-old child:

$411,000 - $400,000 = $11,000/$1,000 = $11 x $50 = $550 phaseout

Child Tax Credit = $2,000 base - $550 phaseout = $1,450

How do the advance payments of the Child Tax Credit work? One of the unique features of the expanded 2021 Child Tax Credit under the American Rescue Plan is that half of the tax credit is to be paid to taxpayers in advance. Six payment dates are set for 2021: July 15, August 13, September 15, October 15, November 15, and December 15.

Calculation of the advance payments for the Child Tax Credit is based on a taxpayer’s most recently filed 2019 or 2020 tax return. Basically, the IRS looks at these returns and calculates the Child Tax Credit using the 2021 credit amount and thresholds. Then, using the direct deposit bank information provided with the tax returns, the IRS pays half of the credit in six installments.

If a taxpayer was not required to file (and did not file) a tax return for 2020, the IRS has created a tool through which taxpayers may file a simplified tax return, through the Child Tax Credit Non-filer Sign-up Tool. This simplified tax return will allow eligible individuals to register for advance Child Tax Credit payments and the third Economic Impact Payment, as well as claim the 2020 Recovery Rebate Credit.

What if my client’s financial picture is different from 2020?  Remember that the advance payments of the Child Tax Credit are prepayments of a taxpayer’s actual 2021 Child Tax Credit. The advance payments are calculated based on 2019 or 2020 income tax information. Your client’s financial or family situation may change in 2021, which would affect their Child Tax Credit amount.

For instance, your client may receive advance payments exceeding their actual eligible credit. If so, they may have to pay back the excess received depending on their modified AGI, with the following guidelines:

• Taxpayers with modified AGI below $60,000 (married filing jointly), $50,000 (head of household), or $40,000 (single) will not be required to pay back the excess payments.
• Taxpayers with modified AGI above $120,000 (married filing jointly), $100,000 (head of household), and $80,000 (single) will be required to pay back the full excess Child Tax Credit received in advance payments.
• Taxpayers with modified AGI between these thresholds will be required to pay back a portion of the excess amount.

If the advance payments received are less than a taxpayer’s actual eligible Child Tax Credit, the taxpayer will claim the additional credit on their 2021 income tax return.

Let’s look at another example. Say that a family with two children ages two and twelve filed a 2020 income tax return with modified AGI of $140,000. Based on the family’s 2020 modified AGI, the family is eligible for the full amount of the Child Tax Credit totaling $6,600 ($3,600 + $3,000). Assuming all other criteria are met, the family will receive advance payments of half of the Child Tax Credit in the amount of $3,300 ($6,600/2) to be paid in six installments of $550 ($3,300/6) each from July to December 2021.

When the taxpayers file the 2021 income tax return, the Child Tax Credit will then be calculated based on the 2021 income and family situation. The advance payments will reduce the calculated 2021 Child Tax Credit as reported on the 2021 tax return. If advance payments exceed the eligible 2021 credit, the taxpayers may have to repay the excess amount depending on 2021 modified AGI.

Taxpayer 3 Example

Married Filing Jointly with $140,000 modified AGI with 2-year-old and 12-year-old children

$3,600 (2-year-old) + $3,000 (12-year-old) = $6,600 estimated Child Tax Credit

$6,600/2 = $3,300 advance total estimated Child Tax Credit monthly stimulus payments

$3,300/6 = $550 received per month July-December 2021

What else do I need to know?

The IRS is sending two letters to taxpayers with important information regarding the Child Tax Credit. Letter 6417 should be received before any advance payments of the credit are made. This letter will provide the Child Tax Credit information and the amounts of the advance payments.

Also look for Letter 6419 in January 2022. This letter will provide the total amount of advance Child Tax Credit payments received, and will be essential when preparing 2021 income tax returns. If updates need to be made for bank account information, Child Tax Credit eligibility information, or to opt out of the advance payments, direct your clients to the IRS Child Tax Credit Update Portal.

It’s important to note that the expansions to the Child Tax Credit have not been made permanent yet and apply only to tax year 2021. However, understanding how the 2021 Child Tax Credit is calculated and how the advance payments of the credit are applied will avoid unwanted taxpayer surprises for your clients when 2021 income tax returns are filed.

More questions? Read the IRS Child Tax Credit FAQs.

Helpful Links

IRS Child Tax Credit Non-filer sign up tool

IRS Child Tax Credit Update Portal

Keep reading the Becker blog for more important tax updates that all tax professionals, accountants and CPAs should be in-the-know of.

The content contained in this article is for informational purposes only and is not tax advice. You should consult a tax advisor for advice applicable to your situation.

Need a refresher on tax law changes in 2021? Head to Becker’s Tax Resource Center for helpful news and tax resources to prepare yourself for the new tax season.