Everything You Need to Know About the Child Tax Credit for Your 2021 Return

The $1.9 trillion COVID-19 relief package will provide tax credits to more than 36 million American families with children. If you’re one of those families, you’ll need to know how the payments — which will total up $3,600 per child— may affect your tax return.  You will want to consult with your tax advisor for the specific details of this tax credit for children under age 18.

What a tax credit is
A tax credit is designed to reduce the amount of income tax you owe to the federal and state governments. They’re a dollar-for-dollar reduction of the income tax you owe: If you owe $1,000 in federal taxes but you’re eligible for a $1,000 tax credit, your net liability drops to zero.  

Credits are usually designed to encourage or reward certain types of behavior that are considered beneficial to the economy, the environment or to further any other purpose the government deems important — such as a tax credit to replace old appliances with energy-efficient ones.

Tax credits are different from tax deductions. Tax credits reduce your tax liability dollar for dollar, so a credit reduces your tax liability by the full $1. A deduction reduces final tax liability, but it only does so within a person’s marginal tax rate. So if you’re in the 22% tax bracket, you’d save 22 cents for every marginal tax dollar deducted.

The purpose of the Child Tax Credit
The Child Tax Credit was created in 1997 as part of the Taxpayer Relief Act. The original credit was $400 per child under age 17.

The credit was adopted because Congress believed personal exemptions for dependents, which was $2,550 in 1996, didn’t “reduce tax liability by enough to reflect a family’s reduced ability to pay taxes as family size increases.” Or in other words, Congress recognized that it’s expensive to properly raise and care for children — and the more children in a family, the greater the expenses. So Congress created the Child Tax Credit to help ease the financial burden on families.

About the 2021 Child Tax Credit
In March 2021, President Joe Biden signed the American Rescue Plan into law, which helps families afford the everyday expenses of raising children. As part of the expansion of the Child Tax Credit, families with a child between ages 6 and 17 will receive $3,000 per child. Families with children under 6 will receive $3,600 per child.

This money will be divided into monthly payments, which started being mailed out to families in July 2021, and will continue through December 2021. Eligible taxpayers will claim the other half when they file their 2021 taxes in 2022. 

Who qualifies for the Child Tax Credit
Not all American families with children qualify for the Child Tax Credit. You can check your eligibility online, but here are the qualifying factors the IRS uses to determine eligibility:

• You child must be 17 years old or younger at the end of the year (children born in 2021 qualify, though you may need to add your qualifying child to the Child Tax Credit Update Portal to let the IRS know about your new child)
• Your income is below $75,000 for single filers, $112,500 for head-of-household filers and $150,000 for married couples filing a joint return (if your income changed in 2021 and you think you may qualify, you can also let the IRS know through the portal)
• Your child has a Social Security number
• Your child is a U.S. citizen, national or resident alien
• You live within the U.S. or Puerto Rico
• You claimed your child as your dependent on your 2020 taxes (if you’re divorced and your ex-spouse claimed the child, you won’t receive the monthly child tax credits)

The size of the benefit gradually diminishes for single filers earning more than $75,000 per year, or married couples making more than $150,000 a year. This credit is now fully refundable, which means if the amount of the tax credit is larger than the amount of tax owed, that taxpayer receives a refund for the difference. Up to $1,400 of the Child Tax Credit is refundable. 

For the 2020 tax year, you can use either your 2019 income or your 2020 income to calculate your tax credit, and you can use whichever number gets you the bigger tax credit.

How the Child Tax Credit could affect you and your taxes
If you were one of the 127 million Americans who received a stimulus check in 2021, you probably know that check was based on income, just like the Child Tax Credit. However, if you received more money in your stimulus check than you were entitled to, you didn’t have to pay it back.

That’s not the case with the Child Tax Credit. According to the IRS, if you receive a total amount of advance Child Tax Credit payments that’s more than the amount you can properly claim in the 2021 tax year, you may need to repay some or all of the excess payment back to the IRS.

You can opt out of receiving payments on the update portal, even if you’ve already received payments. The 2021 deadlines to unenroll are:

• October 4 for the October 15 payment
• November 1 for the November 15 payment
• November 29 for the December 15 payment

If you owe money for things like child support, consumer debts or student loans, your Child Tax Credit payments may be garnished by creditors, including state and local governments and private creditors. However, some states have shielded their constituents from Child Tax Credit garnishment. Some financial institutions have done the same.

The IRS also won’t deduct money from your monthly payments if you owe federal taxes. But if you get a refund when you file your 2021 taxes, any remaining amount from the Child Tax Credit that’s included in your refund could be used to offset your tax debts.

What to do with your Child Tax Credit
Consider depositing the funds from the Child Tax Credit into an education savings plan, such as a 529 College Savings Plan. There are certain tax advantages to choosing an education savings plan, and our helpful professionals at your local First National Bank and Trust can help you decide which might be the best option for you and your child. 

This article is for information only, and is not intended to provide any tax advice.  You will want to consult with your tax advisor for the specific details and how you might benefit.
 
If you’d like to learn more about your options, find a First National Bank and Trust location near you, or contact us.