Every year, the Child Tax Credit reduces the tax liability of American parents. If it lowers their tax burden below zero, it can even put money in their pockets. The credit's size increased following the Tax Cuts and Jobs Act of 2017. And now, thanks to the American Rescue Plan Act of 2021, it's even bigger—and slightly more complicated—for the 2021 tax year. Here’s what you need to know.
Child Tax Credit Basics
Before the American Rescue Plan Act, American parents, who met certain income thresholds, could claim a $2,000 tax credit per dependent child younger than 17. As a tax credit, it directly reduces income taxes owed, dollar for dollar. That means someone who owed $3,000 in federal income taxes before claiming the old credit (for one dependent child) would owe only $1,000 afterward. Tax deductions, on the other hand, reduce your taxable income and may have a smaller effect on your ultimate tax bill.
The old Child Tax Credit was partially refundable. If claiming the Child Tax Credit lowered your tax liability below zero, the IRS would cut you a check for the difference, maxing out at $1,400 per dependent child.
How 2021 is Different
The American Rescue Plan Act changed the tax credit for just one year. Taxpayers can now claim a credit of $3,000 for every dependent child between the ages of 6 and 17 (inclusive) and $3,600 for every dependent child 5 or younger. The credit is now fully refundable — which means if your tax burden is low enough you could receive the entire credit as cash — and there is no lower income limit. The additional $1,000 or $1,600 of each credit and the original $2,000 phase out at higher incomes levels.
Rather than wait for Americans to file their 2021 tax returns, the government is distributing half the credit ahead of time in the form of monthly checks. The program covers roughly 39 million households and about 88 percent of the children in the United States.
How Monthly Payments Work
Families began receiving advance monthly payments on their estimated 2021 Child Tax Credit in July 2021. Checks are typically $250 or $300 per child and will continue through December. The balance will be disbursed with your 2021 tax refund.
Because the advance payments are based on previous tax information, some families receiving checks won’t end up qualifying for the credit when they file for 2021. In that case, taxpayers will be responsible for returning the payments. If your income increased in 2021, threatening your eligibility for the Child Tax Credit, it may make sense to wait to spend the money or opt-out of advance payments.
Setting Expectations and Managing Monthly Payments
The Advance Child Tax Credit Eligibility Assistant on the IRS website can help you determine whether you qualify. By answering a few questions, you can see how much you should expect to receive for 2021. If you’d rather not receive advance payments, you can use the online Child Tax Credit Update Portal to opt-out.
This one-year increase to the Child Tax Credit will be a boon to parents of young children, but it comes with caveats that could leave some taxpayers unexpectedly owing money when they file their return. It’s important to understand how it will affect you specifically so you can know whether to spend those checks. Keep in mind that unless Congress passes a law extending the Child Tax Credit increase, the value of the credit reverts to a partially refundable $2,000 credit per child for 2022.