Should You Opt Out of the Advance Child Tax Credit?

If you have children under the age of 18, by now, you likely have gotten your first Advance Child Tax Credit payment, either by check or by direct deposit. Be aware; this is money you would have received credit for on your 2021 tax return when you file it next year anyway. You are just receiving it in advance, meaning you may not get as much as expected when filing your tax return.

The Government is touting the Advance Child Tax Credit as a significant step toward reducing child poverty and sustaining families during the pandemic. However, receiving small monthly payments may spell trouble for those who traditionally rely on large tax refunds to fund their IRAs, property taxes, and vacation.

Others may decide to deliberately cut back on tax withholding during the year and use the tax credit to make up for the under-withholding when they file their return. However, they may be surprised to find they owe tax next spring and may even have an underpayment penalty. The list goes on for those the advance credit payments aren't going to be very helpful. Small monthly payments can easily be used upon frivolous items and result in unpleasant surprises at tax time.

The American Rescue Plan Act of 2021 authorized the advance payments for one year only (2021). The monthly payments are automatically made to all qualifying individuals unless they go to the IRS website and opt-out. The Biden Administration estimates that 39 million families are qualified for the advance payment, and about 2.6% had opted out of the first payment (July 15, 2021).

The payments are estimated based on a taxpayer's family makeup (children and filing status) and income since the credit phases out for higher-income taxpayers. The IRS bases the advance credits on the income taxpayers reported on their 2020 returns (or 2019 if the 2020 return hasn't been filed). Some taxpayers may be in for an unpleasant surprise when they discover they did not qualify for the advance payments they received due to one of two reasons. Either the number of their qualified children changed, or the children's ages disqualify them for the credit. On top of that, many may not have been working in 2019 or 2020. The income the advance credit was based upon was lower than their actual 2021 income, which may be above the 2021 credit phaseout threshold, thereby reducing or eliminating the credit.

The credit is reduced by $50 for each $1,000 (or fraction thereof) by which the taxpayer's modified adjusted gross income exceeds the thresholds illustrated below.

• $75,000 for single filers and married persons filing separate returns.

• $112,500 for heads of household.

• $150,000 for married couples filing a joint return and qualifying widows and widowers.

A taxpayer whose advance credit payments exceed what their actual credit turns out to be will need to repay the excess with their 2021 tax return.

But, there is a safe harbor repayment for lower-income taxpayers where the excess advance repayment is eliminated or reduced. Therefore, families with a 2021 MAGI (modified adjusted gross income) below the applicable income threshold (see table below) do not have to repay any advance credit, even if they receive too much. Those with a MAGI above the "complete phase-in" amount will have to repay the entire amount of any overpaid advance credit when they file their 2021 tax return. Those whose AGI is between the threshold and the total phase-in amount will have to repay a proportional amount of the overpayment.

Here are the credit amounts for 2021 based upon the child's age on the last day of the year.

• $3,000 for a child between the ages of 6 and 17 (monthly advance payment $250).

• $3,600 for a child under the age of 6 (monthly advance payment $300)

The advance credit is 50% of the annual credit divided into six payments between July and December 2021. But remember, the advance credit estimate is based upon the 2020 tax return (or the 2019 return if 2020 has not yet been filed).

Example: On their 2020 tax return Harry and Mary claimed two children, one age 2 and the other age 7, and their income was under the $150,000 threshold. Thus, for 2021 they would have a child age 3 and another age 8, and the IRS would estimate their credit for 2021 to be $6,600 ($3,600 + $3,000).

Their advance monthly payments would be $550 ($6,600 x 50%) divided by six months.

Suppose you've received advance child credit payments in January 2022. In that case, the IRS will send you a letter recapping the amount of advance credit they sent you. This information will be needed when reconciling the advance credit payments with the actual credit on your 2021 return. Just in case the letter goes astray, you should carefully keep track of the advance credit payments you received.

The focus of this article is the advance child credit payments. But you may be interested to know that the American Rescue Plan Act did not repeal the prior version of the child tax credit that capped the amount at $2,000 and allowed only part of it to be refundable. The phaseout described in this article applies to the increase in credit. Families that aren't eligible for the higher child credit can claim the regular credit of $2,000 per child (less the amount of any monthly payments they received in advance). Provided their AGI is below $400,000 on joint returns and $200,000 on other returns.

If you have questions about how these advance payments may impact the outcome of your 2021 tax return, please get in touch with our office.