For the 2021 tax year only, the new American Rescue Plan Act (ARPA) makes big, taxpayer-friendly changes to the federal income tax child tax credit (CTC).

Here’s what you need to know, starting with some necessary background information.

CTC Basics

For 2018-2020 and 2022-2025, the maximum annual CTC is $2,000 per qualifying child.

A qualifying child is an under-age-17 child who could be claimed as your dependent for the year. Basically, that means the child lived with you for more than half the year; did not provide more than half of his or her own support; and is a U.S. citizen, U.S. national, or U.S. resident.

The maximum $2,000 CTC is phased out (reduced) if your modified adjusted gross income (MAGI) for the year exceeds $200,000, or $400,000 for a married joint-filing couple. The credit is phased out by $50 per $1,000 (or fraction of $1,000) of MAGI in excess of the applicable phaseout threshold.

For 2018-2020 and 2022-2025, the CTC is partially refundable.

You can collect the refundable amount even if you have no federal income tax liability for the year. So, the refundable amount is free money.

The refundable amount generally equals 15 percent of your earned income above $2,500.

An alternative formula for determining the refundable amount applies if you have three or more qualifying children. In any case, the maximum refundable amount for 2018-2020 and 2022-2025 is limited to $1,400 per qualifying child.

(If you have a 2020 tax liability, the CTC can offset up to $2,000.)

More Generous CTC Rules for 2021

For your 2021 tax year only, ARPA makes the following taxpayer-friendly changes.

Qualifying Children Can Be Up to 17 Years Old

The definition of a qualifying child is broadened to include children who are age 17 or younger as of December 31, 2021.

Bigger Maximum CTC with Separate Phaseout Rule for the Increase

ARPA increased the maximum CTC to $3,000 per qualifying child, or $3,600 for a qualifying child who is age 5 or younger as of December 31, 2021. But the increased 2021 credit amounts are subject to two phaseout rules:

-The increased CTC amount—$1,000 or $1,600, whichever applies—is phased out for single taxpayers with MAGI above $75,000, for heads of household with MAGI above $112,500, and for married joint-filing couples with MAGI above $150,000. The increased amount is phased out by $50 per $1,000 (or fraction of $1,000) of MAGI in excess of the applicable phaseout threshold.4

-The “regular” $2,000 CTC amount is subject to the “regular” phaseout rule explained earlier.

Key point:

If you're not eligible for the increased CTC amount for 2021 because your income is too high, you can still claim the regular CTC of up to $2,000, subject to the regular phaseout rule.

 As you would expect in these unusual times, some of the relief is in the form of direct government financial assistance and some is from tax benefits that can impact both tax year 2020 and tax year 2021.

CTC is Fully Refundable for Most People 

For the 2021 tax year, the CTC is fully refundable if you (or, if married, you and your joint-filing spouse) have a principal residence in the U.S. for more than half the year. If you are a member of the U.S. Armed Forces who is stationed outside the U.S. while serving on extended active duty, you’re treated as having a principal residence in the U.S.

For 2021, the CTC is fully refundable even if you have no earned income for the year.

The MAGI phaseout rules explained earlier apply in calculating your allowable, fully refundable CTC for 2021.

IRS Will Make Advance CTC Payments 

Another ARPA provision directs the IRS to establish a program to make monthly advance payments of CTCs (generally via direct deposits).

Such advance payments will equal 50 percent of the IRS’s estimate of your allowable CTC for 2021. The advance payments will be made in the form of equal monthly installments from July through December 2021. To estimate your advance CTC payments, the IRS will look at the information shown on your 2020 Form 1040 (or on your 2019 return if you have not yet filed your 2020 return).

If you receive advance CTC payments in excess of your allowable CTC for the 2021 tax year, you’ll generally have to repay the excess in the form of an increase in the federal income tax liability shown on your 2021 Form 1040.

But under a safe-harbor rule, taxpayers with MAGI below $80,000, or $100,000 for heads of household, or $120,000 for married joint-filing couples may be allowed to keep some or all of the excess payments.

Child ID Requirements

As was the case before ARPA, you must include a qualifying child’s name and Social Security number (SSN) on your 2021 Form 1040 to claim a CTC for the child.

In addition, the SSN must have been issued before the due date for filing your 2021 return. If you can’t meet these ID requirements for a qualifying child, you can claim the smaller $500 credit explained below.

Smaller $500 Credit

For 2018-2025, you can claim a $500 nonrefundable credit for a dependent who does not meet the definition of a qualifying child.

For 2021, the most common situation when this smaller credit will be available is when you have a dependent child who will be age 18 or older as of December 31, 2021. But you can also claim the smaller credit for other qualifying relatives, as defined. The MAGI phaseout rule for this smaller credit is the same as the regular CTC phaseout rule explained at the beginning of this article.

Takeaways

For 2021, the temporary changes made by ARPA will make the CTC more widely available and worth more for many families.

Thanks to the 2021 advance CTC payment deal, you can start collecting some of the resulting cash in July.

For 2021, ARPA also made the federal income tax child and dependent care credit more lucrative for many families, as explained in ARPA Adds Dollars to the Child and Dependent Care Tax Credit. You may be eligible for both credits, which could amount to a nice windfall.

*Info obtained from the Bradford Tax Institute and the IRS.gov website

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