Updated Child Tax Credit and Dependent Care Credit for 2021

What is the Child Tax Credit?

The Child Tax Credit is a tax benefit provided to United States taxpayers for each qualifying dependent child. The purpose of this credit is to assist taxpayers in providing for their families. Since this is a credit, taxpayer liability is reduced on a dollar-for-dollar basis.

Child Tax Credit Changes

As a result of the American Rescue Plan Act, the amount families can receive in child tax credits has been increased from $2,000 in 2020 to $3,000 per child aged 6 through 17 and $3,600 per child under 6 for the 2021 tax year. Additionally, families can receive advance payments of these credits beginning in July of 2021. The IRS will provide half of the total credit amount that a family qualifies for in the form of an advanced monthly payment over the last six months of 2021, and the remaining half can be claimed when 2021 tax returns are filed. The advanced payment equates to $250 per month for a $3,000 annual credit, and $300 per month for a $3,600 annual credit. These advanced payments are not treated as taxable income since the payments represent the advanced receipt of the tax credit.

While the previous child tax credit was partially refundable, the 2021 credit is fully refundable meaning the full amount of the credit is provided to the taxpayer regardless of their tax liability. These changes apply to the 2021 tax year only, and the credit will revert to the rules in effect for 2020 if no additional legislation is enacted.

What are the limitations?

There are two income phase-out rules that apply: one phase-out for the previously enacted child tax credit amount of $2,000 per child, and a separate phase-out rule for the new $3,000 and $3,600 credit amounts. For the pre-2021 authorized child tax credit amount of $2,000 per child, the credit is gradually phased out beginning at a modified adjusted gross income level of $400,000 for joint filers and $200,000 for all others. The additional $1,000 and $1,600 credit amount authorized for 2021 is phased out beginning at a modified adjusted gross income level of $150,000 for joint filers, $112,500 for head of household filers, and $75,000 for all others. To apply the phase-out rules, any reductions in qualified credits are first applied on the additional $1,000 and $1,600 amounts, and then the pre-existing phase-out schedule is applied to the remaining $2,000 credit.

The two separate phase-out schedules both apply a reduction of $50 in the credit amount for each $1,000 earned above the threshold:

Steve is joint filer with a Modified Adjusted Gross Income of $175,000 for 2021 and one four-year-old daughter. The $3,600 child tax credit amount will be reduced by $50 for each $1,000 earned above the $150,000 level. Because Steve earned $25,000 above the $150,000 threshold, his child tax credit amount will be reduced by $1,250 ($50 X 25) and he will receive a total credit of $2,350 ($3,600 - $1,250).

Samantha is a joint filer with a Modified Adjusted Gross Income of $410,000 for 2021 and has one child who is sixteen years old. The $3,000 child tax credit amount is reduced by $50 for each $1,000 earned above $150,000 until it is reduced to $2,000. The remaining, pre-existing $2,000 child tax credit amount is reduced based on the second phase-out schedule which begins at a joint filed MAGI level of $400,000. This $2,000 credit is reduced by $50 for each $1,000 above the $400,000 level. Since Samantha earned $10,000 above the $400,000 level, the $2,000 child tax credit is reduced by $500 (10 X $50) to arrive at a net qualified child tax credit amount of $1,500 for 2021 ($2,000 - $500).

To be eligible for the child tax credit, you also must have provided at least half of the child’s support during the prior year, and the child must have lived with you for at least half the year, with some specific exceptions defined by the IRS. The child cannot file a joint tax return, and the child must be 17 or younger on December 31st, 2021, for the credit to be claimed.

How do I qualify for the advanced payments?

To qualify to receive these advanced payments, a 2019 or 2020 return must have been filed where the child tax credit was claimed on the return. If a return was not filed in either of these years where the child tax credit was claimed, advanced payments can still be received if the following four requirements are met: Provided the IRS information in 2020 to receive the Economic Impact Payment using the Non-Filers: Enter Payment Info here tool, main home is located within the US for more than half the year or filing a joint return with a spouse who has a main home in the US for more than half the year, qualifying child is under age 18 at the end of 2021 with a valid social security number, and taxpayer earned less than the defined income limits.

How do I receive the monthly advanced payments?

Taxpayers who qualify and would like to receive these benefits monthly should verify that direct deposit information has been provided to the IRS. Taxpayers who included bank account information within their 2020 tax returns can receive electronic direct deposit as opposed to paper checks. An online portal through the IRS also may be able to be accessed to provide banking information for the advanced payments.

Child and Dependent Care Tax Credit

The child and dependent care tax credit is a credit provided for a certain percentage of work expenses incurred for the care of dependents which provides the taxpayer the ability to work or search for work. In 2021, this credit was expanded by increasing the amount of work-related expenses taken into consideration, increasing the percentage applied to these expenses, and the income limitations were adjusted. The credit was also adjusted to become refundable to the taxpayer. Ultimately, these changes mean that more people will qualify for this credit and the credits generally will be larger.

To qualify, you or your spouse must pay someone to care for qualifying dependents while you work or search for work, and the taxpayer must have earned income during the year to qualify. Up to 50% of work-related expenses can be claimed for this credit, dependent on income limitations. For 2021, the 50% percentage begins to phase-out at an income level of $125,000 and completely phases out at an income level of $438,000.

The maximum amount of work-related expenses which can be considered for the credit is $8,000 for one qualifying dependent, or $16,000 if there are one or more qualifying dependents. In this case the maximum credit amount a taxpayer could qualify for would be either $4,000 or $8,000 depending on the number of dependents they have. The amount received for the credit cannot exceed the amount of earned income during the year. For 2021, the credit is fully refundable meaning that taxpayers can qualify even if the credit amount exceeds the amount owed for federal income tax.

A dependent child must be 12 or younger at the time the care is provided, and the credit cannot be claimed for payments to care providers who are your spouse, a parent of the dependent child, and a dependent listed on your tax return.