If you have kids, you probably got an increase in tax credits - OR you may be in for a not-so-nice surprise during tax time next year. Allow me to bring you the facts.
TAX CREDIT VS. TAX DEDUCTION
First, let me explain the difference between a tax credit and a tax deduction. Hint: you want the tax credit. A tax credit limits your tax liability $1 for $1 so if you owe $2,000 and get a $2,000 tax credit you owe...$0! On the other hand, a tax deduction only lowers your tax bill by your tax rate. For example, you are in the 22% tax bracket. You owe $2,000 and have a $2,000 deduction. In this instance, your tax liability is only decreased by $440 ($2,000 x 22%) and you still owe $1,560. BIG DIFFERENCE.
There are 2 credits that got an increase:
The Child Tax Credit
The Dependent Care Credit
Let me break them down for you.
THE CHILD TAX CREDIT
The most important thing to note, and the reason I am writing this blog in the first place, is IF you expect to make more this year than prior years, you may end up paying the credit back or receiving a lower refund.
NEW CHILD TAX CREDIT
Here’s how you qualify:
If you qualify based on your 2019 or 2020 tax return (whichever is the most recently filed) the IRS started depositing 50% of this tax credit to your bank account on July 15th split over the next six months.
Example: Bob & Sally are married and file jointly. They have two kids, a 1yo and a 3yo, and their AGI (income) was $140,000 on their 2020 tax return. Their total advanced tax credit would be $600 a month ($3,600 x 2 kids = $7,200 x 50% to be advanced = $3,600 divided by 6 months = $600 a month).
But, if you make more than the above to qualify for the increased child tax credit, you can still claim the original $2,000 credit. See below:
Remember my important note above? These advances are being trued up on your 2021 tax return based on your 2021 income and if you expect to make more this year than you did in 2019/2020, you may be receiving a much smaller refund this year or, even worse, have to pay the credits back. Ding ding ding! Let me walk you through some more examples:
Example 2: Let’s say Sally & Bob are actually going to make $360,000 this year. Their child tax credit on their 2021 tax return would be $4,000 (2 kids x $2,000) BUT because they already received $3,600 in advance they are only going to receive a $400 tax credit ($4,000 - $3,600 of 50% advance credit). Sally & Bob normally count on their tax refund every year for their family vacation but are very surprised come tax time to find their refund is only $400. But, oh no! They already booked their family trip to Hawaii counting on their tax refund to pay off the credit card bill. Oops!
The “It Gets Worse” Example: Let’s say Bob & Sally ended up making $500,000 this year. They are now completely phased out of the child tax credit and have to pay back the full $3,600 child tax credit advance on their 2021 tax return. Yikes!
Townsend Tip: Use this calculator and put in your 2021 income to see what your credit will *actually* be. No one likes surprises...especially a tax surprise.
If you want to opt out of the advance payments or update your information, the IRS has created a portal. If you had kids this year and want to alert the IRS so you can receive those credits, the IRS indicated that it would be available this summer, but last I checked it is still unavailable.
DEPENDENT CARE CREDIT (how to get a credit for child care expenses so you can work)
The child tax credit increase got more attention this year, but the dependent care credit also got a HUGE boost and may be an even larger benefit to families. First, this credit is now refundable! Second, the amount of care expenses you are allowed to claim increased from $3,000 for 1 child, $6,000 for 2+ children, to $6,000 for 1 child & $16,000 for multiple children. That is HUGE! Also, income limits increased to qualify for the credit. Here’s the latest:
Example: Sally & Bob with their 2 kids making $200,000 in 2021 paid a nanny $40,000 so they could both work = $16,000 (max expenses allowed to claim for multiple children) x 20% = $3,200 dependent care tax credit! WOW!!!!
To recap…
If you have kids and if your income is in the right range, your tax liability may be SIGNIFICANTLY lower this year.
Otherwise, if you are making over $400,000 this year, but made significantly less in prior years, you might be in for a big tax surprise this year.
I hope this helps you better understand your situation. If you're a TF client, this is on our next meeting's agenda (if we haven’t already talked about it) and if you're not and want someone on your team to walk you through topics like these and how they impact your unique situation, schedule a free intro call here.
