Child Tax Credit and the Credit for Other Dependents
No matter how bad a child is, he is still a good tax credit. — Modification of an American Proverb
The child tax credit was enacted by Congress in 1997 to lower the tax burden on lower income Americans with children. The child tax credit (CTC) can be up to $2,000 for each qualifying child under age 17 by the end of the tax year, who is a US citizen, resident, national, or an adopted child who lived with you during the tax year. Except for the fact that the child must be younger than 17, all other tests for a qualifying child under the dependency exemptions must be satisfied. Children who qualify include a natural child, stepchild, grandchild, great-grandchild, brother, sister, or step- or half-siblings or any of their descendents. The child tax credit can only be claimed for a 12-month tax year.
A phaseout of the credit starts when your modified adjusted gross income (MAGI) exceeds the phaseout amount:
For most people, MAGI = adjusted gross income. The phaseout income threshold depends on filing status:
- Married Filing Jointly: $400,000
- All Other Filing Statuses: $200,000
If your income exceeds the phaseout amount, then the credit is reduced by $50 for each $1,000, or fraction thereof, above the phaseout amount.
Example: Calculating the Child Tax Credit for Incomes Above the Phaseout Amount
Ava is a single parent with 2 dependent children who qualify for the child tax credit, and she earned $215,020 for the tax year. Because her income is $15,020 more than the phaseout amount of $200,000 for a head of household, she must reduce the $4,000 child tax credit that she would otherwise be entitled to by:
- $215,020 − $200,000 = $15,020, which is rounded up to $16,000, since the $20 portion is a fraction of $1,000.
- $16,000/$1,000 = 16
- 16 × $50 = $800
- Child tax credit = 2 × $2,000 − $800 = $3,200.
The new tax package passed by the Republicans at the end of 2017, known as the Tax Cuts and Jobs Act (TCJA), the child tax credit has been increased to $2,000 per child, with up to $1400 being refundable. However, the personal exemption has been eliminated, although a $500 credit can be claimed for dependents other than children qualifying for the child tax credit. The income phaseout amount has also been increased to $400,000 married filing jointly, and $200,000 for everyone else. If a dependent does not qualify for the child tax credit, then they may qualify for a new dependent credit of up to $500 for each dependent. The new law also requires that each child have a Social Security number before the due date of the return, including extensions, to qualify for the child tax credit. If the dependent child does not have a Social Security number, but has an ITIN, then the taxpayer may be able to claim the new dependent credit of up to $500 for that child. The Tax Cuts and Jobs Act has also reduced the earnings threshold from $3000 to $2500, starting in 2018.
Because of the Covid-19 pandemic, the new Consolidated Appropriations Act for 2021 (H.R. 133), signed into law on December 27, 2020, allows taxpayers to substitute 2019 earned income for 2020 earned income for both the Earned Income Tax Credit and for the Additional Child Tax Credit, if it is advantageous to do so, but this substitution may not be used to calculate any other tax items, such as gross and taxable income.
The American Rescue Plan Act (ARPA): Enhanced Child Tax Credit for 2021 Only
The Democrats have greatly increased the generosity of the child tax credit. The American Rescue Plan Act (ARPA) has greatly increased the child tax credit for the poor, eliminating the work requirement, extending the age of qualifying children to 17, and making the credit fully refundable and half of it advanceable. However, these changes only apply to the 2021 tax year, after which it will revert to previous law. These are the major provisions:
- The credit is:
- $3,600 per child ages 0 - 5
- $3,000 per child ages 6 - 17.
- Children aged 17 at year-end also qualify for the CTC; other tax years, the upper age limit will continue to be 16.
- The CTC is fully refundable: no earned income requirement.
- The taxpayer must live with the qualifying child in the US or Puerto Rico for more than ½ year.
- The CTC is phased out to the pre-2021 of $2,000 per child, phasing out from $3,600 or $3,000 when AGI reaches $75,000 for single taxpayers ($112,500 HoH, $150,000 MFJ). The credit is reduced $50 for each $1,000, or fraction thereof, of MAGI exceeding the applicable threshold.
- The CTC is further phased out from $2,000 per child when AGI reaches $200,000 for both Single and HoH ($400,000 MFJ) to $0 when AGI reaches $239,001 ($439,000 MFJ), a $50 reduction for each $1,000, or fraction thereof, of MAGI exceeding the applicable threshold).
- Taxpayers can opt out of advance payments of the CTC, but if they do not, then ½ of the expected 2021 CTC will be paid as equal periodic payments starting in July 2021, based on previous tax information from the taxpayer and reconciled on 2021 tax returns, when the remaining amount will be paid or credited.
- Excess advance payments must be repaid but will be reduced for lower income taxpayers if the overpayments were the result of a reduction in the number of qualifying children.
The $500 nonrefundable Credit for Other Dependents can be claimed for dependents who do not qualify for the child tax credit. Qualifying dependents include qualifying relatives who are US citizens, US nationals, or US resident alien, but not residents of Canada or Mexico who could otherwise qualify as a qualifying relative. A qualifying dependent needs to have a Social Security number, an Individual Taxpayer Identification Number (ITIN), if the resident alien is not eligible for a Social Security number, or an Adoption Taxpayer Identification Number (ATIN), which is a temporary identification number for children in the process of being adopted. The same MAGI limits that apply to the child tax credit ($200,000 or $400,000 if married filing jointly) also applies to the credit for other dependents.
The child tax credit and the credit for other dependents are figured on Form 8812, Credits for Qualifying Children and Other Dependents. Because they are nonrefundable credits, they are limited by your ordinary income tax liability, which may be reduced by other claimed credits, such as the foreign tax credit, credit for child and dependent care expenses, education tax credits, and the retirement savings contribution credit. A nonrefundable credit does not offset payroll tax liability, i.e., Social Security and Medicare taxes.
Additional Child Tax Credit
For tax year 2021 only, the Additional Child Tax Credit is not applicable for qualifying children since the entire amount of the child tax credit is refundable, but the old law will apply in 2022 and thereafter. However, the Additional Child Tax Credit can be claimed by taxpayers in 2021 if they did not qualify for the refundable child tax credit because of residency requirements. An alternative way of calculating the Additional Child Tax Credit can be found in Part II-B of Form 8812, Credits for Qualifying Children and Other Dependents if the taxpayer has 3 or more children and paid Social Security and Medicare taxes exceeding their earned income credit.
The ordinary child tax credit, like most other credits and deductions, has an implicit work requirement, because it can only be used to offset ordinary income tax liability and for most people, especially poor people, that income tax liability comes from earning more than the total sum of the other tax credits and deductions.
Because $600 of the child tax credit is nonrefundable, families with little or no tax liability will not be able to benefit from the child tax credit. And since the standard deduction has been greatly increased for head of household status and for married filing jointly, many families will not be able to benefit from the child tax credit. At the same time, a single parent who makes less than $10,000 will not only not benefit from the regular child tax credit, but they will not even get much of the Additional Child Tax Credit. Even though the Additional Child Tax Credit is refundable, the refundable amount is limited by earnings.
Although the child tax credit is generally limited to ordinary income tax liability or AMT liability, an additional refundable credit may be claimed on Form 8812, Credits for Qualifying Children and Other Dependents if your earned income exceeded $2,500. Thus, the Additional Child Tax Credit has an explicit work requirement. However, if you have more than 2 children, then you can still claim a refundable credit even if your earned income is not over $2,500. The purpose of the earnings requirement is to promote work.
Poor people cannot use the traditional child tax credit, because it can only offset ordinary income tax liability: it cannot be used to offset employment and certain other taxes. Therefore, poor people receive most or all their benefit from the Additional Child Tax Credit, because it is refundable. For instance, in 2018, the standard deduction is $18,000 for a head of household, so a parent with 1 child may claim the parent's own standard deduction of $18,000. Therefore, this parent would have no ordinary income tax liability if income does not exceed that. This is without even considering other possible deductions or tax credits that the parent may claim, such as a traditional IRA contribution. Therefore, the Additional Child Tax Credit provides most or all the tax savings for lower income taxpayers.
Richer taxpayers will have sufficient tax liability from ordinary earnings to claim the entire $2000 as the regular child tax credit. More children requires a higher income to rely only on the ordinary child tax credit.
Because it is refundable, the Additional Child Tax Credit can be used to reduce payroll tax liability. The refundable credit is limited to the lesser of the unclaimed portion of the nonrefundable credit amount or 15% of your earned income above $2,500. Combat zone pay, which is otherwise excludable, can be included in earned income when calculating the Additional Child Tax Credit.
Maximum Additional Child Tax Credit = Lesser of Unused Child Tax Credit or (Earned Income − $2500) × 15%
Examples: Calculating the Additional Child Tax Credit for Employees
Example: Amy, who had earned income of $20,000, could only claim a $200 child tax credit for her 2 children, since that was the extent of her ordinary income tax liability, which is figured thus: $20,000 − $18,000 (2018 standard deduction for head of household) = $2000 taxable income; tax liability = $2000 of taxable income × 10% marginal tax rate = $200. Therefore, Amy can only claim $200 total of the regular child tax credit, but she will be able to claim the full $1400 of the refundable Additional Child Tax Credit for each child. Assuming that Amy did not have any other tax credits or deductions, she could only claim the full $600 of the ordinary child tax credit for each of her children if her taxable income was at least $12,000, and since she has a standard deduction of $18,000, her total income must be at least $30,000. With $12,000 of taxable income, Amy could then claim the ordinary child tax credit of $600 for each child, so her child tax credit would be $1000 greater than it would be with an income of only $20,000.
For taxpayers with more than 2 children, an additional credit may be available by using the following generalized procedure:
- (Earned Income − $2,500) × .15
- Amount Taxpayer Paid in Social Security and Medicare Taxes as an Employee (listed in Boxes 4 and 6 of Form W-2) + 1/2 of any Self-Employment Taxes − Earned Income Credit
- Tentative Credit = Greater of #1 or #2
- Unclaimed Credit = Maximum Child Tax Credit − Claimed Portion of Credit
- Additional Child Tax Credit = Lesser of #3 or #4
It seems that Congress intended to limit the Additional Child Tax Credit to the lower of either the taxpayer's payroll tax liability or to the unused portion of the child tax credit, to limit any possible refund. 15% of earned income is very close to the 15.3% payroll tax on earned income that is assessed on employees, the employer paying ½ of that, so Steps 1 and 2 seem to be designed to limit the additional credit to slightly less than the full payroll tax liability on the earned income. So a self-employed taxpayer who had no earnings as an employee would always select Step 1, since that will always exceed Step 2.
Note that Steps 2, 3, and 5 ensure that the child tax credit, unlike the earned income credit, will never exceed the taxpayer's total tax liability. So although it is a refundable tax, in that it reduces payroll tax liability, it is not a negative tax. However, 2 other refundable credits after listed after the Additional Child Tax Credit in the Payments section of Form 1040:
- 40% of the American Opportunity Tax Credit
- net Premium Tax Credit, which is the Obamacare tax credit for lower income taxpayers
If either of the above credits can be claimed, then those may lead to a greater tax refund or will at least reduce the payroll tax liability for the self-employed.
Also, Step 4 and Step 5, together, ensure that the following equation is always true:
Child Tax Credit + Additional Child Tax Credit ≤ Number of Children × $2,000
Tip: if you can claim the child tax credit or the additional child tax credit and you want to receive more take-home pay, then increase your withholding allowances by filing a new Form W-4 with your employer.
After 2017, the earnings exclusion for the Additional Child Tax Credit was scheduled to rise from $3000 to $14,600, thus eliminating or reducing the credit for many poor families, but The Protecting Americans from Tax Hikes Act, otherwise known as the PATH Act, (Division Q of P.L. 114-113) has made the change a permanent part of the tax code.
Longer Delays for Refunds for Taxpayers Claiming the Earned Income Tax Credit or the Additional Child Tax Credit
Starting in 2017, there will be a longer wait for refunds for people claiming the Additional Child Tax Credit and the Earned Income Tax Credit. The EITC is fully refundable, meaning that the taxpayer will receive a refund even if no taxes were paid. The ACTC is refundable, but only to the extent of paid taxes, including employment taxes. Because the regular child tax credit can only offset ordinary tax liability, most poor people mainly benefit from the ACTC. Most other tax credits cannot be used to lower employment tax liability. Other refundable tax credits, such as the Premium Tax Credit for healthcare coverage, are not subject to the delay. However, the whole refund will be delayed, not just the portion attributable to the EITC and the ACTC.
The IRS is required to delay the refunds until at least February 15 so that it has the chance to verify the claimed credits, because, previously, many refunds were paid erroneously because of errors in claiming the refund or from fraud. Therefore, there will be some delay regardless of when the tax return is filed, so taxpayers who want their money sooner should file as soon as possible. Because of the Presidents’ Day holiday, the refunds may be delayed even for early filers until the end of February.
This delay was enacted as a provision under the Protecting Americans from Tax Hikes Act of 2015, often known by its much briefer moniker, the Path Act.
Tax preparers may offer the tax refund sooner, but they are really offering a loan, since the delay is required by law. These loans often have unfavorable terms, so they should be avoided.
The estimated time for refunds can be checked after February 15 using the IRS2Go mobile app, or by checking the Where's My Refund? - It's Quick, Easy and Secure page at IRS.gov.