What does the child tax credit have to do with Star Wars?
Towards the end of the Return of the Jedi (Episode VI) the rebel alliance is closing in on the Death Star. Lando Calrissian is leading the charge with the fighters and cannot get a reading on the shield that is protecting the Death Star. At the last moment Lando realizes that the Empire has been expecting them and orders all fighters to break off the attack and pull up as the shield is still working. As all of the fighters and ships pull up, enemy ships are detected in sector 27 and Admiral Ackbar shouts: “It’s a trap!”
That is exactly how everyone should feel about the new advance child tax credit payments starting in July 2021: it is indeed a trap should you not be ready for it.
Some background: In prior years the child tax credit was reported on the income tax return reducing the tax liability. Tax liability is your taxable income multiplied by your tax rate. If you owed, for example, $10,000 in tax and had four kids, in 2020 your tax liability ($10,000) would have been reduced by the child tax credit of $8,000 ($2,000x 4 kids). Your tax payable would then have been $2,000. Your federal withholding or estimated tax payments would (hopefully) offset the remaining amount. You never got the cash for the child tax credit, but you did get the tax benefit of it by not paying as much when you filed your annual tax return.
Starting this year, taxpayers have the ability to receive up to 50% of the child tax credit in prepayments. The prepayments will be sent to taxpayers and will be based on the 2020 tax returns. The tax credit has also increased. For couples earning less than $150,000 the tax credit is $3,000 per child. If your income is above $150,000, but under $400,000 the credit is $2,000 per child, and you do not qualify for the credit if your income is more than $400,000.
Lots of detail so far, but we believe it is important to know this as it will affect you differently this year. Since the child tax credit can be paid early, up to half of it, your tax liability is likely to change as well. Let’s use the example above of having a tax liability of $10,000. This year your credit would have been $12,000 (4 kids x $3,000), and this could have generated a larger refund for you EXCEPT this year due to new laws the IRS paid half of it as an advance between July and December. Meaning the IRS will only credit your tax liability by $6,000 leaving you owing $4,000 when in prior years you have only owned $2,000. Sure, you got the cash, but did you save it to pay taxes? The above scenario does not account for kids no longer qualifying for the credit, your income increasing, or changes you may have made in your withholding.
Since the advance has the ability of leaving you owning more at tax time (in addition to you reporting to us the amount of advance your received) we would encourage you to not take the advance and continue to use the tax credit as it has been used in the past: a non-cash reduction to the amount of tax you owe. We know that every circumstance is different and unique and believe the best option for our clients would be to unenroll from receiving the advance child tax credit payments.
The IRS has announced that a tool is available online at irs.gov to allow you to unenroll. (https://www.irs.gov/credits-deductions/advance-child-tax-credit-payments-in-2021)
We hope you will enjoy the rest of your summer and look forward to continuing to serve you.