20 Second Advisor: New Money from Uncle Sam (aka: child tax credit) and why it may give families a surprise tax bill next year!
For many American families with children, the Treasury Department started depositing money into their bank account starting in July. What is this new money? Well, the American Rescue Plan (passed earlier this year) expanded the child tax credit from $2000 per child* to either $3,600 (for kids under 6) or $3000 (for kids over age 6) for families making less than $150,000. In addition, they made the credit fully refundable (ie even if you don’t pay any taxes, you can still get the credit). Lastly, the American Rescue Plan made the credit “advanceable.”
Normally, taxpayers wouldn’t get the credit until they file their taxes in April of each year. For 2021, the IRS is “advancing” up to 1/2 the credit to taxpayers in monthly installments. On one hand, this is great for families that really need the monthly boost to their income (instead of having to wait for the tax refund each year). On the other hand, it could lead to a big jump in taxes each year for families that don’t understand how this new advanceable feature works.
For example, let’s say a family has 2 kids over age 6 and they normally owe $5000 in federal income taxes. In past years, they would have received the child tax credit of $2000 for each kid (2 x $2,000 = $4,000). This would have lowered their tax bill from $5,000 to $1,000. For 2021, the family’s credit is now $6,000 ($3,000 for each kid). The IRS is going to advance them 1/2 of the $6,000 throughout the remainder of the year ($500 per month x 6 months = $3000). When the family files their taxes, the family will get the remaining 1/2 of the credit ($3000) and 1/2 will have been already received throughout the year. In this example, the family would have a $5,000 tax bill but only get the remaining/left-over $3,000 child tax credit. In this example, the family will owe $2,000 on April 15th instead of the $1,000 they normally paid. Overall, they are getting way more money from Uncle Sam, but it could increase their tax bill in April.
Moral of the story: Families receiving the new advanceable credit should be saving some of that for taxes. Families that spend all of the advanceable tax credit may find themselves with a larger than normal tax bill next April 15th and not have the funds to pay for it.
*Families that have income above $150,000 will see their credit reduced from these new higher amounts to the older/lower amount of $2,000. Further, families with AGI above $400,000 begin to loose the $2000 credit as well until it completely phases out.
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