Tax

For tax year 2021, Congress is giving away billions of dollars in additional tax credits on your Form 1040 individual tax return.

These temporarily expanded tax credits include the child tax credit, the dependent care credit, and the health insurance premium tax credit.

With good planning on your end—which you have more control over than most do because you are in business for yourself—the various credits could easily put an additional $5,000 or more in your pocket for tax year 2021.

Child Tax Credit—Current Law

In tax year 2020, you received a $2,000 tax credit for qualifying children who had not reached age 17 by the end of the tax year. Up to $1,400 of the credit was refundable if you had earned income and had no overall tax liability.

If your modified adjusted gross income (MAGI) exceeded $200,000, or $400,000 on a married-filing-jointly return, then your 2020 credit decreased by $50 for each $1,000 (or fraction thereof) your MAGI was over the threshold.

Child Tax Credit—Tax Year 2021

For tax year 2021 only, the child tax credit amounts are

• $3,000 ($1,000 extra) per qualifying child, for qualifying children ages 6 through 17 at the end of the tax year; or
• $3,600 ($1,600 extra) if the qualifying child is 5 or under at the end of the tax year.

Planning point. The tax code measures your child’s age on December 31. For example, if your child turned 4 in July, your child is 4 on December 31.

Phaseout 1. You’ll reduce the 2021 credit amount that exceeds the $2,000 base credit by $50 for each $1,000 (or fraction) by which your modified adjusted gross income (MAGI) exceeds

• $150,000 for married, filing jointly, or for qualifying widower;
• $112,500 for head of household; or
• $75,000 for all other filing statuses.

Phaseout 2. Once your MAGI exceeds $200,000, or $400,000 on a married-filing-jointly return, then your $2,000 base credit decreases by $50 for each $1,000 (or fraction thereof) that your MAGI is over the thresholds.

In addition, the entire child tax credit is 100 percent refundable as long as either you or your spouse has a principal place of abode in the U.S. for more than one-half of the tax year.

Heads up. Here’s a new wrinkle you need to manage: the IRS will advance you 50 percent of your anticipated child tax credit based on your last filed tax return.

You’ll reconcile the advance payments received with your actual 2021 child tax credit, and if the advance payments exceed your actual credit, you have to pay back the excess with your 2021 tax return.

The IRS will make the advance payments in equal monthly amounts between July and December 2021. You will have access to an IRS online portal where you can opt out of the advance payments or can update your information to avoid having to repay any of the amounts on your 2021 tax return due to a change in circumstances.

Dependent Care Credit—Current Law

In tax year 2020, you could claim a tax credit if you paid someone to care for your under-age-13 dependent or for your spouse or dependent who isn’t able to care for himself or herself.

Your maximum expenses eligible for the credit were 

• $3,000 for one qualifying individual, or 
• $6,000 for more than one qualifying individual.

The credit rate was 35 percent up to an AGI of $15,000. Your credit rate then decreased by 1 percent for each additional $2,000 of AGI (or fraction thereof). Once your AGI was $43,000 or higher, you had a 20 percent credit rate.

Dependent Care Credit—Tax Year 2021

For tax year 2021 only, the maximum creditable expenses are

• $8,000 for one qualifying individual, or 
• $16,000 for more than one qualifying individual.

The credit rate is 50 percent up to an AGI of $125,000. Your credit rate then decreases by 1 percent for each additional $2,000 of AGI (or fraction thereof). Once your AGI is $185,000 or higher, you have a 20 percent credit rate.

However, there is a new upper limit: once your AGI reaches $400,000, you reduce your credit rate by 1 percent for each additional $2,000 (or fraction thereof) of AGI until the rate is 0.0 percent at an AGI of $440,000.

In addition, the dependent care credit is 100 percent refundable as long as either you or your spouse has a principal place of abode in the U.S. for more than one-half of the tax year.

Employer-Provided Dependent Care Assistance

For tax year 2021 only, the maximum employer-provided dependent care benefit excluded from your income as part of your cafeteria plan goes from $5,000 to $10,500 (or $5,250 for married filing separate).

Premium Tax Credit—Current Law

The Affordable Care Act (Obamacare) created the premium tax credit to help you afford insurance purchased on your state’s health insurance marketplace.

Your premium tax credit is equal to

• total monthly premiums for the tax year for the second-lowest silver health plan available on your state’s health insurance marketplace, less
• a certain percentage of your annual household income, with that percentage determined by your annual household income.

The percentage of your annual household income you must pay ranges from 2.06 to 9.78 percent in tax year 2020.

Once your household income exceeds 400 percent of the federal poverty level (FPL), you are no longer eligible for the premium tax credit. For example, the 400 percent thresholds outside of Alaska and Hawaii for tax year 2020 are

• $67,640 for a household of two,
• $85,320 for a household of three, and
• $103,000 for a household of four.

You can receive advances of the premium tax credit based on information you provide to the health insurance marketplace. On your tax return, you then compare your credit with the advance amounts and pay back any advance payments in excess of the actual credit, subject to limits.

New Law—Good Deal

The American Rescue Plan Act of 2021 (ARPA) retroactively removed the requirement to repay any excess advance premium tax credit payments for tax year 2020.

Premium Tax Credit—Tax Years 2021 and 2022

ARPA made several changes to expand access to the premium tax credit for tax years 2021 and 2022.

For tax year 2021 only, if you receive (or receive approval for) unemployment for any week beginning during tax year 2021, then

• you qualify for the premium tax credit (but if married, you must file a joint return with your spouse), and
• you will not take into account any of your household income in excess of 133 percent of the FPL for a family of the size involved.

The above provision creates larger premium tax credits for most anyone who receives unemployment during tax year 2021.

In addition, for tax years 2021 and 2022 only

• you can claim the premium tax credit even if your household income exceeds 400 percent of the FPL, and
• the amount of your household income you must contribute toward your health insurance to calculate your premium tax credit ranges from 0.0 percent to 8.5 percent based on your household income, which is a significant decrease over tax year 2020. The 0.0 percent rate goes up to 150 percent of the FPL.

As you can see, you have far more opportunities for tax credits in 2021. If you would like to discuss any of the credits, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• April 30, 2021

The American Rescue Plan Act of 2021 (ARPA) makes major, but temporary, changes to the federal income tax child and dependent care credit (CDCC). 

Except for when it comes to high-income taxpayers, the changes are all favorable.

To understand the changes, let’s first review the basics. Here goes.

CDCC Basics 

If you have one or more qualifying individuals (usually your children) under your wing, you’re eligible for the CDCC. 

The credit covers eligible expenses that you pay to care for one or more qualifying individuals so you can work, or (if you’re married) so both you and your spouse can work. If you’re married, to claim the CDCC, you generally must file a joint Form 1040 for the tax year in question. 

But some married-but-separated taxpayers are exempt from the joint-filing requirement. 

Qualifying individuals are defined as your under-age-13 child, stepchild, foster child, brother or sister, step-sibling, or descendant of any of these individuals. The child must live in your home for over half the year, and must not provide more than half of his or her own support. 

A handicapped spouse or handicapped dependent who lives with you for over half the year can also be a qualifying individual.

Eligible expenses include payments to a day-care center, nanny, or nursery school. Costs for overnight camp don’t qualify. K-12 costs don’t qualify either because those are considered education expenses rather than care expenses. But costs for before-school and after-school programs can qualify. Costs of domestic help can also qualify, as long as at least part of the cost goes toward care of a qualifying individual. 

Key point. Except for tax year 2021, the CDCC is non-refundable. That means you can use it to offset only your federal income tax liability. If you have no liability, you get no credit.

Expense Limitation

Eligible expenses cannot exceed the income that you earn—or that your spouse earns, if you’re married—from work, self-employment, and certain disability and retirement benefits. 

If you’re married, you generally must use the income earned by the lower-earning spouse for this limitation. So, under the general limitation rule, if one spouse has no earned income, you cannot claim the CDCC. 

But if your spouse has no earned income and is a full-time student or disabled, he or she is deemed to have imaginary monthly earnings of either $250 (if you have one qualifying individual) or $500 (if you have two or more qualifying individuals). Under this exception, you can potentially claim the CDCC even though your spouse does not actually work and has no actual earnings. 

Credit Limitations

Except for tax year 2021, your eligible expenses cannot exceed $3,000 for the care of one qualifying individual or $6,000 for the care of two or more qualifying individuals. 

The maximum credit equals 35 percent of eligible expenses if your adjusted gross income (AGI) is $15,000 or less. So, for taxpayers with very modest incomes, the maximum credit is $1,050 ($3,000 x 35 percent) for one qualifying individual or $2,100 ($6,000 x 35 percent) for two or more qualifying individuals. 

Except for tax year 2021, your credit rate is reduced by one percentage point for each $2,000 (or fraction thereof) of AGI in excess of $15,000, until the rate bottoms out at 20 percent. 

Once your AGI exceeds $43,000, you are in the minimum rate (20 percent) income category. The maximum credit for folks in this income category is therefore $600 ($3,000 x 20 percent) for one qualifying individual or $1,200 ($6,000 x 20 percent) for two or more qualifying individuals. 

Taxpayer-Friendly Changes for 2021

For your 2021 tax year only, the ARPA makes the temporary changes summarized below.

Credit Is Potentially Refundable 

For 2021, the CDCC is refundable if your main residence is in the U.S. for more than half the year. For joint-filing married couples, either spouse can meet this requirement. 

Credit Will Be Much Bigger for Many Families 

For 2021, the dollar limits on the amount of eligible expenses for calculating the CDCC are increased to $8,000 if you have one qualifying individual (up from $3,000) or $16,000 if you have two or more qualifying individuals (up from $6,000). 

For 2021, the maximum credit rate is increased to 50 percent (up from 35 percent). But the credit rate is reduced by one percentage point for each $2,000 (or fraction thereof) of AGI in excess of $125,000. So the rate is reduced to 20 percent if your AGI exceeds $183,000. 

For 2021, the maximum CDCC if you have AGI of $125,000 or less is $4,000 for one qualifying individual ($8,000 x 50 percent) or $8,000 for two or more qualifying individuals ($16,000 x 50 percent). Under the “regular” rules for tax years before and after 2021, the maximum credit amounts are only $1,050 and $2,100, respectively.

For 2021 the maximum CDCC if you have AGI of more than $183,000 is $1,600 for one qualifying individual ($8,000 x 20 percent) or $3,200 for two or more qualifying individuals ($16,000 x 20 percent). Under the regular rules for tax years before and after 2021, the maximum credit amounts when the credit rate is reduced to 20 percent are only $600 and $1,200, respectively.

Credit Rate Is Further Reduced or Eliminated for High-Income Taxpayers

For 2021, the credit rate is 20 percent if your AGI is between $183,001 and $400,000. But once your AGI exceeds $400,000, a second credit-rate-reduction rule kicks in. Your rate is reduced by one percentage point for each $2,000 (or fraction thereof) of AGI in excess of $400,000. So, the rate is reduced to 0 percent if your AGI exceeds $438,000.

Flexible Spending Account Deal for 2021 

For tax year 2021, the ARPA also increased the maximum amount you can contribute to an employer-sponsored dependent care flexible spending account (FSA) from $5,000 to $10,500. Your contribution reduces your taxable salary for federal income and payroll tax purposes (and usually for state income tax purposes, too, if your state has an income tax). Then you can take tax-free withdrawals to reimburse yourself for eligible dependent care expenses. 

If you would like to discuss the CDCC, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• April 28, 2021

For the 2021 tax year only, the American Rescue Plan Act of 2021 (ARPA) makes big, taxpayer-friendly changes to the federal income tax child tax credit (CTC). 

Here’s what you need to know, starting with some necessary background information.

CTC Basics

For 2018-2020 and 2022-2025, the maximum annual CTC is $2,000 per qualifying child. 

A qualifying child is an under-age-17 child who could be claimed as your dependent for the year. Basically, that means the child lived with you for over half the year; did not provide more than half of his or her own support; and is a U.S. citizen, U.S. national, or U.S. resident.

The maximum $2,000 CTC is phased out (reduced) if your modified adjusted gross income (MAGI) for the year exceeds $200,000, or $400,000 for a married joint-filing couple. The credit is phased out by $50 per $1,000 (or fraction of $1,000) of MAGI in excess of the applicable phaseout threshold.

For 2018-2020 and 2022-2025, the CTC is partially refundable. 

You can collect the refundable amount even if you have no federal income tax liability for the year. So, the refundable amount is free money. 

The refundable amount generally equals 15 percent of your earned income above $2,500. 

An alternative formula for determining the refundable amount applies if you have three or more qualifying children. In any case, the maximum refundable amount for 2018-2020 and 2022-2025 is limited to $1,400 per qualifying child. 

(If you have a 2020 tax liability, the CTC can offset up to $2,000.)

More Generous CTC Rules for 2021

For your 2021 tax year only, ARPA makes the following taxpayer-friendly changes. 

Qualifying Children Can Be Up to 17 Years Old 

The definition of a qualifying child is broadened to include children who are age 17 or younger as of December 31, 2021.

Bigger Maximum CTC with Separate Phaseout Rule for the Increase

ARPA increased the maximum CTC to $3,000 per qualifying child, or $3,600 for a qualifying child who is age 5 or younger as of December 31, 2021. But the increased 2021 credit amounts are subject to two phaseout rules: 

1. The increased CTC amount—$1,000 or $1,600, whichever applies—is phased out for single taxpayers with MAGI above $75,000, for heads of household with MAGI above $112,500, and for married joint-filing couples with MAGI above $150,000. The increased amount is phased out by $50 per $1,000 (or fraction of $1,000) of MAGI in excess of the applicable phaseout threshold.
2. The “regular” $2,000 CTC amount is subject to the “regular” phaseout rule explained earlier. 

Key point. If you’re not eligible for the increased CTC amount for 2021 because your income is too high, you can still claim the regular CTC of up to $2,000, subject to the regular phaseout rule.

CTC Is Fully Refundable for Most Folks

For the 2021 tax year, the CTC is fully refundable if you (or, if married, you and your joint-filing spouse) have a principal residence in the U.S. for more than half the year. If you are a member of the U.S. Armed Forces who is stationed outside the U.S. while serving on extended active duty, you’re treated as having a principal residence in the U.S.

For 2021, the CTC is fully refundable even if you have no earned income for the year. 

The MAGI phaseout rules explained earlier apply in calculating your allowable, fully refundable CTC for 2021.

IRS Will Make Advance CTC Payments (We Hope)

Another ARPA provision directs the IRS to establish a program to make monthly advance payments of CTCs (generally via direct deposits). 

Such advance payments will equal 50 percent of the IRS’s estimate of your allowable CTC for 2021. The advance payments will be made in the form of equal monthly installments from July through December 2021. To estimate your advance CTC payments, the IRS will look at the information shown on your 2020 Form 1040 (or on your 2019 return if you have not yet filed your 2020 return). 

If you would like to discuss the CTC with me, please don’t hesitate to call me on my direct line at 408-778-9651.

• By Leon Clinton
• April 24, 2021