Tax

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

With the passage of the American Rescue Plan Act of 2021 (ARPA), Congress has temporarily abolished the health insurance premium tax credit “subsidy cliff.” 

For 2020 and 2021, self-employed and small-business owners and other individuals who must purchase individual health insurance may qualify for premium tax credit health insurance subsidies even if their income far exceeds the old limit of 400 percent of the federal poverty level (FPL).

To take advantage of the government subsidy, go to the health insurance marketplace (federal marketplace or state exchange) before August 15, 2021. The government expanded the open enrollment period. You can’t be turned down.

For 2020 and 2021, Americans who earn over 400 percent of the FPL are required to pay no more than 8.5 percent of their modified adjusted gross income (MAGI) for their premium tax credit (PTC) health insurance. Regardless of how high their income is, they are entitled to a PTC to the extent the cost of the silver benchmark plan exceeds 8.5 percent of MAGI.

Let’s take a look at Al and Alice. They are a self-employed, married couple who live in Seattle. Both are 62 years old. The annual cost for them of the benchmark silver plan in their area is $21,000. Their MAGI is $150,000. 

For 2021 and 2022, they are required to pay no more than $12,750 for PTC health insurance (8.5 percent x $150,000 = $12,750). Thus, they are entitled to a PTC of $8,500 ($21,000 – $12,500 = $8,500). 

If their MAGI was $200,000, they would have to pay $17,000 for PTC coverage and would still be entitled to a $4,000 tax credit ($21,000 – $17,000 = $4,000).

If you are looking for a possible reduction in your health insurance cost, I suggest checking out www.healthcare.gov. The government will direct you to the proper place (federal marketplace or state exchange).

• By Leon Clinton
• April 21, 2021