Many people are asking what the advance child tax credit payments that start in July will do to their 2021 taxes. The short answer is, it could reduce your refund.
Let’s say you have 1 kid. Normally the child tax credit is $2,000. The “enhanced” credit for 2021 is now $3,000 (if the kid is ages 6-18) or $3,600 (ages 5 and under). You’ll receive 1/2 of the credit in advance over the last 6 months of the year. So let’s say you qualify for a $3,000 credit for the kid. The advance is: 3,000 / 12 x 6 = $1,500 ($250 per month from July-December).
So when you file your 2021 return, the credit is $3,000 … but you’ve already received $1,500 in advance, so really the credit you’ll claim on the return is the other $1,500 … which is less than the $2,000 credit you’d normally receive. Your refund would drop $500 (but remember you’re getting $1,500 in advance so you come out ahead over all).
Also the credit for daycare expenses is substantially increased for 2021. If you pay daycare expenses the credit you’ll receive will likely be higher. As always with taxes, there are caveats: if you use a daycare flex plan through your employer, you’ll save on income taxes and FICA taxes through payroll, but your tax credit is reduced.
Example with Numbers
Let’s take a married couple with 1 kid, and $90,000 of total income. Let’s keep things simple and say they have no daycare expenses and they claim the standard deduction.
$90,000 – $25,100 standard deduction = $64,900 taxable income.
The tax on $64,900 is $7,300.
In a normal year, the child tax credit is $2,000. $7,300 – $2,000 = $5,300 net tax liability.
With the enhanced child tax credit, here’s how the return ends up differently. Let’s say the kid is over age 5 and so the credit amount is $3,000.
ADVANCE RECEIVED: the advance received would be $1,500, leaving another $1,500 of credit to claim on the return. $7,300 – $1,500* = $5,800 net tax liability. (*-The full credit is $3,000, but 1/2 of it was paid between July and December of 2021.)
ADVANCE NOT RECEIVED: this couple would get a $3,000 child tax credit claimed in full on their return. $7,300 – $3,000 = $4,300 net tax liability.
As I have written about before, tax refunds are not magic, no matter what H&R Block or TurboTax might try to convince you of. Tax refunds are born out of a combination of tax credits and tax withholding. So in our example here, whether this couple owes or gets a refund depends on how much tax they had withheld from their paychecks versus their net tax liability of $5,300/$5,800/$4,300.
What Should You Do?
I know many tax pros who are giving a blanket recommendation to opt out of the advances. I am not doing so myself, though I do tell people to use caution, especially if their income is close to phaseout thresholds on the child tax credit ($75,000 for single, $112,500 for head of household, $150,000 for married filing jointly).
People also need to understand that their refunds might go down, but they’re coming out ahead overall. They’re simply getting part of the refund paid before the tax return is filed.