In the tax bill being debated in Congress, one of the provisions is to expand the child tax credit. The proposal would:
- Increase the refundable portion child tax credit (known as the “additional child tax credit”), for 2023, by $200, to $1,800. And increase it to $1,900 for 2024 and $2,000 for 2025.
- Index both the regular child tax credit (currently $2,000) for inflation, starting with 2024 (it’s still $2,000 for 2023; will be something higher [presumably, depending on the inflation adjustment] for 2024 and each year afterwards).
In this post I wanted to talk about the refundable portion of the child tax credit.
Refundable vs. Non-Refundable
Tax credits come in 2 varieties: non-refundable and refundable.
- Non-refundable = can bring a taxpayer’s tax liability down to $0, but not below $0
- Refundable – can create a refund (essentially treated as a deposit the taxpayer made)
The child tax credit is non-refundable, but part of it may be refundable, depending on the taxpayer’s earned income.
The non-refundable portion of the credit is applied against a taxpayer’s regular income tax, alternative minimum tax, and any payback of premium tax credits (excess advance premium tax credits).
The non-refundable portion does not apply to taxes such as self-employment tax, additional Medicare tax or the net investment income tax, or any penalties relating to early distributions from retirement accounts (the 10% penalty) or other Form 5329 penalties.
In the video, I show exactly where the non-refundable portion goes on the Form 1040 and which taxes (including those from Schedule 2) it applies against.
Ordering Rules
Want to make your head really spin? Of course you do.
With non-refundable credits, there are ordering rules, meaning there’s a system where certain non-refundable credits are used before other non-refundable credits. For the full ordering rules, see the instructions to Schedule 8812, or the Internal Revenue Manual at 21.6.3.4.1.
For most taxpayers, these credits here are the ones that will show up most often.
- For example, the foreign tax credit, child and dependent care credit (Form 2441), education credits, retirement savings credit, and residential energy credit are all used first
- Then the other dependent credit
- And THEN the child tax credit
If the child tax credit is not used in full at this point, then part of the credit becomes a refundable child tax credit, also known as “additional child tax credit.”
Example 1
Joe and Ellen are married with one child. They qualify for a $2,000 child tax credit. Their tax liability is $7,000, and they have a $600 dependent care benefit (Form 2441). This is their only other credit. The $7,000 tax liability is first reduced by $600 (so down to $6,400) and then reduced by $2,000 for the child tax credit. The child tax credit, in this case, is fully non-refundable, and all used up at this point. There is no additional child tax credit.
Example 2
Let’s say Joe and Ellen’s tax liability is $500. The Form 2441 credit is applied first. This credit is non-refundable, so $500 gets used (and the other $100 of the credit is lost to the wind). This reduces their tax liability to $0. This means, the non-refundable portion of the child tax credit is not used at all. This is where the refundable child tax credit/additional child tax credit comes into play.
Refundable Portion of CTC
The amount of refundable CTC depends on the taxpayer’s earned income. Up to 15% of earned income above $2,500 may be refundable. The maximum refundable portion is $1,600 per child. The proposed bill in Congress would increase the maximum refundable portion to $1,800
Example 3
Continuing with Example 2, let’s say Joe and Ellen’s earned income is $30,000. Up to 15% of earned income above $2,500 is refundable.
$30,000 – $2,500 = $27,500 x 15% = $4,125.
The overall limitation for 2023, though, is $1,600. (Would be $1,800 if this proposal in Congress passes).
So, Joe and Ellen would receive $1,600 as an additional child tax credit. Note that the full CTC would be $2,000 – the unused $400 is lost.
Proposals
The proposal in Congress would increase the maximum refundable portion to $1,800 for 2023 and then $1,900 in 2024 and $2,000 in 2025. The $2,000 full credit amount would be indexed for inflation (i.e. it will increase) starting in 2024.