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.
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.
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.
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 contact us at 262-358-8297.
To aid in the battle against the coronavirus and its health, societal, and economic effects, U.S. President Joseph Biden signed into law a new act containing numerous tax measures, including the new recovery rebate credit, as well as reforms to the child tax credit, the child and dependent care credit, and the excess business loss regime.
Here's all you need to know, starting with some background details. The federal income tax child tax credit has undergone significant, taxpayer-friendly reforms (CTC)
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:
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 jointly 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.
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 jointly 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).
On December 27, 2020, the Consolidated Appropriations Act of 2021 was signed into law. About $900 billion was set aside for various coronavirus (COVID-19) relief programs, as well as $1.4 trillion in government funding and a slew of tax provisions.
It opened the door (retroactively and going forward) for PPP participants to also claim the employee retention credit (ERC).
Reminder. Tax credits are the best. They usually reduce taxes dollar-for-dollar.
(The ERC is not quite as good as the usual tax credit, because you increase taxable income by the amount of the credit. But it’s still good—very good.)
The CARES Act, enacted on March 27, 2020, created the PPP money, but it prohibited you from getting both PPP money and tax credits from the ERC; you had to choose one benefit or the other. Now, thanks to the new December law, you can have both tax-free PPP money and tax credits from the ERC.
And perhaps the best news of all comes from the IRS in its recently released, business-friendly guidance on how the rules work when you want to claim both PPP and ERC benefits.
How the Law Changed
The CAA made four important changes retroactive to 2020:
You may now qualify (yes, retroactively) to claim the ERC for 2020 wages even though you had a 2020 PPP loan.
You may not claim the ERC on PPP wages used for PPP loan forgiveness.
You can elect not to claim the ERC, so as to increase your tax-free PPP monies.
If your lender denies your PPP loan forgiveness, you can claim the ERC for the qualified wages even when you made the election not to claim the ERC for those wages.
Congress made the changes retroactive to March 13, 2020, allowing you to now amend your 2020 payroll tax returns to claim the employee tax credits for which you are eligible.
You likely hadn’t thought of amending payroll tax returns, because it’s not often done. But you have the three-year statute of limitations for amending payroll taxes just as you have it for your income tax returns.
If you are married, most likely you’ve always filed a joint tax return with your spouse.
Most of the time, a joint return shows less overall tax than two separate tax returns do, because the married-filing-separately status has many tax disadvantages.
Fast-forward to the 2020 tax filing season, however—and nothing is as it was.
This year, four tax provisions will be key to determining whether you’ll be better off filing a joint tax return or separate tax returns for tax year 2020:
The American Rescue Plan Act of 2021, which was signed into law on March 11, 2021, excludes from tax the first $10,200 of 2020 unemployment benefits paid to an individual with 2020 modified adjusted gross income (MAGI) of less than $150,000.
Recovery Rebate, Round 1
The recovery rebate, round 1, is a refundable tax credit on the 2020 tax return, equal to
Your credit decreases by 5 percent of the amount your adjusted gross income (AGI) exceeds
The IRS gave you an advance payment of this credit based on either your 2018 or 2019 AGI and dependents. And now the IRS looks at your 2020 tax return and does the following:
Recovery Rebate, Round 2
This is a refundable tax credit on the 2020 tax return, equal to
Your credit decreases by 5 percent of the amount your AGI exceeds
The IRS gave you an advance payment of this credit based on your 2019 AGI and dependents. And now the IRS looks at your 2020 tax return and
Recovery Rebate, Round 3
This is a refundable tax credit on the 2021 tax return, equal to
Your credit phases out over the following AGI ranges:
The IRS will give you an advance payment of this credit based on your 2019 or 2020 AGI and dependents. If your first advance payment used your 2019 return information, then the IRS will send an additional payment based on your 2020 tax return if the IRS processes your 2020 tax return by August 15, 2021.
You then reconcile your advance payment(s) on your 2021 tax return:
Why Separate Returns Could Be Better
There are two main reasons you may have net lower federal tax with separate returns versus a joint return.
First, if your MAGI is $150,000 or more on a joint return, but the spouse who received the unemployment compensation earns under $150,000 on a separate return, then that spouse can take the full exclusion up to $10,200 (except possibly in a community property state).
Second, if one spouse has AGI of $75,000 or less, but your joint AGI is over $150,000, then that spouse can claim the dependents and get all the available round 1 and round 2 credits on the 2020 tax return as well as the entire round 3 advance payment.
When considering the above, keep two important notes in mind:
Important note. You may lose other deductions and credits on a separate return. The only way to know which is better in light of these temporary provisions is to run your tax returns both ways and see which puts you ahead. For example, separate returns can change your health insurance premium tax credit and perhaps some non-tax items such as your Medicare premiums.
As you can see there’s much to consider. If you would like me to check this out for you, please call me on my direct line at xxx-xxx-xxxx.
Congress is offering billions of dollars in future tax deductions for those who file Form 1040 individual tax returns for the tax year 2021. The child tax credit, dependent care credit, and health insurance premium tax credit are among the tax credits that have been temporarily extended.
The numerous credits could potentially place an extra $5,000 or more in your wallet for the tax year 2021. With good tax planning, this money could be all yours.
Child Tax Credit—Current Law
For qualifying children under the age of 17 at the end of the 2020 tax year, you got a $2,000 tax credit. If you had earned income and no net tax obligation, you received up to $1,400 of the credit as a refund.
This credit decreased by $50 per $1,000 over the MAGI threshold.
The MAGI threshold for 2020 is $200k or $400k MFJ.
The entire child tax credit is fully refundable if you or your spouse has a primary residence in the United States for more than 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
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
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
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
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 contact us.
This is likely it--your last chance to obtain first- and second-draw Paycheck Protection Program (PPP) monies.
A new law, the PPP Extension Act of 2021, extends the expiration date to the later of May 31 or when the money runs out. Note the phrase “when the money runs out,” and be forewarned that this can happen within weeks. So don’t procrastinate--not even for one day.
If you qualify for the first-draw PPP money, complete your application now. The money is going to run out fast--and once it’s gone, so is the PPP. Legislatively, the new round for the PPP ends on May 31. The clock ticks.
You qualify for the PPP if any of the following are true:
If you qualify, you want the PPP. It’s a much-needed, tax-free cash infusion. It’s called a loan, but it’s not. You have to repay loans. The PPP does not have to be repaid--it’s forgiven.
Plus, expenses paid with this forgiven PPP loan are tax-deductible.
If you need my help with either the first-draw or second-draw PPP, please contact us.
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Spencer Accounting Group, LLC does not provide investment, tax, legal, or retirement advice or recommendations in these blogs. The information presented here is not specific to any individual's personal circumstances.
Keana Spencer is an Accountant, Entrepreneur, and Educator to her clients, with a strong passion. Keana has over 10 years of experience and through her practice, she is a source of knowledge and strategies to her clients.