As you probably already know, a third round of stimulus has become law. And you may already know the law includes another stimulus payment. On top of that the law includes enhancements to the Child Tax Credit. But there is a whole lot more to it. Let’s take a look.
Like the preceding stimulus checks this check is an advance payment of a credit on your current year’s tax return. So, the current stimulus check is a tax credit based on your 2021 income and tax return. But it was or will be paid based on the most current tax return the IRS has on file (2019 or 2020).
This round of stimulus checks has a much tighter phase out range. For Married Filing Jointly (MFJ) the phase out range is $150,000 - $160,000 of AGI, $112,500 - $120,000 for Head of Household (HOH) and $75,000 - $80,000 for single. Depending on which filing status applies to you, you could lose between 10% - 20% of the credit per $1,000 of income over the lower limit.
Another difference with this round of stimulus, is that you earn it for all dependents (including parents), not just children that qualify for the Child Tax Credit.
The third difference applies to payment. The IRS took its first look at your tax records a couple of weeks ago and paid the credit (or didn’t) based on the most current tax return they have on file. The IRS will take a second look 90 days after May 17th and make a payment based on the most current tax return on file. The final look will occur when you file your 2021 tax return and the payment will be calculated based on your 2021 tax return.
None of the credits paid are recoverable. In other words, if you get paid the credit you get to keep it, regardless of how it might be calculated based on a different year's tax return.
These factors bring up some interesting scenarios:
- If your 2020 income would put you in or above the phase-out range and you haven't filed your 2020 return and your 2019 tax return which had lower income qualifies you for the credit , sit on your 2020 return until you determine if a payment has been received and/or mailed.
- If your 2020 income is lower than 2019 and will make you eligible for the credit, make sure that you get your 2020 return filed soon but definitely before 90 days after May 17th. Note that this earlier than the extended deadline of 15 Oct.
- If Junior was a dependent in 2020 and won’t be in 2021 and you get a check based on him, he’ll get a second check when he files his 2021 tax return. Just make sure you don’t miss the second look (90 days after 17 May).
- If your 2021 earnings are near or in the phase-out range and you have a lot of dependents look really hard at reducing your income. Increase deductible contributions to retirement plans at work, defer bonuses into next year or even take unpaid time off. Here’s an example. You're married with 3 kids and have an AGI of $160,000. Your boss allows you to take enough unpaid time off to reduce your income to $150,000. Just looking at the federal income tax changes and the credits, that time off would cost you $800. Your income would go down by $10,000. Your income taxes would go down by $2,200 (22% bracket) and you would get $7,000 in credits. Not a bad price for about 3 weeks of extra time off.
The Child Tax Credit is also changed for 2021. The first big change is that it goes up from $2,000 per child to $3,000 per child. In addition, the credit is increased to $3,600 for children under the age of 6. The upper limit for the credit is increased from 16 to 17 (technically younger than 18).
The credit is subject to a dual phaseout. The first phaseout occurs at the same income limit as the stimulus checks and is $50 per $1,000 over the threshold until the additional $1,000 or $1,600 is eliminated. Then the phaseout stops and starts again at the limits established for the normal Child Tax Credit ($400,000 for MFJ).
Up to 50% of the credit will be paid out in 2021 starting in July. You’ll want to keep good records of these payments, so that you can accurately complete your 2021 tax return. Unfortunately, this credit can be clawed back if income in 2021 puts you into the first phase out range and 2020 didn’t. There is a safe harbor for the claw back, but your income has to be pretty low.
One last thing. The credit is fully refundable. That means if you have a lot of kids eligible for the credit and your normal tax bill is pretty low you might get a larger refund than what you actually had withheld from your taxes.
Military Finances are Different
While this particular change to taxes applies to all Americans, that isn't always the case. There are special carve outs in the tax code for military members and veterans. There are also benefits available to active and retired military members that don't have a civilian equivalent. That's why we think you should work with a financial planner or advisor that specializes in working with military (active and retired). If you'd like to chat, give us a call or sign up for a free initial consultation.
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