Wednesday, April 14, 2021
3 Credits in the “American Rescue Plan” Mediators Must Know About
Congress has recently passed the “American Rescue Plan” (aka the “stimulus bill”), which has provisions that can significantly increase the benefit of child-related deductions and credits.
The law makes changes to the Child Tax Credit, Child Care Credit, and Earned Income Credit that enhance their value to the person receiving them, especially for the 2021 tax year.
I thank the folks at Family Law Software for getting these details laid out in a recent newsletter. Their divorce financial planning software is exceptional and has a robust tax module we use to help our clients see the tax impact of their financial decisions. They have recently added a feature allowing mediators to see the benefits of these new credits when given to one party or the other.
The Child Tax Credit Boosted for 2021
The new law increases the Child Tax Credit for 2021 only. That credit is increased from $2,000 per child to $3,000 per child. Here are the details.
- Children normally must be under the age of 17 at year-end to qualify, but for 2021, that age is 18.
- For children under the age of 6, the credit can be an additional $600, for a total of $3,600, also for 2021 only.
- For 2021, the credit is refundable (meaning they get it even if they pay no taxes) for people who have no income. For other years if a party's income is less than $2,500, the credit is not refundable.
- Also, for years other than 2021, the credit is only partially refundable. For 2021, it is fully refundable. Like the previous provision, this one helps low- income people who do not have any tax liability.
- The 2021-only benefits (an additional $1,000 per child, plus $600 for children under age 6) start phasing out if the party's income is $75,000 (single), $112,500 (head of household), and $150,000 (filing jointly).
For comparison, the existing- law benefit ($2,000 per child) starts phasing out at $200,000 for single or head of household and $400,000 if joint.
Child Care Credit
The Child Care Credit gives parents a credit against taxes for a percentage of child care expenses, up to a maximum amount of covered expenses.
- In years before and after 2021, the percentage ranges from 20% to 35% (depending on income) and the maximum covered expenses is $3,000 for 1 child and $6,000 for 2 or more children.
- This gives you a maximum credit of $1,050 for 1 child (35% of $3,000) and $2,100 for 2 or more children (35% of $6,000).
But in 2021, both the maximum percentage and the maximum expense level counted have increased.
- The maximum percentage is now 50% and the expense that can be counted increases to $8,000 for 1 child and $16,000 for 2 or more children. As a result, in 2021, the maximum credit is $4,000 for 1 child and $8,000 for 2 or more children, almost $3,000 and $6,000 more than the credit in other years.
- In the years before and after 2021, the credit can reduce taxes to zero, but if a party doesn’t owe any tax, they don't get any benefit from the credit. In 2021, if they have an $8,000 credit and don't owe any tax, they will still get an $8,000 payment.
Another change concerns the phase-down for higher-income taxpayers.
- The credit always phased down for higher-income taxpayers, but the phase-down is different in 2021. For 2021, the phase-down can reduce the percentage to zero for very high-income taxpayers (adjusted gross income of $440,000 or more).
- For other years, the phase-down can reduce the percentage to 20% of day care expenses, but not below that level.
Earned Income Credit
The new law also increases the benefits from the Earned Income Credit, primarily for 2021 only.
The Earned Income Credit is a government subsidy to people who have some earned income but are still low-income earners. The credit increases as earned income increases, up to a point, and then decreases (to zero) as income increases further past that point.
For tax year 2021, if you were head of household and had one child, that peak income point was $19,520. The Earned Income Credit at that point is $3,617. The credit decreases as income increases beyond this point. The credit would hit zero when earned income reached $41,756. (These numbers are all inflation-adjusted every year and are not affected by the Stimulus Bill.)
Here are the key changes from the stimulus bill, which apply to 2021 only:
- If you have no children, the maximum credit goes from $543 to $1,502.
- Qualifying childless taxpayers may be as young as age 19, if they are not students. (For years other than 2021, the youngest age is 25.)
- Taxpayers have an option to use 2019 earned income, if that gives a better result than 2021 income.
Another change in eligibility, relating to people who file as "married filing separately", will be permanent.
- Until now if you filed as "married filing separately," you were not eligible. Now, you may be eligible even if you claim that tax status. You need to have lived with a qualifying child for more than half the year.
- And you need to either have separated before July 1; or have signed a divorce or separation agreement and be living apart by December 31.
As always couples should consult with their tax advisor when making these decisions.
J. Anthony Licciardello is a mediator and Certified Divorce Financial Analyst (CDFA) with Wentworth Divorce Consultants located in Norton, Massachusetts, Barrington, Rhode Island, and Dennis, Massachusetts.