Some Comments on the 2021 Enhanced Child Tax Credit

Key features of the New Child Tax Credit:  The American Rescue Plan increases the child tax credit from $2,000 to $3,000 for dependent children age 5 to 17 and to $3,600 for children 5 and under.   

The extra $1,000 or $1,600 is phased out at AGI of $75,000 for single filers and $150,000 for married joint filers.  

Half of the tax credit will be paid in advance and half will be applied as a credit towards taxes paid on the 2021 tax return.   The Kiplinger report has a useful on-line tax calculator that provides an estimate of a taxpayer’s monthly stipend based on four variables – (1) filing status, (2) number of children age 5 or under, (3) number of children age 6 to 17, and (4) estimated AGI.   The AGI estimate is obtained from the 2020 tax return unless one is not available in which case AGI is obtained from the 2019 return.

The new child tax credit is only in existence for the 2021 tax year. The Biden Administration wants to make the tax credit permanent.

Some Comments on the New Child Tax Credit:

Comment One:   The rationale for the advanced monthly payment of the childcare tax credit is that the advanced payment will give taxpayers money in their pockets during the year.  Advanced payments are not needed to achieve this goal.   This goal could be achieved by allowing taxpayers who plan to claim the credit the right to reduce the amount of tax withheld from their paycheck.   Advanced payments for the tax credit covering health insurance premiums enacted in the ACA are needed because the person claiming the credit must pay insurance premiums and the credit is sent directly to the health insurance firm.  No such imperative exists for the child tax credit.

Comment Two:   The advanced monthly payments are based on an estimate of 2020 income or 2019 income if 2020 income was not available.  The taxpayer will receive advanced payments larger than she is entitled to if actual AGI exceeds estimated AGI, a situation that is likely given depressed income levels in 2020 and the current strong recovery.  Will many taxpayers owe the IRS money in this situation?  Why did Congress create an advanced tax credit that increases financial uncertainty when it would be less complex to simply have taxpayers adjust the amount of tax withheld.  Taxpayer estimates of the amount that should be withheld are almost certainly likely to be more reliable than estimates generated from past AGI.  Also, the amount withheld can be modified at any time in the tax year as income changes.

Comment Three:   The child tax credit will increase the number of taxpayers paying little or no tax.    The tax credit is refundable and does not alter the marginal tax rate applied to taxable income; hence, the tax credit does not appear to impact the difference in taxes paid from the choice between a conventional or Roth IRA.  However, the extra liquidity and lower tax obligation might make the choice of a Roth more attractive.  The potential tax savings from the use of Roth accounts in retirement are huge.  Consider a recent post on the advantages of Roth accounts.  Hope to share more on this topic soon.

Final Comments on the Biden Economic Approach:  I do believe the Biden team has their heart in the right place.   I would have prioritized permanent subsidies for health insurance premiums and additional subsidies for retirement savings over the expansion of the tax credit because such subsidies are more likely to remain in place over the long haul and these subsidies help fix other economic problems.

Many of the benefits enacted in the COVID relief bill including their child tax credit and some health care subsidies phase out quickly.    Phaseouts are sometimes necessary in order to meet budget blueprints and rules of the reconciliation process.   The case can be made that the reason for the short phaseout of some benefits in the COVID relief bill is political because Congress will have to vote on these popular benefits prior to elections.

The extra unemployment benefits in the COVID relief bill have been eliminated in many states.  In retrospect, funds allocated to programs like the enhanced unemployment benefit should have been allocated to a permanent enhanced childcare or health care tax subsidy.

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