Updated: Jul 1
This is an overview of the many tax benefits included in the American Rescue Plan Act recently passed by Congress that will impact families with children and lower-income taxpayers during 2021. These include increased child care benefits plus an increased child tax credit, including advanced monthly payments for some.
Child and Dependent Care Credit
The new law increases the amount of credit. The percentage of employment-related expenses for qualifying care considered in calculating the credit modifies the phase-out of the credit for higher earners and makes it refundable for eligible taxpayers.
For 2021, eligible taxpayers can claim qualifying employment-related expenses up to:
$8,000 for one qualifying individual, up from $3,000 in prior years, or
$16,000 for two or more qualifying individuals, up from $6,000.
The maximum credit rate in 2021 is increased to 50% of the taxpayer's employment-related expenses. This means the maximum credit will be $4,000 for one qualifying individual or $8,000 for two or more qualifying individuals. In past years the credit rate varied from 35% down to 20%. When figuring the credit, a taxpayer must subtract tax-free employer-provided dependent care benefits, such as those provided through a flexible spending account, from total employment-related expenses.
A qualifying individual is a dependent under the age of 13, a dependent of any age, or a spouse who is incapable of self-care and lives with the taxpayer for more than half of the year.
As before, the more a taxpayer earns, the lower the percentage of employment-related expenses that are considered in determining the credit. However, under the new law, more individuals will qualify for the maximum credit percentage rate. That's because the adjusted gross income level at which the credit percentage starts to phase out is raised to $125,000. In contrast, it was only $15,000 under the prior law. Above $125,000, the 50% credit percentage goes down as income rises. It is entirely unavailable for any taxpayer with an adjusted gross income of over $444,000.
The credit is fully refundable for the first time in 2021. This means an eligible taxpayer can benefit, even if they owe no federal income tax. To qualify for the refundable portion of the credit, a taxpayer, or the taxpayer's spouse if filing a joint return, must reside in the United States for at least half of the year.
Workers Can Set Aside More in a Dependent Care FSA for 2021
The maximum amount of tax-free employer-provided dependent care benefits are increased to $10,500. This means an employee can set aside $10,500 in a dependent care flexible spending account instead of the usual $5,000. However, workers can only do this if their employer adopts this change. Employees should contact their employer for details.
Childless EITC Expanded for 2021
For 2021 only, more workers without qualifying children may be eligible for the earned income tax credit. This fully refundable tax benefit helps many low- and moderate-income workers and working families. That's because the maximum credit is nearly tripled for these taxpayers and is, for the first time, available to younger workers and now has no age limit cap.
For 2021, EITC is generally available to filers without qualifying children at least 19 years old with earned income below $21,430 or $27,380 for spouses filing a joint return. The maximum EITC for filers with no qualifying children is $1,502.
Another change for 2021 allows individuals to figure the EITC using their 2019 earned income if it was higher than their 2021 earned income. In some instances, this option will give them a more considerable credit.
Other Changes Expand EITC for 2021 and Beyond
Additional new law changes expand the EITC for 2021 and future years. These changes include:
More workers and working families who also have investment income can get the credit. Starting in 2021, the amount of investment income they can receive and still be eligible for the EITC increases to $10,000.
Married but separated spouses who do not file a joint return may qualify to claim the EITC. They are eligible if they live with their qualifying child for more than half the year and either:
Do not have the same principal place of abode as the other spouse for at least the last six months of the tax year for which the EITC is being claimed, or
Are legally separated according to their state law under a written separation agreement (or decree of separate maintenance), and do not live in the same household as their spouse at the end of the tax year for which the EITC is being claimed.
Expanded Child Tax Credit for 2021
The American Rescue Plan Act made several notable but temporary changes to the child tax credit, including:
Increasing the amount of the credit.
Making it available for qualifying children who turn age 17 in 2021.
Making it fully refundable for most taxpayers.
Allowing many taxpayers to receive half of the estimated 2021 credit in advance.
Taxpayers who have qualifying children under age 18 at the end of 2021 can now get full credit even if they have little or no income from a job, business, or other sources. Before 2021, the credit was worth up to $2,000 per qualifying child. The refundable portion was limited to $1,400 per child and required at least $2,500 of earned income. The new law increases the credit to $3,000 per child ages 6 through 17 at the end of 2021 and $3,600 per child age 5 and under at the end of 2021. For taxpayers who have their primary homes in the United States for more than half of the tax year and bona fide residents of Puerto Rico, the credit is fully refundable. The $1,400 limit and earned income requirement do not apply.
The maximum credit is available to taxpayers with a modified adjusted gross income of:
$75,000 or less for single filers and married persons filing separate returns.
$112,500 or less for heads of household.
$150,000 or less for married couples filing a joint return and qualifying widows and widowers.
Above these income thresholds, the excess amount over the original $2,000 credit — either $1,000 or $1,600 per child — reduces by $50 for every $1,000 in additional modified AGI. The initial $2,000 credit continues to be reduced by $50 for every $1,000 that modified AGI is more than $200,000 or $400,000 for married couples filing a joint return.
Advance Child Tax Credit Payments
From July 15 through December 2021, Treasury and the IRS will advance one-half of the estimated 2021 child tax credit in monthly payments to eligible taxpayers. Eligible taxpayers have a primary home in the United States for more than half the year. This means the 50 states and the District of Columbia. U.S. military personnel stationed outside the United States on extended active duty are considered to have a primary home in the United States.
The monthly advance payments will be estimated from the taxpayer's 2020 tax return or their 2019 tax return if 2020 information is unavailable. Advance payments will not be reduced or offset for overdue taxes or other federal or state debts that taxpayers or their spouses owe. Taxpayers will claim the remaining child tax credit based on their 2021 information when they file their 2021 income tax return.
The IRS is developing an online portal that taxpayers can use to opt-out of the advance child tax credit payments or notify the IRS of changes in their situations, such as the child's birth in 2021, impacting the monthly payment amounts. The IRS should be releasing details about this soon.
These are substantial financial benefits. If you have further questions regarding these benefits, please give this office a call.