The recently enacted American Rescue Plan Act (ARPA) of 2021 has good news for your business clients in the form of extension of key COVID-19 credits, including the employee retention credits, and credits for paid family and medical leave. However, key provisions in the new law provide “extra credits” for your individual clients, especially those with families.
Recovery rebates. The new law provides a third round of recovery rebates for individual taxpayers. While most clients will have received the rebates in the form of advance payments, they are technically refundable tax credits that will need to be reconciled on their 2021 tax return.
For 2021, the amount of the tax credit is $1,400 each for adults and any dependents with a valid Social Security number. Initial advance payments that your clients have already received were based on your clients’ 2019 returns, unless their 2020 returns were filed and processed by the initial determination date. However, additional advance payments will be made based on 2020 returns that are filed by the additional payment determination date – that is, the earlier of 90 days after the 2020 return filing deadline (July 15 for returns due April 15) or Sept. 30, 2021. So, for example, a client who welcomed a new baby who was first reported on the 2020 return will get an additional advance payment if that return is filed and processed before the additional advance payment determination date.
For single filers, the credit phases out between $75,000 and $80,000 of adjusted gross income (AGI). The phaseout range is $150,000 to $160,000 for joint filers, and $112,500 to $120,000 for head of household filers.
When filing a client’s 2021 return, the amount allowed as a credit against the tax shown on the return is reduced by advance payments received by the client. Therefore, clients who received the full amount in advance do not get any credit on their returns. Clients who did not receive the full amount in advance – for example, because they added a new dependent in 2021 – will be able to claim the additional amount as a credit against tax due or a refund for 2021. On the other hand, the reverse is not the case. Clients who turn out to be eligible for 2021 credits that are less than the amount of advance payments they received will not have to repay the difference.
Child tax credit. ARPA significantly increases the child tax credit, increases the age limit for qualifying children from 16 to 17, and makes the credit fully refundable for 2021. Moreover, the plan calls for the IRS to make advance payments of a portion of the credit during the year.
For tax years 2018 through 2026, the child tax credit is normally $2,000 per child, phased out for taxpayers with modified AGI above $400,000 on a joint return or $200,000 on another return.
Under ARPA, the amount of the credit is increased to $3,000 for a child age 6 or older, and $3,600 for a child under age 6 for 2021.
For 2021, the credit is subject to a two-part phaseout. The increased amount of the credit above $2,000 per child is phased out by $50 for each $1,000 (or fraction thereof) of modified AGI above $150,000 on a joint return, $112,500 on a head of household return, and $75,000 on a single return. After that, the regular $2,000-per-child credit is phased out under the normal rules for taxpayers with modified AGI above $400,000 on a joint return or $200,00 on any other return.
ARPA directs the US. Treasury to establish a program for making monthly or other periodic advance payments of a portion of the credit beginning in July 2021. The total advance payments will equal 50% of the allowable credit calculated based on information from the taxpayer’s 2019 or 2020 return (depending on which return was filed and processed at the time of the calculation). However, the information will be modified to account for the passage of time since the return year. For example, if a credit was claimed on a 2019 return for a child who was age 16, that child would not be included in the calculation for 2021 since the child would have aged out of the credit. On the other hand, ARPA directs the U.S. Treasury to establish an online portal to allow taxpayers to update information for calculating the advance payments, such as the birth of a child, a change in marital status, or a significant change in income. Taxpayers will also be able to use the online portal to opt out of receiving advance payments.
As a general rule, the child tax credit is only partially refundable. However,ARPA makes the credit fully refundable for 2021.
As with the recovery rebate credit, advance payments of the child tax credit will have to be reconciled on a client’s 2021 return. The amount of the credit allowed against the tax shown on the return will be reduced by the amount of advance payments. If the advance payments exceed the amount of allowable child tax credit, the excess will be treated as an increase in tax. However, the increase in tax will be reduced by a safe harbor amount based on modified AGI. For taxpayers with modified AGI of $60,000 on a joint return, $50,000 on a head of household return, or $40,000 on a single return, the safe harbor amount is $2,000 multiplied by the excess (if any) of qualified children taken into account in determining the advance payments over the number of qualifying children taken into account in determining the actual allowable credit. The safe harbor amount will be phased out for taxpayers with modified AGI up to 200% of the income thresholds.
Child and dependent care credit. As with the child tax credit, the credit for child and dependent care is made refundable for 2021. In addition, ARPA increases the dollar limits on creditable expenses, the credit percentage, and the phaseout thresholds for higher-income taxpayers.
For 2021, the dollar limit on creditable expenses is increased from $3,000 to $8,000 for taxpayers with one qualifying child or dependent. The dollar limit is increased from $6,000 to $16,000 for taxpayers with two or more qualifying children or dependents. The credit percentage is increased from 35% to 50%, subject to a phaseout for taxpayers with AGI above $125,000 (up from $15,000). For 2021, the credit percentage is reduced by 1% (but not below 20%) for each $2,000 (or fraction thereof) of taxable income above $125,000. In addition, the remaining 20% credit rate is reduced by 1% for each $2,000 (or fraction thereof) of AGI above $400,000. Thus, for taxpayers with AGI between $183,000 and $400,000, the credit rate is 20% and, for taxpayers with AGI above $438,000, the credit is fully phased out.
ARPA also increases the amount of excludable employer-provided dependent care assistance from $5,000 to $10,500 (from $2,500 to $5,250 for married filing separately) for 2021. As under prior law, expenses paid with excludable dependent care assistance cannot be taken into account in calculating the child and dependent care credit.