Tax Prep: What to do if You Received Advance Child Tax Credits

Tax season always adds complexity to our lives, but your 2021 tax return could have a few more twists and turns if you received advanced payments of the IRS Child Tax Credit. Let's discuss. Since I’m not a credentialed financial advisor, the answers (observations) I give are strictly my opinion.

Child Tax Credit 101

Brimming with goodies, the American Rescue Plan (ARP) was signed into law on March 11, 2021 - almost exactly a year after our country screeched to a halt due to the onset of the COVID-19 pandemic.

Among the American Rescue Plan's many features was the largest Child Tax Credit (CTC) ever. What is the CTC? It's a tax benefit for American taxpayers for each qualifying child and is intended to provide financial relief for working families. It decreases taxpayers’ tax liability on a dollar-for-dollar basis.

The ARP increased the Child Tax Credit from $2,000 to $3,000 per child over the age 6 and to $3,600 for kids under age 6. The plan also raised the age of eligibility from 16 to 17. Working families making up to $150,000 for a couple or $112,500 for a family with a single parent (called Head of Household) received full credit.

Under the ARP, the Internal Revenue Service (IRS) paid half the total credit amount in advance monthly payments beginning July 15, 2021, unless you informed Uncle Sam that you wanted to opt out of advance payments. You will claim the other half when you file your 2021 income tax return. (These changes apply to tax year 2021 only.)

Here are two handy examples I borrowed from The Child Tax Credit Section on the White House's website:

Tax Implications

So, if you didn't opt out (and have kids) you started receiving monthly payments of $250 or $300 per child in mid-2021. And few people opted out. In fact, over 36 million families received advance CTC payments - the need for financial assistance obviously played a role in these decisions. Those that received advanced payments can claim the rest of the CTC, if eligible, upon filing their 2021 tax return.

Therein lies the challenge.

The thing that may cause heartburn for some taxpayers when filing their 2021 taxes – particularly those expecting sizable tax refunds – will be a result of these monthly direct deposit CTC payments delivered to those millions of families from July 15 through the end of 2021. Early receipt of direct deposit credits in many cases will reduce the availability of former “boosted refunds” or a “lower amount of taxes due” for families who didn’t opt out. Eligible taxpayers were warned of this possibility, but the lure of early financial assistance proved hard to resist.

Refund Reduction?

There are a couple of ways that the receipt of advance CTC payments could result in you receiving a smaller tax refund than expected or even owing the IRS money:

If the total amount of advance CTC payments received during 2021 exceeds the amount of the 2021 CTC you can properly claim on your 2021 tax return, you may need to repay that excess amount.
For certain taxpayers, the total amount of advance CTC payments received in 2021 might be greater than the amount of increase in their 2021 CTC compared to the amount of CTC they claimed for tax year 2020. Thus, these taxpayers will claim a smaller amount of Child Tax Credit on their 2021 tax return, as compared to their 2020 tax return. This could reduce the taxpayer's refund…or cause the taxpayer to owe money to the IRS.

CTC Tax Tools

In January 2022, the IRS should have sent you a form - Letter 6419 - that details the total amount of early CTC payments sent to you during 2021. This letter should help you reconcile the total amount of the CTC payments you received during 2021 with the amount of the CTC you can properly claim on your 2021 tax return.

You, not the IRS, must determine the amount of the CTC (if any) for which you are eligible. Without getting too deep into the weeds, to determine that amount, use Schedule 8812, Credits for Qualifying Children and Other Dependents. Schedule 8812 helps the IRS determine your eligibility and the amount of your credit based on your 2021 tax return information and the total amount of any advance CTC payments you received in 2021. Here's the IRS' instructions on how to fill out Schedule 8812 and other helpful information.

Government assistance, large and small, comes with a price. This is your price.

Still the Same

One thing that didn’t change in 2021was the amount workers could contribute to traditional and Roth IRAs.

The maximum for 2021 – as well as for 2022 – remained at $6,000 for workers under age 50. The “catch up” contribution for folks 50 and over also remained unchanged…at $1,000. The IRS has typically increased contribution limits to IRAs every couple of years due to inflation-induced “cost of living.” Not this year…a time when the need for such an adjustment appears rather apparent.

Inflation adjustments for 401(k)s and similar plans rose to $20,500 for 2022 from 2020 and 2021 levels of $19,500. But based on what’s happening with inflation at 7% or more, that won’t be enough to stay even unless inflation begins to ebb, which appears unlikely.