As you may know, Congress passed a stimulus bill in March, 2021, officially called the American Rescue Plan.
The bill has many provisions, but three tax provisions in particular will affect the calculations in Family Law Software, especially for the 2021 tax year, with significant impact on cash flow, taxes, and child support.
This will affect your negotiations for who claims the tax exemptions and thus the child tax credit.
This post explains the provisions and how handle them in Family Law Software.
Child Tax Credit
The new law increases the Child Tax Credit (also known simply as the Child Credit) for 2021 only.
The headline here is that the credit is increased from $2,000 per child to $3,000 per child, but only for 2021.
There were a number of additional tweaks that will benefit specific groups of people:
- Children normally have to 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 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.
Bottom line: a typical individual who can claim the child tax credit for an 8-year old and a 10 year old (for example), would get a $6,000 child credit in 2021 (up from $4,000).
And, if that individual had no tax liability, they would get that $6,000 as a payment from the government.
Child Care Credit
The Child Care Credit gives you a credit against taxes for a percentage of 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).
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.
That is quite dramatic!
And there’s more!
In years before and after 2021, the credit can reduce your taxes to zero, but if you don’t owe any tax, you don’t get any benefit from the credit.
In 2021, if you have an $8,000 credit and you don’t owe any tax, you will get an $8,000 payment from the government!
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 other years, the phase-down can reduce the percentage to 20% of day care expenses, but not below that.
For 2021, the phase-down can reduce the percentage all the way to zero for very high-income taxpayers (adjusted gross income of $440,000 or more).
To summarize: for 2021, the credit has been reshaped to give less benefit to very high-income taxpayers and dramatically more benefit to low-income taxpayers.
Earned Income Credit
The new law also increases the benefits from the Earned Income Credit, primarily for 2021 only.
The Earned Income Credit is effectively a government subsidy to people who have some earned income (typically wages and tips), but not a lot.
The credit increases as earned income increases, up to a point, and then decreases (to zero) as income increases further past that point.
For example, 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 at all.
Now, you may be eligible even if you are married filing separately.
You have to have lived with a qualifying child for more than half the year.
And, you have to either:
- Have separated before July 1; or
- Have signed a divorce or separation agreement and be living apart by December 31.
Changes In the Software
A number of the most dramatic changes in the American Rescue Plan are effective for 2021 only.
So what should we do?
The software gives you a checkbox to specify whether or not to include the changes that are effective for 2021 only.
You will find this checkbox where you enter Wages, and also at the top of the Child Support screen.
If your goal is to get accurate after-tax cash flow for 2021, you would check the box.
(If you check the box, we will also include the Stimulus payment itself as another tax rebate.)
If your goal is to use 2021 as a template for future years’ budgets, you would probably clear the box.
A similar trade-off applies if you are calculating child support.
If you want to base child support on actual 2021 taxes and child care, you would check the box.
If you want to base child support on likely 2022 and future incomes and taxes, then you would clear the box.
One wrinkle: it is conceivable that Congress will extend the 2021 changes to future years. That is highly speculative at this point. But we will give you the option to run the calculations as if the extension will occur.
That’s another checkbox, located just below the first one.
In any event, you will probably want to see the 2021 incomes, taxes, and child support both ways, to see how much of a difference it makes.
We will make this easy: check the box, and see the results one way. Then clear the box and see the results the other way.