If you have kids, you already know how expensive they are. Clothes, new clothes, newer clothes, medical expenses, diapers/toys/video games depending on age, school supplies, and, of course, birthday, Christmas and more presents. And that’s just barely getting started. But what you may not know is that, when it comes to the IRS, kids can save you money—or at least get some of it back!
Today, we’re going to look at one of best ways to reduce your total tax bill: The Child Tax Credit (CTC). The CTC is one the most popular tax credits Congress ever created. But, Congress being Congress, in 2021 they made some big changes to the CTC, and I’m going to tell you about them.
Tax Credits vs Deductions
Before we begin you may be asking yourself, “What is a Tax Credit?”
In order to explain tax credits, it’s easier to show you difference between a Tax Credit and a Deduction. Tax credits reduce the taxes you owe, dollar-for-dollar. Whereas a deduction will lower your income that you have to pay tax on. This sounds like the same thing, but it’s not.
Here’s an illustration:
Let’s say you make $50,000 and are in a 20% tax bracket. This means you owe the IRS $10,000 in tax (20% x $50,000). If you are entitled to a tax credit of $3,000, you will now owe the IRS only $7,000 ($10,000 minus $3,000). If you had a $3,000 deduction instead of a tax credit, your net income would now be $47,000 ($50K – $47K), and the tax you owe is now $9,400 (20% x $47,000).
| Illustration above | Tax Credit | Deduction |
|---|
| Gross Income | $50,000 | $50,000 |
| Deduction | $0 | $3,000 |
| Net Income | $50,000 | $47,000 |
| Tax Rate | 20% | 20% |
| Tax Due (before credit) | $10,000 | $9,400 |
| Tax Credit | $3,000 | $0 |
| Total Tax Due (after credit) | $7,000 | $9,400 |
Simply put, deductions lower the money you get taxed on. Tax Credits lower your taxes due. That’s why tax credits are more valuable.
Types of Tax Credits
There are two types of tax credits:
- Refundable tax credits
- Non-refundable tax credits
A refundable tax credit will allow you a refund after your taxes go to zero. A non-refundable tax credit can make the taxes you owe go to zero but will not give you a refund beyond that. Any extra tax credit you get after that is carried forward to the next tax year.
All tax credits are non-refundable unless Congress says otherwise. Currently the only refundable tax credits are:
- Child Tax Credit – if you have kids (or dependents)
- Earned Income Tax Credit – if you don’t make that much money
- American Opportunity Tax Credit – for payments to colleges & universities
- Premium Tax Credit – for health insurance purchase from the federal marketplace
How do I qualify for the Child Tax Credit
To qualify for the Child Tax Credit, you must meet these qualifications:
- Your child (or dependent) must be a US Citizen
- They must’ve lived with you for more than half the year
- The children must be under the age of 17
- Your income must be under a certain threshold – i.e., as you make more money, you start losing the credit.
How much do I save?
Congress is always changing the rules, so the amount changes year-to-year. So, we’re going over the most current years.
In 2020, you were allowed a Child Tax Credit of $2,000 per qualifying child, with a refundable portion being up to $1,400. Your threshold starts at $200,000 if you’re single ($400,000, if you’re married). As you start making more than the threshold, your Tax Credit starts getting reduced (also known as the “phaseout”).
Child Tax Credit for 2021
As part of the American Rescue Plan, Congress made two changes to the Child Tax Credit
- They increased the Child Tax Credit (chart below)
- You may payments in advance
Here’s a chart on how they increased the Child Tax Credit in 2021:
| 2021 | 2020 |
|---|
| Amount you receive per child | $3,000* | $2,000 |
| Age requirement | < 18 years old | < 17 years old |
| Income Threshold if you’re single | $75,000 | $200,000 |
| Income Threshold if you’re married | $150,000 | $400,000 |
| Refundable portion | All of it | $1,400 |
2021 Pros and Cons: the pros are that the amounts have gone up and it’s fully refundable. The biggest con is the phaseout starts at a much lower amount.
Advanced Payments
Another big change in 2021 is that Congress allowed you to get the payment in advance, and not wait until you filed your tax return. The advanced payments were made from July to December of 2021. If you received a child tax credit on your tax return in 2019 & 2020, you may have seen payments from the IRS in your bank account.
What happens if you got too much or too little? You must reconcile the difference on your tax return to see if you got the right amount. If the IRS didn’t give you a big enough tax credit, they will give you rest when you file your taxes. And if they paid you too much, you will have to pay them back.
IRS Letter 6419
To reconcile your Advanced Child Tax Credit payment, the IRS is mailing you a letter (Letter 6419) that lets you know how much you got. Make sure to save this and give it to your accountant.
If you don’t get the letter or misplaced it, you can go to the IRS.gov website and get your information here.
2022 and beyond
Congress tried to extend the Advance Payments but couldn’t pass a bill. So currently, the Child Tax Credit goes back to how it was in 2020. However, it’s a hot topic in Congress, so if anything changes, I’ll make sure to let you know.
Conclusion
As I mentioned earlier kids are expensive, but the CTC is one way to save money. However there is another great way to save money through your kids. If you own a company, you can hire your kids. It’s complicated and the IRS has lots of rules, so I wrote an article about it here.