When tax time comes, your children can be worth a lot of money — even if you didn’t earn any income. There are two main tax credits that apply to children, and they are frequently confused. One gives a significant refundable credit simply for their existence. The second gives a refundable credit (this year) for money spent on childcare during 2021.
Sadly, many families that would qualify for these refundable credits don’t earn enough to be required to file a tax return. So the credit is never claimed. If you know a low-income parent who might qualify, you’d do them a big favor by sharing this column.
Child tax credit
This was the program that made headlines last year when, as part of the American Rescue Plan Act, it was enlarged and made refundable. As I wrote last May, the child tax credit was introduced in 1998 to give families with children a payment of $400 for each child. Over the years that number had grown, and by 2020 the amount had risen to $2,000. That year, it was only partially refundable against taxes paid.
But last spring Congress boosted the child tax credit to $3600 for each dependent child under the age of 6 at year-end 2021, and $3000 for every dependent child under age 17. Plus, it became totally refundable to the filer — meaning you didn’t have to pay any taxes to qualify for the credit!
There are income limits to qualify for this refundable credit. It goes only to those who have parental income under $75,000 on a single return, or $150,000 on a joint return (or $112,500 for those filing as head of household). Above those income levels the credit phases out.
Notably, this credit is not limited by the number of children claimed as dependents on a qualifying tax return.
To get the money into the hands of families faster, the government started sending out the credit in advance — in the form of monthly payments beginning on July 15. Not all deserving families received the monthly credit, though. And some only received a few months of checks. As a result, many low-income families now need to file a 2021 tax return to claim the credit (or the remaining credit balance after previous monthly payouts).
An extra bonus
And here’s a reminder to those who had a baby in 2021. In addition to claiming the Child Tax Credit (if you’re eligible), you also get to claim the $1,400 stimulus payment that was paid out early last year. It, too, is refundable! So if you qualify based on income, your 2021 baby may be worth a combined $5,000. File for it!!
Child care tax credit
One of the challenges of COVID-19 was the lack of affordable childcare. But, depending on your income, you could get a credit equal to as much as half of your childcare expenses last year on the tax return you are filing now.
The American Rescue Plan Act significantly increased the amount of this now-refundable credit. So even if you don’t have a tax liability, you can claim the credit on your 2021 return. (This credit is expanded only for year 2021, and is scheduled to return to previous levels in 2022.)
The cap on expenses eligible for the child and dependent care tax credit for 2021 is $8,000 (up from $3,000 previously) for one child or $16,000 for two or more children (up from a previous limit of $6,000).
Normally, only employment-related expenses qualify. The more a taxpayer earns, the lower the percentage of the tax credit. The 50% maximum credit percentage starts to phase out at $125,000 for 2021, and is eliminated for any taxpayer with adjusted gross income over $438,000 in 2021.
The program is actually called the “child and dependent care credit” because it applies not only to childcare costs for children under age 13 but also to dependent adults who are incapable of self-care.
One caveat: If you pay for childcare through a dependent care flexible-spending account, the childcare expenses you cover through that FSA cannot count toward the tax credit, since the money in that account already gets a tax benefit.
The “kiddie tax”
And here’s a reminder for those tempted to shift income into a child’s name, presuming they will pay a lower tax rate. Under current rules, a minor child’s unearned income—including capital gains distributions, dividends, and interest income—is taxed at the parents’ tax rate if it exceeds the annual limit ($2,200 in 2021).
Bottom line: The tax law creates incentives for everything from mortgage interest to charitable contributions to encourage certain behaviors. Your children are expensive, but the government is creating incentives to have them!