Great News, Child Care Tax Credit Expanded for 2021

Great news if you are paying childcare expenses that enable you to work. As part of President Biden’s American Rescue Plan Act (ARPA) signed into law on March 11, 2021, the child and dependent care tax credit has been substantially increased. Here are the details:

The credit increases and other provisions of the ARPA that apply to this credit only apply to 2021. The increase in the credit is part of the government’s effort to ease families’ financial burdens during the pandemic.

A tax credit can be either nonrefundable or refundable. Nonrefundable credits can only offset a taxpayer’s tax liability, at most bringing it down to zero, while a refundable credit offsets the tax liability and any credit amount in excess of the liability is refunded to the taxpayer. Generally, the childcare credit is nonrefundable. However, for 2021, it is fully refundable if the taxpayer’s primary residence (or at least one spouse on a joint return) is in the U.S. for more than half the year.

The credit is based upon a percentage of the taxpayer’s care expenses for a child under the age of 13 (the expenses count up to the date the child actually turns 13) that allow a taxpayer to work. In the case of a married couple, the credit only applies if they are both employed. There are special provisions for a spouse who is disabled or a student that are not covered in this article.

There is a maximum to the expenses that can be used to figure the credit for 2021:

  • $8,000 for one child, up from the normal $3,000 in any other year. 
  • $16,000 for two or more children, up from the normal $6,000 in any other year. 

In addition, the percentage used to calculate the credit for most taxpayers has been increased to 50%. In any other year, that percentage would vary depending upon the taxpayer’s adjusted gross income (AGI), with lower-income taxpayers benefiting from the highest percentage rate (35%) and the lowest percentage rate (20%) for higher-income taxpayers.

A combination of the higher maximum expenses and the 50% rate results in a significant increase in the maximum credit:

  • $4,000 for one child (50% of expenses up to $8,000) 
  • $8,000 for the care of 2 or more children (50% of expenses up to $16,000)

This increase in the credit is targeted at lower-income taxpayers, so it includes a phaseout provision for higher-income taxpayers. The 50% credit rate begins to phase out when the taxpayer’s AGI reaches $125,000 (1 percentage point for each $2,000 above the $125,000 threshold), but the rate isn’t reduced below 20% until the AGI reaches $400,000, at which point the credit phaseout picks up again.

In addition, since the purpose of the credit is to help lower-income workers’ childcare expenses, the expenses used to calculate the credit are limited to the taxpayer’s income from working. In the case of a married couple, the expenses are limited to the working income of the lowest-earning spouse.

This all may seem a bit complicated, so here is a typical example:

Example: A married couple has 2 children under the age of age 13 and both work. One spouse makes $25,000 and the other makes $18,000. They have no other income, so their AGI is $43,000 ($25,000 + $18,000)—under the AGI phaseout threshold of $125,000. During the year, they incurred $14,000 in childcare expenses for their 2 children. The maximum expenses allowed are $18,000, but in this example, we are limited to the $18,000 of expenses or the working income of the lowest-earning spouse, which is $14,000. Thus, we must use $14,000 as the expense amount. Child care for this couple costs $7,000 ($14,000 x 50%).


For those who enjoy employer-provided dependent care assistance, the ARPA also changes (for 2021 only) the exclusion for employer-provided assistance for dependent care, increasing the maximum amount of excludable earnings from $5,000 to $10,500 for a married couple filing jointly ($5,250 for married filing separate).

If you have questions about how this one-year change might affect your tax situation, please give our office a call.

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Big Increase in Child Tax Credit For 2021

An increased child tax credit is part of President Biden’s stimulus package to help tackle the coronavirus pandemic and stimulate the economy. This stimulus package, which was passed by Congress on March 10, 2021, and is known as the American Rescue Plan Act, will provide lower-income parents with substantial financial assistance and support various other efforts to stimulate the economy. Even though the benefit of a tax credit traditionally isn’t available until after the tax return for the year has been filed, for 2021, the IRS will pay a portion of the credit in advance in the form of monthly payments from July through December.

Here are the details.

  • Additional Credit Amounts – Normally, the credit is $2,000 per eligible child. For 2021, it has increased to $3,000 for each child under age 18 (normally under age 17) and $3,600 for children under age 6 at the end of the year. 
  • Refundability – A tax credit can be either nonrefundable or refundable. Nonrefundable credits can only offset a taxpayer’s tax liability, at most bringing it down to zero, while a refundable credit offsets the tax liability and any credit amount in excess of the liability is refunded to the taxpayer. Generally, the child tax credit is nonrefundable, but for 2021, it is fully refundable. 
  • High-Income Phaseout – The credit is designed to only provide parents of lower incomes with a tax benefit. Thus, the credit phases out for higher-income taxpayers at a rate of $50 for each $1,000 (or fraction thereof) by which the taxpayer’s modified adjusted gross income (MAGI) exceeds the threshold.

2021 MAGI PHASEOUT – CHILD TAX CREDIT 

Filing Status

Threshold

Married Filing Jointly

150,000

Heads of Household

112,500

Others

75,000

Example 1: Jack and Jill have two children—Ella, age 4, and Joe, age 8. Their child tax credit for 2021 before the phaseout will be $6,600 ($3,600 + 3,000). They file a joint return and their AGI is below $150,000, so they are entitled to the full $6,600. However, if their AGI for 2021 is $170,000, they would have to reduce (phase out) the credit by $1,000 ($50 x [($170,000-$150,000)/1,000]). Thus, their child tax credit would be $5,600. 


Note:
This phaseout only applies to the increase in the credit. Families that aren’t eligible for the higher child credit would still be able to claim the regular credit of $2,000 per child subject to the normal phaseout thresholds of $400,000 for married couples filing jointly and $200,000 for others.

Example 2: Using Jack and Jill from example #1, they qualified for a credit of $6,600 before phaseout. If their AGI had been $220,000, they would be completely phased out of the additional 2021 credit but would still qualify for the normal $2,000 per child credit. Since their AGI is below the regular $400,000 phaseout threshold, their credit for 2021 would be $4,000 (2 x $2,000).


Advance Payments – Under a special provision included in the new tax law, to get the credit benefit into the hands of taxpayers as quickly as possible, the Secretary of the Treasury has been charged with establishing an advance payment plan. Under this mandate, those qualifying for the credit would receive monthly payments equal to 1⁄12 of the amount the IRS estimates the taxpayer would be entitled to by using the information on the 2020 return. If the 2020 return has not been filed, the 2019 information is to be used. If the 2019 return is used to determine the advance payments, the amount of the payments can be altered (either reduced or increased) when the 2020 return is filed. The initial advance payment won’t arrive before July 1, 2021, and monthly payments would end in December 2021. Any balance of the credit due to a taxpayer would be claimed on their 2021 tax return.

  • Reconciliation on the 2021 Tax Return - The advance payments will reduce the child tax credit claimed on the tax return, but not below zero. If the aggregate amount of the advance payments to the taxpayer exceeds the amount of the allowable credit, the excess must be repaid unless the taxpayer meets the safe harbor test. 
  • No Repayment Safe Harbor – The amount of the excess advance repayment is eliminated or reduced based on a safe harbor that applies to lower-income taxpayers. Thus, families with a 2021 MAGI below the applicable income threshold (see table below) will not have to repay any advance credit overpayments that they receive.

SAFE HARBOR APPLICABLE MAGI

Filing Status

Threshold

Married Filing Joint

60,000

Heads of Household

50,000

Others

40,000 

Child’s Death – A child isn’t taken into account in determining the annual advance amount if the death of the child is known to the IRS as of the beginning of the calendar year for which the estimate is made.

Online Portal – The Secretary of the Treasury will establish an online portal for taxpayers to elect to not receive advance payments or provide information that would affect the amount of the advance payment, including the birth of a qualifying dependent, change in marital status or significant changes in income.

It will take the Treasury some time to initiate the advance payments, but if you have questions about the child tax credit, please give our office a call.

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Are Your Unemployment Benefits Taxable?

With the passage of the CARES Act stimulus package early in 2020, the federal government began supplementing the normal state weekly unemployment benefits by adding $600 per week through the end of July 2020. When this provision ran out, and with Congress at a stalemate, President Trump issued an executive order in early August that extended the supplement, but at $400 per week, with the federal government providing $300 and the state the other $100. Then, the COVID Tax Relief Act that was enacted in late December of 2020 extended the federal unemployment supplement through March 14, 2021, but at $300 per week. Now, President Biden’s American Rescue Plan that Congress enacted in March of 2021 has extended the $300 benefit through September 9, 2021, and increased the number of weeks an individual can qualify for the benefits from 50 to 74.

The American Rescue Plan Act originally slated the weekly amount to be $400. That was before a provision to treat the first $10,200 of unemployment income as tax-exempt was included, at which point the weekly supplemental amount was reduced to $300. However, the tax exemption of the first $10,200 of unemployment compensation will only apply to taxpayers with AGIs less than $150,000. Prior to this change, unemployment benefits were fully taxable income for federal purposes.

This change is retroactive to 2020, and if you have already filed your 2020 tax return, on which you included unemployment compensation, and you qualify for the income exclusion, the IRS has indicated that filing amended returns is not necessary unless the calculations make the taxpayer newly eligible for additional credits and deductions not already in the original return. The IRS will determine the correct taxable amount of unemployment compensation and recalculate the tax.


Those who received unemployment benefits will be sent a Form 1099-G (Certain Government Payments) from the state that paid the benefits. This tax form shows the amount of unemployment benefits paid to the individual during 2020 and the amount of income tax withheld if any.

There have been reports of people receiving Form 1099-G when they never applied for and didn’t collect any unemployment benefits for 2020. In these cases, the individual’s personal information was apparently used fraudulently by someone else to claim the unemployment benefits. If this happens to you, you should contact the government office that issued the erroneous form to request a correction.

Also, be aware that children under age 19, or full-time students over age 18 and under age 24 with unearned income in excess of $2,200, are subject to what is referred to as the kiddie tax. The kiddie tax taxes the child’s unearned income at the parent’s rate. Normally, we think of unearned income as being interest, dividends, and capital gains, but certain other types of income, including unemployment benefits, are considered to be unearned income. This can lead to some unpleasant tax surprises, as those who have already filed their 2020 tax returns may have discovered. But the $10,200 retroactive exclusion should eliminate the unemployment tax for most kiddie tax returns. An amended return may be needed in this situation.

There are several states where unemployment benefits are not taxable. Of those, seven states do not have a state income tax, so obviously, unemployment benefits are not taxable in those states, which are the following:

  • Alaska 
  • Florida 
  • Nevada 
  • South Dakota 
  • Texas 
  • Washington 
  • Wyoming 

Several states have state income tax but do not tax unemployment benefits:

  • California 
  • Montana 
  • New Hampshire 
  • New Jersey 
  • Oregon 
  • Pennsylvania 
  • Tennessee 
  • Virginia 

Two states exempt 50% of amounts above $12,000 (single taxpayer) or $18,000 (married taxpayers):

  • Indiana 
  • Wisconsin 

The remaining states fully tax unemployment benefits.

A word of caution: Some states may pass laws to conform to the federal treatment, or even automatically conform. Unfortunately, that information was not available when this article was prepared.

If you’ve collected unemployment compensation, the benefits’ impact on your tax bill will depend on a number of factors, including the amount of unemployment income you received, whether your benefits are covered by the $10,200 exclusion, what other income you have, whether you are single or married (and, if married, whether you and your spouse are both receiving unemployment benefits), and whether you had or have income tax withheld from benefit payments.

If you have questions about the taxation of unemployment compensation, please give our office a call.

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SBA Announces Changes to COVID-19 EIDL Loans

The U.S. Small Business Administration (SBA) recently announced a major update to the COVID-19 Economic Injury Disaster Loan (EIDL) program. As of the week of April 6, 2021, the maximum loan amount for COVID-19 EIDLs will increase to $500,000. 

Under the CARES Act, the EIDL program was expanded to cover eligible businesses experiencing substantial economic injury resulting from the pandemic. The act also relaxed a number of traditional EIDL loan stipulations, making COVID-19 EIDL loans more readily available.

This latest update from the SBA drastically expands both the maximum loan limit and the period of economic injury that they cover. Previously the limit for COVID-19 EIDL loans was a maximum of $150,000 covering six months of economic injury. As of the week of April 6, 2021, the maximum loan amount is $500,000 and covers up to 24 months of economic injury. 

Loan applicants whose loans are already in process at the time of the EIDL expansion will automatically be considered for the new maximum limits. Additionally, current COVID-19 EIDL loan recipients will be able to request a loan increase. Borrowers should visit the SBA website for further guidance. 

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IRS Announces Individual Tax Deadline Extension

For the second year in a row, the federal income tax filing due date for individuals has been postponed. The postponements come as a part of the fallout of the coronavirus pandemic and the legislation that has resulted from it, which has added complexity to tax filings and systemic strain to the U.S. tax bureau.

On Wednesday, March 17, the Internal Revenue Service (IRS), in conjunction with the U.S. Treasury Department, announced an extension of the federal income tax filing due date for individuals. Individual returns for the 2020 tax year are now due on May 17, 2021, rather than the standard date of April 15, 2021.

The IRS stated their intention to issue formal guidance on the extension soon. As of now, here are the details that we are aware of, per the IRS news release:

  • In addition to a filing extension, any federal income tax payments owed for 2020 are also automatically extended to the new due date, with no penalties or interest.
  • The filing and tax payment postponements are applicable for self-employed individual filers.
  • Taxpayers who do not pay any amounts owed by May 17 will begin to accrue penalties and interest at that point.
  • There is no need to file for an extension or contact the IRS—this extension is automatic.
  • Individuals who need more time than the May 17 due date provided should file Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return to apply for an extension through October 15, 2021. This would result in an extension for filing; any payment due would still need to be paid by May 17 to avoid penalties and interest.
  • The postponement does not apply to the April 15 deadline for estimated tax payments.

Individual taxpayers should be sure to note that this extension only applies to federal income tax filings. While it is possible that states will follow suit with a due date extension, individual taxpayers need to refer to their state tax bureau for guidance on state income tax filings.

As your tax advisors, please be aware that we are actively monitoring the situation for updates that impact you, both federally and locally. We will continue to work hard to meet current tax deadlines and operate under the assumption that all other standard deadlines remain in effect unless an announcement is made by tax authorities. We will be sure to reach out again in the event of any further developments. 

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