Keeping up with tax law changes for 2021 has been no easy task. The American Rescue Plan implemented major changes to several areas of tax law, especially concerning refundable tax credits. Here are the details every tax preparer should know about tax law changes to refundable credits in 2021.
Recovery Rebate Credit 2021
The Recovery Rebate Credit was first available in 2020 and allowed taxpayers to receive stimulus payments as a refundable tax credit if they had not already received those payments earlier in the year. In 2021, some of your clients may receive a recovery rebate credit for the third round of stimulus payments that began to be distributed in April 2021.
This payment was slightly different from the previous two in that it allowed payments for children who had Social Security numbers but their parents did not (around 2.2 million children). The parents of these children may not have received the payment during the year but can collect it through the Recovery Rebate Credit.
Note that if a client received a stimulus payment for someone they did not end up claiming on their 2021 tax return, no repayment is necessary.
The Earned Income Tax Credit 2021
Who qualifies for the Earned Income Tax Credit? Under the new 2021 rules, far more taxpayers are eligible.
Income threshold increase
Historically, you could not claim the EITC if you had investment income that exceeded the annual limit. This year that limit has been raised significantly from $3,650 in 2020 to $10,000 in 2021. This increase is permanent, and the investment income limit will continue to be raised each year from the baseline of $10,000 based on Consumer Price Index (CPI).
Married but separated filing separately
Another change expands eligibility for individuals who are married but separated from their spouse and filing separate returns. Previously, if a taxpayer was married filing separately, they had to have a qualifying child and be living separately from your spouse for at least six months. Under the updated rules, they can qualify even if they have not lived separately from their spouse for six months if they are under a separation instrument and do not share a residence with their spouse at the end of the year. They must still have lived with a qualifying child for at least six months of the year, but they do not have to claim the child on their tax return.
Previously, a taxpayer without a child had to be at least 25 and under 65 to qualify for the EITC. This requirement has been updated with the following age limits:
- 24 if the taxpayer was a student for at least 5 months of the year
- 18 if they were in foster care anytime after the age of 14 or were homeless in any taxable year
- 19 for all other non-student taxpayers
- No upper age limit
Increase in maximum benefits & maximum income
The maximum benefit for individuals in 2021 is $1,502, compared to $538 in 2020. The maximum income for individuals in 2021 is $21,430, compared to $15,820 in 2020.
Using prior year income
Taxpayers in 2021 can still use their income from 2019 to calculate EITC if their 2019 income was higher than their 2021 income. However, they cannot use their 2020 income.
The Child Tax Credit 2021
The 2021 Child Tax Credit has been widely discussed in the media thanks to the new advance payments, but it’s undergone a major overhaul in other areas as well.
Age requirements for qualifying children
Previously, children had to be under age 17, but 17-year-olds can now count as qualifying children.
Earned income requirements
The earned income requirements have been completely lifted in 2021. Taxpayers no longer have to have earned income or any income to qualify for the CTC.
Credit amounts & refundable portions
In 2020, the Child Tax Credit was a maximum of $2,000, and only $1,400 of that amount was refundable.
Now, the CTC has increased to $3,600 for children under age 6 and $3,000 to children ages 6-17 and is fully refundable for taxpayers that have lived in the United States for more than six months.
Income limits & phase outs
In 2020, the CTC began to phase out at $400,000 for Married Filing Jointly (MFJ) and at $200,000 for every other filing status. For every $1,000 of income that exceeded the limit, the CTC was reduced by 5%.
The 2021 CTC has a two-part phase out. The new income limits are $150,000 for MFJ, $112,500 for head of household (HOH), and $75,000 for all other filing statuses. The credit is reduced by 5% for every $1,000 of income over the threshold until it reaches $2,000. At that point, the credit remains at $2,000 until a taxpayer’s income reaches the next threshold. These thresholds are the same as those in 2020 ($400,000 for MFJ and $200,000 for other tax filing statuses). At this point, the credit will once again be reduced by 5% for every $1,000 of income over this threshold until it disappears completely.
Of course, one of the most significant changes to the CTC in 2021 were the monthly advance payments. These payments began to go out in July and continued through December. This means that unless your clients opted out of the advance payments on the IRS website, they have likely already received half of their 2021 CTC.
These payments must be reconciled on Schedule 8812. After reconciliation, many of your clients will likely have an excess Child Tax Credit amount, meaning they qualify for more CTC than they have already received in the advance payments. In most cases, this will mean that they still qualify for the remaining half of their CTC.
In rarer cases, taxpayers may have received an excess advance amount, meaning they received more CTC via the monthly advance payments than they actually qualify for. This might occur if a taxpayer received the payments but is not claiming the child on their 2021 return.
Repayment of excess advance payments
These excess payments are subject to repayment. However, taxpayers qualify for full repayment relief if their AGI is below $60,000 for MFJ, $50,000 for HOH, or $40,000 for single or married filing single (MFS). They can receive partial repayment forgiveness if their income is above the previous thresholds but below the following: $120,000 for MFJ, $100,000 for HOH, and $80,000 for single or MFS. If their income is above these thresholds, there is no repayment relief, and they must repay all advance CTC payments.
The CTC & Puerto Rico
Before the American Rescue Act, Puerto Ricans were required to have at least three qualifying children to claim any part of the CTC. They also must have filed Form 1040-PR or 1040-SS and have paid Social Security taxes, Medicare taxes, and/ or self employment tax.
The ARPA repealed these restrictions permanently, and Puerto Ricans now have the same eligibility requirements as mainland filers. However, they did not receive any advance payments and must file Form 1040-PR or 1040-SS to claim the credit. These changes affect all U.S. territories, but other territories will claim the credit on their territory’s tax return form and may have received advance payments.
The Child and Dependent Care Credit 2021
Like the CTC, the Child and Dependent Care Credit significantly increased in 2021. Equally important, the credit is a refundable credit in 2021 for taxpayers who have lived in the United States for more than six months. The credit is still non-refundable for a taxpayer that has not lived in the United States for more than six months.
Increases & phase outs
Prior to 2021, $3,000 of care expenses for one dependent or $6,000 for more than one dependent could be counted as qualifying expenses for the CDCC. Of that amount, 35% would be used to calculate the credit, so the total maximum credit would be $1,050 for one dependent or $2,100 for more than one dependent. The credit began to phase out for AGIs greater than $15,000, and once an AGI reached $43,000 the credit was reduced to 20% of the qualifying expenses.
In Child and Dependent Care Credit 2021, these amounts have increased to $8,000 in qualifying expenses for one dependent or $16,000 for more than one dependent. Of that amount, 50% is used to calculate the credit, for a maximum credit of $4,000 for one dependent and $8,000 for more than one dependent. The phase out limits are also significantly higher, and do not begin until AGI reaches $125,000. The credit is then reduced by 1% for every $2,000 of income over this threshold. Once AGI reaches $400,000, the credit is reduced to 20% and then disappears completely at an AGI of $438,000.
For more details on other tax law changes in 2021, be sure to look out for Part 2 of this series.