Critical Tax Law Changes Affecting Family Law Practitioners

Critical Tax Law Changes Affecting Family Law Practitioners

How the Child Tax Credit will affect divorced and separated parents

There are a lot of questions about this year’s advance child tax credit for divorced, separated, and unwed parents who share custody. The IRS has specific rules that are different from prior years, including which households qualify and how the payments are disbursed upfront in monthly installments. Since the rollout of payments began, the IRS has issued guidelines for families who might be concerned about eligibility or about owing the tax agency money in 2022.

Only one parent can get the credit for a shared dependent. If you’re the one who claimed the child on your latest 2020 tax return, then you’ll be the one receiving the advance payments this year. If you incorrectly collect payments for a child this year, you may have to repay part or all of the up to $3,600 credit next year. If parents take turns claiming the kids to every other year, that makes it more complicated.

Say a parent claims the kids in 2020 but won’t claim them in 2021. That parent will get the money but then have to pay it back in 2021. For the parent that claims them in 2021, they will not receive money from July to December. However, they will get all of their money after they file their 2021 tax returns. The money parents receive is an advance of what parents would receive when they go to file their 2021 tax returns. This means when your refund comes next year it will be less than in years past.

In a side-by-side tax comparison for the years 2020 & 2021 for a divorced person filing as head of household with 3 children all under the age of 5, assuming 21K as income and 75K for spousal and child support, these tax changes make a significant difference in the tax refund. When the child and dependent care tax credit and the additional child tax credit are applied to the 2021 return, the refund increases from 9K to over 25K.

Enhanced tax credits could become ‘bargaining points’ in divorce cases.

The $1.9 trillion American Rescue Plan provided Covid-19 relief for millions of Americans, including increases to three write-offs in 2021: the child tax credit, the earned income tax credit, and the child and dependent care tax credit. These enhanced tax breaks may be worth thousands of dollars for eligible families and are adding complexity to divorce cases. Ex-spouses may allow the other parent to claim the write-off by filling out Form 8332 and attaching it to their 2021 return.

When it comes to mediation, tax planning, and divorce strategy, both attorneys and accountants
need to be prepared to discuss these options with their clients.

Changes to the 2021 Child Tax Credit

The American Rescue Plan, which was enacted in March 2021, significantly expanded the credit for the 2021 tax year (and only for the 2021 tax year). For instance, the credit amount was increased to $3,000 for each child six to 17 years of age and to $3,600 for each child 5 years old or younger (also note that the upper age limit was increased from 16 to 17 for 2021). It is estimated that 96% of families will qualify for the credit. To get money to families sooner, the IRS is sending families half of their 2021 Child Tax Credit as monthly payments of $300 per child under age 6 and $250 per child between the ages of 6 and 17. The remaining payment dates for 2021 are Oct 15, Nov 15, and Dec 15.

The credit was also made fully refundable for the 2021 tax year, so tax refunds resulting from this year’s child tax credit can be greater than $1,400, and the $2,500-of-earned-income required was dropped.

What are the income and age caps for the 2021 child tax credit?

For families with higher incomes, the extra amount ($1,000 or $1,600) is reduced – potentially to zero. For single filers, the extra amount starts to phase out if their adjusted gross income exceeds $75,000. The phase-out is triggered at $112,500 for head-of-household filers and $150,000 for joint filers. The credit amount can also be reduced under the pre-existing $200,000/$400,000 phase-out rules.

The IRS looks at your family’s AGI, the ages of your dependents, and a few other things to determine if you qualify for the child tax credit payments. For information on how the amount of your Child Tax Credit could be reduced based on the amount of your income, see Topic C: Calculation of the 2021 Child Tax Credit.

Here’s a quick look at family income and dependent age limits:

INCOME AND AGE CAPS FOR THE CHILD TAX CREDIT

Family upper-income qualification limit Dependent age qualifications
Single filer — AGI below $240,000 Ages 5 and younger — up to $3,600
Head of household — AGI below $240,000 Ages 6 to 17 — up to $3,000
Couple filing jointly — AGI below $440,000 Age 18 — $500
Ages 19 to 24, full-time college students — $500

Who is a “qualifying child” for purposes of the 2021 Child Tax Credit?

For the tax year 2021, a qualifying child is an individual who does not turn 18 before January 1, 2022, and who satisfies the following conditions:

    1. The individual is the taxpayer’s son, daughter, stepchild, eligible foster child, brother, sister, stepbrother, stepsister, half-brother, half-sister, or a descendant of any of them (for example, a grandchild, niece, or nephew).
    2. The individual does not provide more than one-half of his or her own support during 2021.
    3. The individual lives with the taxpayer for more than one-half of the tax year 2021. For exceptions to this requirement, see IRS Publication 972.
    4. The individual is properly claimed as the taxpayer’s dependent.
    5. The individual does not file a joint return with the individual’s spouse for the tax year 2021 or files it only to claim a refund of withheld income tax or estimated tax paid.
    6. The individual was a U.S. citizen, U.S. national, or U.S. resident alien.

 

Is the child tax credit fully refundable?

Before the changes this year with the American Rescue Plan, eligible families could claim a tax credit for their qualifying children when they filed their taxes. The credit would reduce the amount of taxes they owed. That payment rule, however, excluded lower-income families who didn’t owe federal taxes and wouldn’t benefit from a tax saving with the credit.

This year, the credit is “fully refundable,” so qualifying families can receive the full dollar amount even if they don’t owe income taxes. When tax credits are considered refundable, that means that if the amount of the credit is larger than the tax you owe, you’ll receive a refund for the difference.

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