Should I Opt Out of Receiving Advance Child Tax Credit Payments?
You most likely have been bombarded lately with information regarding the Enhanced Child Tax Credit and the upcoming advance payments that are set to begin July 15th. We have been fielding lots of questions from our clients regarding these advance payments and whether they should opt out of receiving them. As a result, we are reaching out to our clients to try and provide a little more clarity on how these advance payments work, and whether you should opt out of receiving them.
First off, be assured that regardless of whether you choose to opt out of receiving these payments or not, you will receive the exact same tax benefit from the Enhanced Child Tax Credits. The advance payments are essentially prepayments to you of a tax credit that you will report on your 2021 tax return. To the extent that you elect to opt out of receiving these payments in advance, you will still get the benefit of these credits on your tax return in the form of an increased refund, or a smaller payment due. It’s just a matter of timing.
With that being said, we want to make you aware of how this issue of timing could impact you when you file your 2021 tax returns. In certain cases, it might be in your best interest to opt out of receiving the advance payments to avoid owing additional taxes when it comes time to file your return. The following are some situations where a taxpayer may want to consider opting out of receiving the advance payments:
- Taxpayer will have a change in the number of dependents that they will report on their 2021 Tax Return – The advance payments will be based primarily on information provided by you on the tax return that you filed for 2020. The payment amounts will be made assuming that you will be reporting the same dependents for 2021. If the number of dependents you will be claiming for 2021 is less than what you reported for 2020, you may want to consider opting out of receiving the advance payments.
Example 1 – Joe is a single taxpayer who claims his two children, ages 7 and 5 every other year. Joe claimed his kids as dependents in 2020 but will not claim them as dependents in 2021. Joe did not opt out of receiving the advance payments and received a total of 6 payments for $550 each ($3,300 total). When Joe files his 2021 tax return, he will effectively have to “pay back” the amount of the advance payments he received, because he was not eligible to receive them. This could result in a significant decrease in the refund Joe normally receives, or even worse, may create a significant payment due with his return.
- Taxpayer will have a significant increase in income on their 2021 Tax Return – The “Enhanced” portion of the Enhanced Child Tax Credit has a different income threshold than the traditional child tax credit. This “Enhanced” credit is equal to between $1,000-$1,600 per dependent, however, this portion of the credit begins to phase out for taxpayers with income in excess of $75,000 on a single return, $112,500 on a head-of-household return and $150,000 on a joint return. Taxpayers who reported income under these thresholds for 2020 will receive the advance payment based on their 2020 income. If their income increases above the threshold in 2021, this could have a significant impact on their 2021 tax return.
Example 2 – Jim and Sue are married taxpayers with one child, age 8. Both Jim and Sue were unemployed from their Sales jobs in 2020 due to COVID, as a result, their income of $100,000 was well below their normal $300,000 per year. They were able to get back to work in 2021, and while their income will still be a little lower than the past, they are excited that they expect to be back over $200,000. Because Jim and Sue reported less than $150,000 on their 2020 tax return and did not elect to opt out of receiving the advance payments, they received six payments for the year, totaling $1,500. Because of their increased income in 2021, they are not eligible to receive the “enhanced” portion of the child tax credit. As a result, they may notice a reduced refund or a payment due with their tax return.
- Taxpayer typically receives a small refund but does not want to owe any tax with their return – The advance Child Tax payment is designed to put half of the child tax credit into the taxpayer’s pocket by the end of the year. For taxpayers that typically receive small refunds, but do not want to owe when they file their tax return, this could cause a problem. This is because while the advance payments are supposed to represent half of the Child Tax Credit, the Child Tax Credit itself was not doubled for 2021. As a result, a smaller portion of this credit will be available to offset your tax liability (since you already received the payment in advance) and could cause you to owe with your return.
- Taxpayer does not need the money right away and would rather be safe and receive a larger refund with their return – For those taxpayers that dread the thought of owing taxes with their return and do not need the money now, opting out may also be a good option. While we do not advocate that our clients use the IRS as a savings account and hope for large refunds, we do not like surprising them with an unexpected balance due with their tax return either. If the thought of owing money with your tax return keeps you awake at night, you probably want to consider opting out.
These are just a few of the scenarios in which opting out may make sense. However, please carefully consider the decision to opt out of receiving these payments, as once you elect to opt out, you cannot change your decision. However, if this is the case, you will still get the benefits of the Enhanced Child Tax Credit when you file your tax return.
As an alternative to opting out, the IRS is still working on another tool that can be used to provide updated information to adjust the amount of the monthly advance Child Tax Credit payments you receive. This could be used in situations where there was a change in your income or the dependents you are claiming on your tax return. We will let you know when this becomes available.
Finally, remember that if you do not opt out of receiving these advance payments, it is important to keep track of the amount that you receive during 2021. We will need this amount to complete your 2021 tax return. We previously mailed you a worksheet that you can use to track these payments. A copy of this worksheet can be found here Advance Child Tax Payment Worksheet
Obviously, this is a lot to digest, and there is likely more information on this issue to come. In the meantime, if you have any questions or concerns, please do not hesitate to give us a call!