Thanks to the passage of the American Rescue Plan Act (ARPA), many Americans received their first child tax credit yesterday. ARPA temporarily increased the Child Tax Credit from $2,000 up to $3,600 for eligible children under six and up to $3,000 for children six to 17. This new credit will dish out a whopping $100 billion to the roughly 35 million qualifying Americans. Under the payment plan, eligible families received their first payment yesterday and will receive additional payments every month. The last payment is scheduled to be on December 15, 2021.

With all of this new income, the question now arises, will this be beneficial for families in the long run, or will it come back to bite? Without a doubt, this credit will provide much-needed financial assistance for many families. At the same time, it may create an unanticipated tax burden for others.

What Is A Tax Credit?

To fully understand how the Child Tax Credit works and the potential ramifications, it's important to understand the difference between tax credits and tax deductions. Tax credits and tax deductions both save you money, but they work in different ways. Tax deductions lower your taxable income, equal to your marginal tax rate or tax bracket. A tax credit is a dollar-for-dollar reduction in your tax liability.

For example, let's say that you are in the 10% tax bracket. A $500 tax deduction will save you $50 because it is 10% (the income bracket you are in) of the deduction. On the other hand, a $500 tax credit saves you $500 in your tax liability. It would save you $500 whether you made $10,000 or $100,000 because it's a credit to the amount of tax you may owe.

How Could The Child Tax Credit Affect Me?

To streamline the process, Congress told the IRS to use previous tax information to determine eligibility, either from 2019 or 2020. A lot can happen in a year which could change the amount that you should qualify for. Here are some situations that could result in you paying back some or all of your Advance Child Tax Credit:

• You or your partner (if filing jointly) receive a raise that pushes you into the next tax bracket. This would especially apply if your joint gross income surpasses $150K or $75k for single filers.
• If you have a 5 year old that turns 6 or a 17 year old that turns 18, your eligible credit decreases. Thus, you would be receiving more than you technically should.
• If a divorce or separation occurs and there is a change in custody, only one parent may claim the credit.

The good news is, some people are shielded from any repayment, depending on their income level (see graph below). If this is all confusing, know that it is confusing for a lot of people. The IRS developed an Advance Child Tax Credit portal for 2021 where you can do all sorts of things, such as update your information and opt-out of payments. More good news, you will not be paying taxes on the credit because it doesn't count as income.

On the flip side, you may have the opposite story. Maybe you make less now than you did in 2020 or 2019, which is what the IRS is basing their decision off. Perhaps you have another dependent than you did last year. Both of these cases would entitle you to additional credit. If that be your case, use the IRS portal to update your information, or claim that credit when 2022 taxes come around.

Conclusion

The Child Tax Credit advance is upon us. Millions of Americans should have received their first payment yesterday and will continue to receive payments every month for the rest of the year. If your situation has remained stable over the last year, you likely do not need to worry much about repayment. If your income is greater this year than before or if your dependent(s) turned 6 or 18, you may need to pay back some of the credit advances to the IRS. If you need to update your information or would like to cancel your payments, head to the Advance Child Tax Credit portal.

If you have additional questions about the Advance Child Tax Credit Payments, the IRS has a FAQ page that may be helpful.

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