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How the Child Tax Credit Is Impacted by the American Rescue Plan

July 5, 2021, 9:01 AM

As divorced and divorcing parents are still adapting to the changes that were enacted to the tax code through the Tax Cuts and Jobs Act in 2017, a new wave of changes must also be considered with the American Rescue Plan passed by Congress in March 2021. This article will define and explain the impact of these most recent changes.

The change involving the economic impact payments paid in 2020 and 2021 is forcing divorced parents to have to resolve the issue of which parent should receive the child’s portion of the first and second economic impact payments that were paid in 2020, and now the third payment in early 2021. It is likely that the parent who claimed the child on his or her 2019 tax return received the benefit of the economic impact payments for that child. However, if a different parent claimed the child on his or her 2020 tax return, that parent could claim the recovery rebate credit on Line 30 of the Form 1040 and receive the 2020 payments retroactively as a credit on his or her tax return.

In addition, the IRS is not requiring that any part of the payment received be paid back. The outcome could be that both parents ultimately receive the child-related payments. If the parents were divorced in 2020, and their 2019 joint income was too high to qualify for any economic impact payment, the parent now claiming the child can also qualify for the recovery rebate credit and receive the missed payments if his or her sole income is below the threshold of $95,000.

The change to the dependency exemption and child tax credit is still misunderstood and captured incorrectly in many divorce agreements. For tax purposes, the first test for determining the custodial parent is to delineate the parent with whom the child resides the greater number of nights during the tax year. Equal custody arrangements are becoming more and more common. It is important to know that there is a second test: which parent has the higher adjusted gross income. The custodial parent is eligible to file as head of household rather than single for the tax year. The results of these tests could be that the “custodial parent” for tax purposes could be different from the custodial parent for child support purposes, as determined by state law.

The child dependency exemption is currently suspended from 2018 to 2025. Thus, stating which parent will claim the dependency exemption in a divorce agreement is essentially meaningless. The real issue to be resolved is determining which parent will claim the child tax credit. The IRS has provided guidance that the child tax credit can be released to the noncustodial parent through Form 8332 just as the dependency exemption was previously. Under the American Rescue Plan, for 2021 the child tax credit is increased from $2,000 per child to $3,600 per child under age six, and $3,000 per child under age 18 at the end of the tax year. The credit begins to phase out when a taxpayer has an adjusted gross income of $75,000 and completely disappears at $240,000. In addition, those who qualify for the increased credit based on their 2020 income will begin to receive monthly payments as an advance on the child tax credit beginning in July 2021 and will not need to wait until their 2021 tax return is filed.

Another credit tied to the parent who claims the child as a dependent is the dependent care credit. This credit is available to the parent who claimed the child for the tax year, has earned income and actually paid the expenses for work-related childcare. Under the American Rescue Plan, the credit starts at 50% of the expenses up to $8,000 for one child, $16,000 for two or more children, and is phased down for taxpayers earning between $125,000 and $400,000. This change is only for tax year 2021 and will return to the prior amounts of 35% of the expenses up to $3,000 for one child and $6,000 for two or more children with a reduction to 20% of expenses for taxpayers with income over $43,000 in tax year 2022 and years thereafter.

Both the expansions of the child tax credit and the dependent care credit have only been enacted for tax year 2021 through the American Rescue Plan. However, President Joe Biden has recently introduced the American Families Plan which would keep the child tax credit expansion in place through 2025, when the original provision is set to expire, and make the expansion of the dependent care credit permanent.

These additional payments outlined herein do not alter the child support that is awarded and currently being paid by one parent to another. The party benefiting from these recent tax changes and receiving child support payments does not automatically suffer a reduction in child support. The payor would have to file a modification action and receive a new court order to reduce child support based on the tax benefits. It is unlikely such an action would be successful since the additional payments are only for a limited period of time and are not expected to continue into the future.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Robert “Bob” Boyd is a co-founder and shareholder of Boyd Collar Nolen Tuggle & Roddenbery and a leader in family law who has received recognition from his colleagues across Georgia and the nation. He can be reached at bboyd@bcntrlaw.com.

Elizabeth “Beth” Garrett is a partner in the Divorce Litigation Support Practice at Frazier & Deeter, primarily assisting high-net-worth individuals and corporate executives with divorce, tax, and accounting issues. She can be reached at beth.garrett@frazierdeeter.com.

Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com.

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