Beware of Pre-Paid Child Tax Credit

If you didn’t opt out of receiving the pre-paid child tax credit then you should have received your first payment on or around July 15th. While it’s nice to receive these advanced payments, you need to be careful as you could be in for a nasty tax surprise come tax time.

Who’s Eligible?

 

The Child Tax Credit is available to parents who have children age 17 and under. For each child under age 6, parents will receive $3,600. And for children ages 6 to 17, parents will receive $3,000 per child.

However, there is a caveat. In order to receive the full tax credit, your Adjusted Gross Income (AGI) for 2021 must be less than or equal to $75,000 if single or $150,000 if married. If you make more than these amounts, then your credit is reduced by 5% for every dollar that exceeds these thresholds.

How Does Pre-Payment Work?

 

If you’re eligible to receive the child tax credit and you didn’t voluntarily opt of the pre-payment, then you will receive a portion of the child tax credit prior to filing your taxes.

One-half of the credit is to be received in equal monthly installments from July through December 2021. For example, if you have 3 children over the age of 6, your total child tax credit would equal $9,000 ($3,000 x 3). You would then be entitled to receive one-half ($4,500) in monthly installments of $750 / month from July through December.

Warning!

 

Receiving the pre-paid tax credit will reduce the amount of tax credit you will receive on your tax return and make it appear that you owe a lot more in taxes than you do.

Continuing with our example above, let’s assume that you owe $15,000 in federal taxes. You will receive a total of $9,000 in child tax credits, which reduces your overall tax bill to $6,000 ($15,000 – $9,000).

However, if you received one-half of the tax credit ($4,500) in advance, then your tax return will show that you owe $10,500 in taxes ($15,000 – $4,500), NOT $6,000 as reflected above. This is because only $4,500 in tax credit will show up on your tax return, not the full $9,000.

But the reality is that you won’t really owe $10,500 as you must factor in the $4,500 that you’ve already received in advance. And simply subtracting the two will leave you with your true tax bill of $6,000 as mentioned above.

So, what is the danger then?

The danger lies with those who actually spend the pre-paid tax credit! For those that do this and don’t have extra cash lying around, they may not have enough money to pay their tax bill.

Take Away

 

Our recommendation is for most people to place the pre-paid tax credit into an interest bearing savings account and NOT SPEND IT! That way, there will be no issue or unexpected surprises when filing your tax return.

I’m curious to know if you’ve opted out of the pre-paid tax credit or not. If not, do you plan to spend it or save it? Please comment below.

Brad Tinnon
CERTIFIED FINANCIAL PLANNER™