Many people will see their refunds reduced or even eliminated, while others will get a windfall.
Democrats’ expansion of the Child Tax Credit may have expired but it’s not gone completely. More than 40 million Americans now must contend with it on their annual tax returns.
And it’s proving a curveball for many.
People who received the monthly Child Tax Credit checks lawmakers created last year may be surprised to see those payments are now reducing or even eliminating their tax refunds.
Some divorced people could be upset to learn they weren’t actually eligible for checks they received and now have to pay the money back.
At the same time, some will see fatter refunds, particularly the several million who opted out of the monthly payments.
So too will people who’ve had babies in the past year. And thanks to a loophole in the law, it’s possible for some to claim bigger child credits than lawmakers intended.
The effects on refunds could be a touchy issue for Democrats, potentially putting them on the defensive over one of the biggest achievements of the Biden administration.
People love refunds, relying on them as an important part of their budgets, and notice if their payments are smaller than expected or if they suddenly owe the IRS.
Some interpret the size of their refunds as an indication of how well they’re faring under the tax system, even though the payments are really just the difference between what is owed and what was withheld from their paychecks. Most people received tax cuts under legislation Democrats approved last year in response to the coronavirus outbreak.
The situation for Democrats is reminiscent of the position Republicans were in during the first filing season after their 2017 tax overhaul, when they came under fire because the size of refunds initially dropped before later rebounding to roughly historic levels.
Lawmakers last year temporarily hiked the maximum child credit to as much as $3,600 per child, from $2,000. They also allowed people to claim it piecemeal, in the form of monthly checks, in what was the country’s first-ever child allowance. The rest is to be claimed on their returns.
The expansion expired at the end of 2021, owing in part to opposition by Sen. Joe Manchin (D-W.Va.).
That the credit can reduce refunds may come as a surprise to some who didn’t realize the payments showing up in their accounts weren’t just free money. They were advances against what people would claim on their returns — the amount they received last year can’t be used now as credits on their returns.
And despite the increase in the credit, many people may nevertheless have less to claim at tax time than they did in previous years.
An example: A couple earning $80,000 with two kids qualifies for $6,000 in credits.
They received half of that last year in monthly payments, leaving them $3,000 to take on their returns. But under the prior law, when the maximum credit was $2,000 per kid, they would have claimed $4,000 at tax time.
Or someone who earns, say, $250,000 with three kids qualifies for a $2,000 per child credit because they make too much money for Democrats’ beefed-up break. If that person took half of that in monthly payments, they’ll only be able to claim $3,000 now versus $6,000 they might have otherwise claimed.
“If everything else was the same, your refund is going to be less,” says Bill Nemeth, a longtime tax practitioner in Atlanta, Ga.
Some divorced people could find they have to return the money.
The IRS sent payments based on what people reported on their 2020 returns. But it’s common for divorced couples to trade kids each year for tax purposes.
That could be a problem for, say, a mom who received the payments because her kids were listed on her 2020 return. The credits were advances against 2021 taxes and if it’s the dad’s turn to claim the kids for that year, then she shouldn’t have received the payments and may have to pay them back, depending on how much she makes. (Democrats excused lower earners from having to pay back money they shouldn’t have received.)
“That’s a tough one to explain that, yes, you did receive the money, however, you weren’t entitled to it because you don’t get to claim Skippy this year so you have to pay it back,” said Allan Reynolds, a tax preparer in Sioux City, Iowa.
So far, the share of returns producing refunds is down three percent from last year, to 72 percent, according to IRS statistics.
At the same time, the size of the average refund is up 14 percent, an increase that has some observers scratching their heads. There are a range of possible explanations, including the likelihood that people expecting big payments tend to file earlier.
Among those getting bigger refunds are people who turned off the monthly payments — something that wasn’t easy. The IRS required both spouses to opt out and the process was laborious. But those who did will now be able to claim more on their return.
There are also more than 3 million babies born every year, and their parents too will see a windfall.
Reynolds said he had a client who had twins last year, which made them eligible for $10,000 — two extra-large child credits as well as two additional $1,400 stimulus checks Congress cut to bolster the pandemic-battered economy.
“The wife literally cried,” he said. “$10,000 to a new family with twins is a big deal.”
Because of quirks in the law, some people can increase their credits beyond what lawmakers intended by merely changing their filing status.
An example: A married couple filing jointly who earned $80,000 and has two kids is eligible for a $6,000 credit. Half of that — $3,000 — was paid last year. The IRS deems that the payment went 50-50 to the spouses — so, $1,500 each. The remaining $1,500 would be claimed on their return.
But they can get more by filing separate returns:
One parent claims both kids and is eligible for a $6,000 credit minus the $1,500 they were already deemed to have received, so they take a $4,500 credit on their tax return.
The other parent, now a separate tax filer, doesn’t have any kids to claim. And if that person’s income is low enough, they don’t have to pay back the $1,500 they were deemed to have received last year.
The result: The couple receives $7,500 from the child credit instead of $6,000 (although there are other, unrelated disadvantages to married people filing separately, such as losing certain tax breaks, that could offset those savings).
“It creates a very strange planning opportunity,” said Donna Byrne, a tax attorney in Independence, Ore.
“It’s a tax minimization strategy that is completely legal under the law as it is written but there are more than a few preparers who have some qualms about it because it feels like double dipping.”
