This blog post was originally published on taxpolicycenter.org, with comments provided by the Economic Security Project and Georgetown Center on Poverty and Inequality.
Beginning in July, most families with children will receive up to $250 a month per child ($300 for children under 6). Those payments are advances of the Child Tax Credit (CTC), which was temporarily expanded in the American Rescue Plan (ARP).
The CTC expansion and monthly advance payments should be extended past their scheduled expiration in 2021. But that’s just a first step. Families will risk owing money to the Internal Revenue Service (IRS) if they get too much in advance payments unless Congress institutes changes to how the IRS calculates the advanced credits.
Why pay the child tax credit monthly?
Advance payments of the credit will help families pay their bills as they come due. Usually, low-income families must wait to get their CTCs when the IRS delivers them as a tax refund the following year.
Monthly payments can reduce income volatility and help ensure people have a basic foundation to meet their needs. Even before the pandemic, many families were struggling to stay afloat, and the pandemic created a financial shock that left many without recourse as bills came due every month.
Black and Hispanic families are especially vulnerable to economic shocks and have less savings on average to cushion against these shocks—a long-standing challenge made worse by the pandemic. Research shows that direct cash assistance—paid consistently throughout the year—improves physical and mental health, leads to better full-time jobs, and increases financial stability.
What happens if you receive too much in advance in 2021?
The advance payment is exactly what it sounds like—an advance of the CTC that you normally receive when you file your income tax return. The catch is that the IRS typically does not know your income or family status until you file that year’s return during the following year.
So, to pay the credit in advance, the IRS uses information based on a prior-year tax return: for this year’s advance payment, either the calendar year 2020 tax return or, if that’s not filed yet, the 2019 tax return. Or, if your income is very low and you don’t have to file a tax return, you can use a new portal on the IRS website to enter the information necessary to qualify for and calculate the advance credit.
But here’s the risk. If the taxpayer’s income increases in 2021, the taxpayer may be entitled to a smaller CTC—and may have to pay some of or all the advance back.
Children who change residences present another risk. To be eligible for CTC, a child must live with the claimant for at least 6 months of the year. But many children move from one caregiver to another throughout the year. Some divorced parents who share custody take turns claiming their child as a dependent.
The ARP contained some protection against overpayments. First, only up to half of the amount of the credit a family appears eligible for, as determined based on the prior-year tax return, will be paid in advance. Second, taxpayers can go to another portal and update their income, marital status, and the number of children who will live with them for at least six months of the year. And third, there is a safe harbor that limits the amount that must be paid back by low- and middle-income families whose children move out of the household.
Full refundability of the credit provides another cushion for lower-income families, ensuring that the lowest income families qualify for the full benefit. This prevents the credit from dropping concurrently with income for many families.
Can the risks of overpayments be further reduced?
If the current method is extended, families will receive payments in 2022 based on their 2020 tax return—a uniquely bad financial year for millions—because the IRS won’t have their 2021 return in January of 2022 when advance payments would begin for the new calendar year.
Fortunately, the IRS could be directed to use another source of information about 2021: information that taxpayers upload to the IRS portal this year. The IRS also could be required to update information about credit eligibility as soon as is reasonably possible after 2021 returns are filed in 2022.
For example, if a person is receiving a payment but information on the 2021 return shows they no longer have a qualified child, payments should be stopped until recipients can attest they will have qualifying children in 2022. Or, Congress could change the timing of the computation of the CTC. Payments of the 2022 CTC could be based on a 2021 tax return (rather than looking back to 2020 for this information), starting in May 2022 extending through April 2023. The credit would still be reconciled with actual 2022 income when a tax return was filed.
Under either option, some sort of safe harbor should be available to very low-income families who receive errant payments. Going forward, taxpayers should retain the option of using an IRS portal to update their family and income status if needed.
Monthly payments can be a critical lifeline for families, particularly those whose incomes bounce around from month-to-month. Congress should work to ensure these payments aren’t interrupted in January 2022. But the current method of advancing payments can cause some people to receive payments and later face financial hardship repaying some or all of the advance payment. By using information from only one prior tax year and keeping the credit fully refundable, Congress can markedly reduce that risk.