The Child Tax Credit was originally enacted to help working families offset the cost of raising children. It was improved by the Tax Cuts and Jobs Act (TCJA) in 2018, and these more favorable rules will apply to families at least through tax year 2025. The American Rescue Plan Act also made some significant improvements to the credit in 2021 in response to the coronavirus pandemic, but these provisions will remain in place for only one year.
The tax year is the same as the calendar year for the majority of American taxpayers, starting on January 1 and ending on December 31.
The Maximum Child Tax Credit
The TCJA increased the maximum Child Tax Credit to $2,000 per child beginning in tax year 2018, up from a maximum of $1,000 per child through December 2017. But this doesn’t necessarily mean that all qualifying taxpayers will receive that much. Your income can reduce this amount. The credit’s amount begins declining as you earn more.
The American Rescue Plan Act increases the credit to $3,600 for each child under the age of three, and to $3,000 for children ages three to 17, for tax year 2021.
First, as the name suggests, you must have a qualifying child dependent to claim this tax credit. The child can't yet have reached age 17 by December 31, the last day of the tax year, and they must be related to you. The American Rescue Plan Act extends this to age 18 by December 31 for tax year 2021.
The definition of “related” for purposes of this credit is broader than you might expect. It includes biological and adopted children, stepchildren, foster children living in your care, siblings, step-siblings, or the children of any of these individuals.
Your qualifying child can't pay for more than half their own support needs during the tax year, if they have any income of their own. In most cases, they must have lived with you, in your home, for more than half the year, but temporary absences such as living away at school for a period of time don't count.
Your child must be a U.S. citizen, a U.S. national, or a U.S. resident alien, and you must claim them as a dependent on your tax return. They must have a valid Social Security number, and you must provide it to the IRS when you file your tax return and claim the credit.
The Refundable Portion of the Child Tax Credit
Beginning with tax year 2018 and through 2025, up to $1,400 of the $2,000 Child Tax Credit can be refundable. The IRS will send you a refund for up to this amount if any part of your credit is left over after eliminating your tax debt. This refund is referred to as the "Additional Child Tax Credit." But the American Rescue Plan Act adjusts this rule as well. The credit is fully refundable for tax year 2021.
You must have earned income from a job or self-employment to qualify for the refundable portion. Nontaxable combat pay also qualifies, but investment income does not—that’s considered “unearned.” Unemployment benefits, public assistance, and worker’s compensation benefits are also considered unearned income.
In response to the pandemic, the IRS has extended another special provision for the earned income rule for tax year 2020, the return you’ll file in 2021. You can use your 2019 earned income to qualify for and calculate the refundable portion of the credit instead of your 2020 earned income, if that’s more advantageous for you.
Calculating Your Refund
The refundable portion of the tax credit is normally equal to 15% of your earned income over $2,500. A taxpayer would therefore need earned income of approximately $12,000 a year to qualify for and receive the full $1,400 refund: $12,000 less $2,500 is $9,500, and 15% of $9,500 works out to $1,425. This taxpayer with earned income of $12,000 would forfeit that extra $25, because the refundable portion of the credit is capped at $1,400. But this rule has also been waived in 2021 by the American Rescue Plan Act.
IRS Publication 972 includes a worksheet to help you figure out the refundable portion of your Child Tax Credit.
Child Tax Credit Income Limits
The Child Tax Credit is also subject to income limits for taxpayers who earn too much. The overall credit is reduced by $50 for every $1,000 over the “phase-out,” or limit, until it's eliminated entirely.
But the TCJA changed this limit, too—in favor of wealthier families. As of the 2020 tax year, the phase-out doesn’t begin for married taxpayers until a pretty significant $400,000. They can earn this much without losing any of their Child Tax Credit. The limit begins for all other taxpayers at $200,000. Unfortunately, the American Rescue Plan Act reduces these thresholds in 2021 to $75,000 for single filers, to $112,500 for heads of household, and to $150,000 for married taxpayers who file joint returns.
An unmarried taxpayer earning $210,000 normally wouldn't receive a $2,000 credit but rather $1,500 in years other than 2021. That $10,000 over the threshold would shave 5% off the credit amount, or $500.
MAGI vs. Gross Income
These income thresholds are based on your modified adjusted gross income (MAGI), not your entire earnings. Many taxpayers find that their MAGIs are the same as their adjusted gross incomes, which can be found on Line 11 of the 2020 Form 1040 tax return.
You can calculate your MAGI by adding back certain exclusions from income you might have taken to arrive at your AGI, including income from Puerto Rico, American Samoa, and foreign-earned income.
Credit for Other Dependents
You might also be able to claim an additional $500 credit, the “Credit for Other Dependents,” for your non-child dependents in tax year 2020. All of the existing rules for claiming adult dependents on your tax return still apply, and they’re largely the same for qualifying child dependents. They cover those who don’t meet the age requirement for the Child Tax Credit. The Credit for Other Dependents isn’t refundable.