Of the many complex financial issues that spouses may need to address during the divorce process, tax considerations can be among the most confusing. These issues can be a major concern for parents since the ability to claim children as dependents can affect the amount of taxes that a person will pay, the tax credits they can claim, and the tax refunds they will receive when filing their annual tax returns. Parents will need to be sure to understand how to address child-related tax issues both during the divorce process and after their divorce is complete. They will also need to understand how they will be affected by changes in tax laws, including the ability to receive advance child tax credits.
Divorced parents have to navigate a lot of challenges, but there’s a new issue thanks to the American Rescue Plan: The Child Tax Credit. The legislation will, among other things, increased the child tax credit to $3,000 per child ages 6 to 17 and $3,600 annually for children under 6 for the tax year 2021.
The American Rescue Plan Act, which was signed into law in March of 2021, allows parents to receive advance payments during the year for child tax credits that will be claimed on their tax returns for that year. For 2021, the child tax credit is $3,000 for a child under the age of 18 or $3,600 for a child under the age of six. Parents may receive monthly payments from the IRS between July and December of 2021, adding up to half of the total amount of the child tax credit. The remaining amount may be claimed on the parent’s tax return for 2021.
Children who will be 17 years old or younger as of December 31, 2021, will qualify for the advance child tax credit, and a parent may receive payments of up to $250 per month. For children who will be five years old or younger as of December 31, 2021, payments will be up to $300 per month. To qualify for the child tax credit, a child must have a valid Social Security number, and a parent must be able to claim the child as a dependent on their 2021 tax return. The tax credit is fully refundable, meaning that even if the amount of the credit exceeds the total taxes owed by a parent, the parent can receive a refund for the full amount of the credit. Even if a parent has an income of $0, they will be eligible to receive advance child tax credit payments, as long as they are eligible to claim tax credits for the child in 2021.
Generally, a parent may claim a child as a dependent if the child lives in their home for at least half of the year and they pay at least half of the costs of supporting the child. In addition, a parent who is filing a single tax return must have a modified adjusted gross income of under $75,000 in 2021. A parent who files as head of household must have an income under $112,500, and a married couple filing jointly must have an income of less than $150,000. Those who have incomes above these thresholds may still qualify for a reduced child tax credit, but at higher income levels, the tax credit will be phased out.
How the Child Tax Credit Typically Works
According to IRS rules, each dependent can only be claimed by one taxpayer. This isn’t an issue for married couples, since they can file jointly and essentially count as a single entity to claim their children as dependents. But divorced parents and those who aren’t married face a challenge: Only one parent can claim a child per year.
Typically, the parent who spends more time with the Child during the year gets to claim the credit. But if the timesharing agreement mandates that it’s a 50/50 split, then the parent with the higher adjusted gross income gets to claim it.
In some cases, divorced or unmarried couples work out their own arrangements, such as those with multiple children dividing their children as dependents or those with only one child or an odd number of children alternating which years they claim a dependent for tax purposes. In those cases, parents typically fill out IRS Form 8332 to direct who should receive the amount.
Advanced payments of the child tax credit
When it comes to the new advanced payments made available in the American Rescue Plan, the IRS began sending the benefits to the person who claims the child on their tax return in 2020. That’s because the agency typically defaults to using the most up-to-date information on file. That can potentially raise issues for children who are moving between parents or households and share custody situations. That’s especially true for parents who alternate years to claim the child tax credit, since one parent would be essentially getting the credit two years in a row. One of the problems we have is that we determine this credit on an annual basis, and that just doesn’t reflect how all children live.
While parents still won’t be able to split children for tax purposes — one parent will still get the entire yearly amount — the $1.9 trillion relief legislation directs the IRS to develop an online portal to help administer the advanced payments. This portal allows parents to update their tax information and specify who should receive the advanced payments so that one parent isn’t getting the tax credit two years in a row if they alternate years.
To help with this, lawmakers have included a safe harbor provision in the legislation. If individuals making less than $40,000 ($60,000 for couples filing jointly) receive an overpayment of the credit, they will not need to repay the amount, nor will it be garnished from wages.
Of course, the safe harbor doesn’t apply to upper-income families, which is where splitting tax years is a more common arrangement, is less likely to be protected. It is in both parents’ best interest to update that information, because if the incorrect partner receives that payment, they will owe it back on their tax return.”
Addressing Advance Tax Credits During Divorce and the Marital Settlement Agreement
Tax credits for children can be a complex issue to address for parents who are separated or divorced. Only one parent may claim a child as a dependent and receive the child tax credit. Parents who have separated and are planning to divorce or those who have begun the divorce process but have not yet legally dissolved their marriage will need to determine how to address the advance payments they receive for the child tax credits and how they will claim dependents and credits going forward.
While a couple is still legally married, they may continue to file joint tax returns and claim tax credits for their children. If a couple has not legally dissolved their marriage as of December 31, 2021, they may file a joint tax return for 2021 in which they will claim child tax credits. However, a couple may need to address advance child tax credits paid between July and December of 2021. If the couple has begun to separate their finances, such as by closing joint bank accounts and opening their own separate accounts, they may need to make an agreement about how they will divide any payments received. The couple may agree that these payments be divided equally between the parents or that the payments be allocated to the parent with who the children are currently living with primarily. In some cases, it may be more beneficial for parents to contact the IRS and choose to forego advance payments for the child tax credit. They may then determine how this credit will be claimed when filing their tax returns for 2021.
During the divorce process, spouses will need to make sure their divorce settlement addresses how they will divide child tax credits going forward. In some cases, the custodial parent with who the child lives with most of the time will have the right to claim tax credits for the child. However, other arrangements may also be made depending on the amount of parenting time a child spends with each parent, each parent’s financial circumstances, or other agreements between the parents. For example, if parents have multiple children, they may agree that each parent will be able to claim a specific child each year, or they may alternate years in which parents will be able to claim one or more children.
Advance Tax Credits for Divorced Parents
For parents who are already divorced, the advance tax credit can present some additional complications. The IRS will make payments based on the tax returns that parents filed in 2021 for the tax year of 2020. If a parent claimed a child as a dependent for 2020, and the child qualifies for the child tax credit for 2021, the IRS will make payments for the advance tax credit to that parent.
If parents will claim children as dependents in 2021 the same as they had done when filing their taxes for 2020, they may not need to make any changes, and they can receive advance child tax credit payments. However, if parents alternate claiming one or more children as dependents each year, the parent who had previously claimed the child tax credit will need to opt-out of receiving advance child tax credit payments. If they fail to do so, and the other parent claims the child tax credit on their tax return for 2021, the parent who received advance child tax credit payments may be required to repay the IRS for these payments when filing their tax return for 2021. However, a parent filing a single tax return who earns less than $40,000, a person filing as head of household who earns less than $50,000, or a couple filing jointly who earns less than $60,000 will not be required to repay the IRS for an overpayment of the advance child tax credit.
For parents who need to opt-out of advance child tax credit payments or otherwise update their information, the IRS has created a Child Tax Credit Update Portal. Parents can log in to this portal and waive advance payments, or they can update their bank account information to ensure that they are able to receive payments through direct deposit. In the coming months, the IRS will also be adding the capability to update information about income, dependents, and marital status, ensuring that parents will be able to address any issues related to the decisions about the ability to claim tax credits following divorce.
Other Tax Credits for Separated or Divorced Parents
Parents will also need to be sure to understand other tax credits they may be able to claim based on the decisions made during their divorce. The Child and Dependent Care Credit allows a parent to claim a tax credit for expenses related to child care or other costs of providing care for a dependent. These may include the costs of daycare or other child care providers, as well as household expenses related to providing care for children, such as payments to a housekeeper who assists with cooking and cleaning. In 2021, a parent will be able to receive a credit for 50% of up to $8,000 in child care costs, or up to $16,000 for two or more dependents.
To qualify for the Child and Dependent Care Credit, the child receiving care must have been 12 years old or younger when the care was provided. Payments must be made to an eligible child care provider. Parties who are not considered to be eligible child care providers include a person’s spouse, the parent of a child, or another person who a parent will claim as a dependent. In 2021, the Child and Dependent Care Credit is fully refundable, meaning that even if the credit reduces the taxes a person owes to $0, they may still receive a refund for any amount of the credit that is left over.
Parents with lower incomes may also qualify for the Earned Income Tax Credit. The qualification for this credit and the amount of the credit a person can claim will depend on their income and the number of children they claim as dependents. In 2021, if a parent can claim one child as a dependent, they will qualify for the Earned Income Tax Credit if they earn less than $42,158 when filing a single tax return or as head of household or $48,108 when filing a joint tax return with their spouse, and the maximum credit they can claim is $3,618. For parents with two children, the maximum earnings are $47,915 for a person filing a single tax return or head of household or $53,865 for married couples, and the maximum credit is $5,980. For parents with three or more children, the maximum earnings are $51,464 for a person filing a single tax return or head of household or $57,414 for married couples, and the maximum credit is $6,728.
If the Parents do not take action, they may need to repay the IRS the amount of advance child tax credit payments received for that child when they file their 2021 tax return next year.
New Phase-Out Scheme for 2021
For 2021, the increase (i.e., the extra $1,000 or $1,600) is gradually phased-out for joint filers with a modified AGI of $150,000 or more, head-of-household filers with a modified AGI of $112,500 or more, and all other taxpayers with a modified AGI of $75,000 or more. However, the increase can’t be reduced below zero (other limitations to this reduction will apply as well).
After any reduction of the increased credit amount is calculated, the pre-existing phase-out is then applied to the remaining credit amount. So, for joint filers with a modified AGI of $400,000 or more and other taxpayers with a modified AGI of $200,000 or more, the credit is subject to an additional reduction – possibly to $0. Once the credit amount is determined, 50% of it will be paid in advance with monthly payments. But those monthly payments run from July to December 2021. The remaining 50% will be claimed as a credit on your 2021 tax return.
When it’s time for settlement, you and your clients need a mediator who is knowledgeable about the issues in divorce, understands the financials, and gets the job done. Whether it is divorce, alimony, time sharing or post-judgment issues, allow Deborah Beylus of South Florida Mediation Services to mediate the case to help you negotiate what matters to you and your clients in a balanced manner. 561-789-0710. www.southfloridamediationservices.com.