Did you receive a letter from the Internal Revenue Service this January? One of those ominous-looking letters that makes you more than a little nervous about what’s inside? Then, when you opened the letter did you find out the IRS was actually asking for more money? If that happened to you, you aren’t alone. A lot of people are being informed they need to pay back their child tax credit in 2022.
How did this happen? To understand that let’s briefly look what the child tax credit is, how it was recently modified and how that modification might be causing you a financial headache today.
The Child Tax Credit
The Federal Child Tax Credit was passed by Congress in 1997 and signed into law by President Bill Clinton. The legislation implemented refundable tax credits based on the number of dependent children a person claimed on their income tax return. The size of the tax credit depended on the person’s income and filing status (single, married, etc.) and over the years grew as high as $2,000.
An important distinction in tax terms must be made–a credit is not the same as a deduction. A deduction reduces the overall income that is subject to taxation. But a credit is even more valuable–it is a reduction in the actual amount of taxes you owe.
Let’s say you make $85,000 a year. A $2,000 deduction that reduces your taxable income to $83,000 is nice, but it’s not a game-changer. But a tax credit, that takes the final amount of money you owe the IRS and knocks two grand off it? That’s a big deal.
Furthermore, the child tax credit was refundable. That means even if you only owed $1,000 in taxes, you could still get a $2,000 credit and get the difference refunded to you. There was a $1,400 cap on the refundable portion of the credit. That means in our example above, the person would get $400 back from the IRS. As an alternative to paying a thousand, that’s not bad.
It’s not hard to see why the child tax credit is significant. It was money in the pockets of lower-income parents, and for middle-class parents raising three children of their own, it was an economic lifeline.
The American Rescue Plan of 2021
The American Rescue Plan–known more casually as the most recent installment of the COVID-19 relief packages that have passed the Congress, made an expansion of the child tax credit. It was upped as high as $3,600, depending on the income and filing status of the person, along with the age of the children.
There was also one other big change the American Rescue Plan made to the child tax credit. The 2021 legislation paid the credit in advance. People got the refundable part of their credit before filing their taxes.
It’s this latter fact that brings us to your ominous-looking letter of January 2022.
How would the IRS know how much your credit be? How would they know what portion of that credit was refundable? The answer is that they looked at your 2020 tax returns and based the size of their checks on that information. It all seems fine up to now. But what happened if there was some significant life change that impacted what your 2021 tax returns actually look like?
Income Changes Lead to Overpayment
Was your income down in 2020? That was certainly the case for a lot of people in the year the pandemic hit the U.S. economy the hardest. Unless your job was classified as “essential”, you were at risk of being laid off. If you worked in sales, generating commissions was tough sledding.
The child tax credit works on a sliding scale, so those who earn less money can get a higher credit. Now, what if your job returned to normal in 2021? Or maybe you got a promotion. Anything that resulted in you earning more money in 2021 means the size of your child tax credit could have been reduced.
But under the terms of the 2021 legislation, the advance payment of your refundable tax credit was based on your 2020 income. Under previous tax law, the size of your income and tax credit would have just risen and fallen together. The terms of the American Rescue Plan created a disjointed relationship between income tax return and the payment of tax credit. You got more money in 2021 than you otherwise would have.
The professed goal of the legislation was to get money into people’s hands quickly post-pandemic and stimulate an American recovery. The flip side of is that now the bill is due. That bill is the letter you got in January.
Divorce Impacts Child Tax Credit Payments
Another way the overpayment of tax credits might have happened is with a divorce and change in child custody. Only one parent can claim children as dependents for income tax purposes. If you were still married in 2020, the kids would have been your dependents and you got the tax credit. Let’s say that you go through a divorce which gets finalized in January 2021, and your spouse has primary custody.
You are not likely the one getting the child tax credit in these circumstances, but under the terms of the American Rescue Plan, an advance payment would have been made to you based on 2020 information. Now the IRS wants their money back.
It’s also common for divorced parents with shared custody to essentially “take turns” in using the child tax credit. Maybe 2020 was your year for the credit and 2021 belonged to your ex. I suppose it’s possible the IRS could have figured that out before cutting you a check based on 2020 information…but they didn’t. Now the IRS wants their money back
Paying Back the Refundable Tax Credit
That January letter–Letter 6419 for reference purposes–can be used in filing your returns this spring. The amount of money you were overpaid in 2021 will be applied to either increase your tax payment this year or reduce the size of your refund.
At The Law Offices of Daniel J. Miller, we know how difficult and aggravating it can be to deal with the IRS. We also know how much divorce impacts tax situations. Whatever your legal needs are, from defending yourself in court to negotiating terms in a divorce settlement, don’t hesitate to call us at (757) 267-4949 or contact us online to set up an initial consultation. .