By Robert E. Duquette, CPA
President Joe Biden signed the American Rescue Plan (ARP) into law on March 11, 2021. The act provides an additional $1.9 trillion of economic relief related to the coronavirus pandemic in addition to the prior $4 trillion authorized for such purpose in 2020. Congressional Republicans universally refused to vote in favor of the measure citing the prior relief had not fully been implemented yet and the risk to inflation, yet multiple polls show the ARP is very popular with most Americans. (The Pew Research Center concluded that about 70% of Americans support it.)
A substantial portion of the $1.9 trillion is in the form of direct aid to federal, state, and local programs, including an expansion of the $300 per week in federal unemployment assistance, relief for small businesses, aid to schools and hospitals, funds to support the vaccine rollout efforts. Almost all American families will benefit from these forms of aid. Still, much of the ARP is being administered through the federal tax code in the form of direct payments and credits to individuals and families. This blog takes a closer look at those provisions. And because I’ve elected to focus this piece on the direct family tax benefits, other equally vital provisions, including a few tax code changes on businesses, are not discussed here.
The review of the family tax updates is accompanied by background descriptions of what the applicable laws were before ARP changed it, including details of limitations, phaseouts, and which years are affected. Keep in mind, there are 591 pages of legal text in the ARP with hundreds of provisions, of which most have yet to be fully understood. Look for more CPA Now and Pennsylvania CPA Journal contributions from this writer and others on the PICPA Federal Tax Committee as the dust settles. Inevitable glitches, technical corrections, hidden implications, pitfalls, and planning opportunities will surely arise over the next several months.
The following details are based on the Joint Committee on Taxation description and the House Budget Committee explanation as of March 16, 2021.
The headliner of the ARP is the advance payment of $1,400 for singles and $2,800 for married couples, with another $1,400 for each dependent. For the first time since COVID relief rebates began, it will include those age 17 and older.
The U.S. Treasury Department has been directed to issue these rebates as advance payments based on the latest tax returns filed for 2019 or 2020. Similar to prior COVID relief rebates, these will be phased out at high-income levels as follows:
- Singles making $75,000 of adjusted gross income (AGI), phased out completely at $80,000
- Married couples making $150,000, phased out completely at $160,000
- Head of households making $112,500, phased out completely at $120,000
And, according to the Joint Committee on Taxation and House Budget Committee reports, taxpayers receiving an advance payment that exceeds their maximum eligible credit based on 2021 tax return information will not be required to repay any amount of the payment to the Treasury. If a taxpayer’s 2021 actual tax credit exceeds the amount of the advance payment, taxpayers can claim the difference on their 2021 tax returns.
This suggests that the final qualifying information for determining the maximum credit possible will be based on the lowest AGI reported in the 2019, 2020, or 2021 tax returns. But, if the 2021 tax return shows a higher AGI than in 2019 or 2020, that 2021 tax return will not serve to reduce any advance already received. Therefore, it may make sense to consider delaying the filing of your 2020 tax return if you expect AGI may be above the threshold limits in 2020 but was not in 2019.
Child Tax Credit
Currently, (e.g., for 2020 tax returns) taxpayers can claim a generally nonrefundable credit of $2,000 for each qualifying child under age 17 at the end of the tax year and who would qualify as a dependent. (Taxpayers can also claim a portion of the credit as refundable: up to $1,400 per qualifying child based on the level of earned income – i.e., the refundable portion was equal to 15% of earned income in excess of $2,500.) Taxpayers can also claim a $500 credit for other qualifying nonchild dependents. The credits are phased out by $50 for each $1,000 or portion thereof by which the taxpayer’s AGI exceeds the applicable threshold – i.e., $400,000 for married filing jointly and $200,000 for all others.
There have been at least four major changes for 2021 only:
- The credit is now refundable, regardless of the earned income formula. Also, the credit increased to $3,000 per child, and $3,600 for children under age 6. The top age for eligible children increased from 16 to 17.
- The phase out thresholds have been altered too. The higher credit amounts for 2021 are gradually reduced for couples and surviving spouses with modified AGI over $150,000, over $112,500 for head of household, and $75,000 for all others. The higher credit amount is phased out by $50 for each $1000 or portion thereof by which the taxpayer’s AGI exceeds the applicable threshold, but not below the prior credit amount. If fully reduced to the prior maximum levels of the credit, that amount is then potentially reduced again based on prior phaseout rules (i.e., $400,000 for joint filers, $200,000 for other filers).
- According to the House Budget Committee Explanation, Treasury is to issue advance payments of the child tax credit based on 2019 or 2020 tax return information. The advance payments will be half of what the IRS determines the eligible credit amount would be based on the 2019 or 2020 tax return and are to be issued in installments starting around July 1, 2021, through the end of 2021. The remaining half will be claimed on the 2021 tax return. As an example, the House Budget Committee states that if Treasury “determines that a monthly payment was feasible, a taxpayer with two children above age 5 would receive $500 per month (2 x $3,000/12) for each of the six months remaining in calendar year 2021, for a total of $3,000. The remaining $3,000 would be claimed in 2021 on the taxpayer’s tax return. If, however, the Secretary determined that it was feasible to make a payment every two months, each advance payment would total $1,000.”
- The taxpayer’s child tax credit claimed on the 2021 tax return will be reduced by the aggregate of advance payments received. However, in the case of taxpayers who received an overpayment of the advance credit due to a child for whom the advance was paid in 2021 based on the 2019 or 2020 tax return, when in fact the child was no longer that taxpayer’s dependent in 2021, there will be a “hold-harmless” amount on the repayment obligation. According to the House Budget Committee, “Under this hold-harmless amount, a taxpayer below certain income thresholds ($40,000 for a single taxpayer, $50,000 for a head of household, and $60,000 for a joint filer) will be protected from repaying up to $2,000 in overpayments per child that was incorrectly taken into account. The hold-harmless threshold is decreased to $0 as the taxpayer’s income rises to double the threshold amount.”
Earned Income Tax Credit
Some taxpayers can claim a refundable earned income tax credit (EITC) based on the number of qualifying children, filing status, AGI, and amount of earned income. The EITC generally equals a specific percentage of earned income, and that percentage depends on how many qualifying children the taxpayer has. As an example, for married-filing-jointly taxpayers with no qualifying children, the pre-ARP minimum credit percentage for 2021 was 7.65% on maximum earned income of $7,100, or $543 (known as the “childless EITC”). In this situation, the credit began to phase out at a rate of 7.65% of AGI (or earned income if greater) above $14,820, resulting in a zero credit at $21,920. The pre-ARP maximum credit percentage was 45% on a maximum earned income of $14,950 for taxpayers with three or more qualifying children, for a maximum credit of $6,728. The credit in that situation began to phase out at a rate of 21.06% of AGI (or earned income if greater) above $25,470, resulting in zero credit at $57,414. (Similar rules applied to all other types of filers with varying levels of phaseout ranges.) “Qualified children” for this credit has used the definition of qualifying child for dependent purposes. Pre-ARP, taxpayers who did not have a qualifying child but who were at least 25 years old, under age 65, were not dependent on another taxpayer's return, and had lived in the United States for more than half of the year, could have qualified for the “childless EITC.”
Below are the ARP changes to this credit:
- The “childless EITC” amount has increased for 2021 only. This is done by increasing the credit percentage and phaseout percentage from 7.65% to 15.3%, increasing the maximum earned income amount that the credit is based on to $9,820, and increasing the beginning of the phaseout range for married-filing-jointly filers to $17,550. The maximum amount of the “childless EITC” becomes $1,502.
- Also for 2021 only, the minimum age of a taxpayer without a qualifying child to be able to claim the “childless EITC” is reduced from 25 to 19. For certain full-time students, the minimum age is reduced from 25 to 24). The upper age limit of 65 was eliminated.
- The limitation on disqualifying investment income for purposes of claiming the EITC has increased from $3,650 (2020) to $10,000. This provision appears to not sunset after 2021 like the other provisions.
- For 2021, taxpayers will be allowed to substitute their 2019 earned income for their 2021 earned income, if 2021 earned income was less than 2019 earned income.
Dependent Care Credit
This credit is a subsidy to help taxpayers defray the cost of providing care for their dependents to allow them to work. Pre-ARP, qualifying taxpayers may claim a nonrefundable credit up to 35% of the lower of either the total amount of their qualifying expenditures, $3,000 for one qualifying dependent or $6,000 for two or more qualifying dependents, or the taxpayers earned income. Therefore, the maximum credit was $1,050 if there was one qualifying individual and $2,100 if there were two or more qualifying individuals. The 35% credit rate was then reduced, but not below 20%, by one percentage point for each $2,000 (or fraction thereof) of AGI above $15,000. Therefore, for taxpayers with AGI above $43,000, the credit rate was 20%.
The ARP makes the following three changes for 2021 only:
- The child and dependent care tax credit is now refundable for taxpayers who have a principal place of abode in the United States for more than one half of the taxable year. The maximum credit rate also has been increased in 2021, from 35% to 50%, with a complex two-part phasedown of the credit discussed below. The limitation on qualifying expenses has been increased from $3,000 to $8,000 for one qualifying individual and from $6,000 to $16,000 if there are two or more qualifying individuals. Thus, the maximum credit will have increased from $1,050 to $4,000 if there is one qualifying individual, and from $2,100 to $8,000 if there are two or more qualifying individuals.
- There is a two-part phasedown of the credit: the additional 2021 credit amount has its own phaseout, and then the former phaseout still applies. First, the 50% credit rate is reduced (but not below 20%) by one percentage point for each $2,000 (or fraction thereof) of AGI above $125,000. Then, the 20% credit rate is reduced (but not below zero) by one percentage point for each $2,000 (or fraction thereof) of AGI above $400,000. Thus, for taxpayers with AGI between $183,000 and $400,000, the maximum credit rate is 20%; for taxpayers with AGI above $438,000, the credit is totally phased out.
- The exclusion for employer-provided dependent care assistance increases from $5,000 to $10,500 (from $2,500 to $5,250 in the case of a married filing separately taxpayer).
Affordable Care Act Health Insurance Premium Credit
As per the Joint Committee on Taxation Description, a refundable health care tax credit (the premium assistance credit) is provided to eligible individuals and families to subsidize the purchase of “qualified health plans” (i.e., health insurance plans offered through an American Health Benefit Exchange created by the Patient Protection and Affordable Care Act, “PPACA”). In general, Treasury makes advance payments with respect to the premium assistance credit during the year directly to the insurer. However, eligible individuals may choose to pay their total health insurance premiums without advance payments and to claim the credit for the taxable year on a federal income tax return. Pre-ARP, the premium assistance credit was generally available for individuals (single or joint filers) with household incomes between 100% and 400% of the federal poverty level for the applicable family size.
The actual amount of the premium credit is based on a sliding scale, and it depends on many complex variables, including availability of employer provided health care, the actual public plan premium cost, family size, and household income vs. official federal poverty levels. Generally, the closer to the official poverty level for a certain family size, the lower the percentage of household income is expected to support health insurance premiums, which increases the federal subsidy toward those policy premiums.
Pre-ARP, the lowest percentage of household income that had been expected to be contributed by a family whose household income was below 133% of the federal poverty level, was 2.07%. The maximum percentage of household income expected to be contributed by a family whose household income was between 300% and 400% of the federal poverty level, was 9.83%.
If advance payments of the premium assistance credit exceeded the amount of credit that the taxpayer was allowed, the excess was treated as an additional tax liability on that taxpayer’s return for that year, subject to a limit on the amount that is recaptured.
For 2021 and 2022, the ARP makes the following adjustments:
- The taxpayer’s share of premiums used in determining the amount of the premium assistance credit has been reduced or eliminated. For example, the lowest percentage of household income expected to be contributed for 2021 by a family whose household income is below 150% of the federal poverty level is 0% percent. The maximum percentage of household income expected to be contributed by a family whose household income is 300% of the federal poverty level is now 6%, which gradually increases to 8.5% for household income at $400,000.
- There is also now a premium assistance credit available to taxpayers with incomes above 400% of the federal poverty level, such as above $106,000 for a family of four. The maximum percentage of household income expected to be contributed by such taxpayers is 8.5%.
- For 2020 only, the ARP removes the requirement that excess advance payments are treated as an additional tax liability on an individual’s income tax return for the taxable year. Accordingly, under the ARP, no excess advance payment is subject to recapture. This applies to taxpayers who file a 2020 income tax return and reconciliations of any advance payment of the credit.
- For taxpayers who receive unemployment compensation in 2021, the taxpayer’s household income is not taken into account to the extent it exceeds 133% of the federal poverty level for the family size involved. Accordingly, per the Joint Committee on Taxation Description, “A taxpayer receiving unemployment compensation during 2021 and whose household income exceeds 133% of the FPL may receive a larger premium assistance credit and may be subject to lower recapture than under present law.”
- Per the Joint Committee on Taxation Description, on Jan. 28, 2021, Biden ordered the Department of Health and Human Services to consider establishing a special marketplace enrollment period “in light of the exceptional circumstances caused by the ongoing COVID-19 pandemic and the economic downturn.”
Some Other Provisions Affecting Families
The ARP extends the Employer Payroll Tax Credit for Paid Sick and Family Leave and the Employee Retention Credit for Employers for both employers and self-employed taxpayers for two more calendar quarters in 2021. The ARP makes several other modifications beyond the scope of this article. Essentially, each change is intended to encourage employers to continue to offer paid sick leave and family leave to their employees in 2021 and keep them on the payroll.
For those struggling to pay student loans, be aware that qualifying student loans that may be forgiven through the end of 2025 would be exempt from federal income tax.
To assist those continuing to struggle with lack of work and prevent the surprise that unemployment compensation is taxable income, up to $10,200 of unemployment compensation received in 2020 would be exempt from federal income tax for households with income below $150,000.
President Biden and his allies say the ARP will ease the suffering of millions of Americans and small businesses, support COVID relief and vaccine efforts, and has the potential to substantially reduce income inequality the United States. A study from the Urban Institute (arguably left of center think tank) concluded that the measures contained within the ARP could cut the household poverty rate by a third and the child poverty rate in half. The argument from critics is that it is not needed, at least to this extent. They say there were signs the economy was recovering, and this infusion of liquidity could ignite inflation.
One thing must be understood about this debate: almost all of the ARP provisions are set to expire at the end of 2021. Yes, there will be enormous pressure on Congress to make the expiring provisions permanent, but many in Congress, including almost all Republicans and some Democrats, are concerned about the total cost of making the benefits permanent. They cite national debt levels, inflation risk, and the increasing weight of the obligation to pay interest on borrowings at increasingly higher rates.
For now, the Federal Reserve is not concerned about inflation, and many economists and members of Congress believe there are several ways to make the ARP benefits permanent and pass a much more expensive package. Specifically, the president has stated he intends to propose a $3 trillion to $4 trillion infrastructure and climate change package later this spring, which may also address making some of the ARP changes permanent. Biden will probably propose to pay for this second proposal by rolling back many of the Tax Cuts and Jobs Act (TCJA) provisions on multinational corporations and the “wealthy.” Keep a watch on this since the “wealthy” often includes small-business owners, many of whom barely made it through 2018 and 2019 with the enhanced cash flows from the TCJA tax cuts for those years. (There is also discussion of bolder proposals such as a wealth tax, a financial services transactions tax, or another type of tax entirely.)
Hopefully, the president’s advisers will be more surgical in how they intend to pay for the next big legislative package and carefully consider the implications and possible ripple effects of certain bold ideas. At least for now, the ARP has not replaced the TCJA , and we must integrate both in our planning, while being mindful of the possibility that the next package could replace many provisions of the TCJA or open up an array of tax increases. Stay tuned, it is going to be an interesting year!
This piece is based on the sources available, as best as I could determine as of the time of this writing, and is for educational purposes only. This blog is not intended to be tax advice under the standards of Circular 230. Taxpayers should check with their own tax advisers for their tax planning and compliance.
Robert E. Duquette, CPA, is professor of practice in the College of Business at Lehigh University and a retired EY senior tax partner. He has served on PICPA’s Federal Taxation Committee for 30 years, focusing on federal tax reform and the national debt. He can be reached at email@example.com.
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