President Biden’s American Rescue Plan includes increased child tax credits. These can help parents dealing with tight budgets and technology demands related to virtual schooling. However, rules around the existing tax code and claiming child dependencies could mean that in some divorced families the wrong parent will get the money.
In March 2021, President Biden signed the $1.9 trillion American Rescue Plan Act into law. This COVID-19 relief effort included money to provide for medical services, keep businesses open, and help schools. But some of the money was earmarked especially for families. The legislation included an additional child tax credit for families with one or more children at home.
The amount of the child tax credit depends on the age of your child: $3,000 per child ages 6 to 17, and $3,600 for children under 6. The law directs the IRS to send up to half the credit directly to parents beginning in July 2021. And that is where things can become complicated for divorced and single parents.
One child, one tax credit, regardless of the makeup of the family. When parents are married and filing jointly, there’s no problem. The couples are included on the family tax return, and the tax credits apply to the household income. But when parents separate or get divorced, the IRS says each child can only be claimed by one taxpayer -- generally the parent who has physical custody the majority of the time.
In many cases, that isn’t the best financial choice for the two families. If one parent is working less and maintaining their household through child support, they may be taxed at a significantly lower rate than the child-support-paying parent. Sometimes they may not owe any taxes at all, and the regular child tax credit would be of no benefit. In those cases, it may be better for everyone to negotiate a different arrangement for child tax credits. For example:
Any time the parents do something other than the IRS default, they must fill out IRS Form 8332 to tell the government who is claiming the child tax credit that year.
In a divorce, if the parents can’t agree, the Michigan family court judge can determine who receives the tax credit as part of the property division. However, unmarried parents in a child custody dispute have no property issues before the judge. If they can’t agree to a different tax credit, the parent with primary physical custody will receive the tax credit automatically.
Negotiations over who will claim the child for tax purposes assume a fixed amount of tax credits each year. This number is generally applied to a taxpayer’s tax return that reduces their income, giving them “credit” for expenses related to the child. The American Rescue Plan’s design -- putting money back into the hands of parents -- changes that assumption in ways that could create problems for separated parents.
The IRS will likely send the 2021 child tax credits to whomever claimed the child on their 2020 tax returns. As Elaine Maag of the Urban-Brookings Tax Policy Center told CNBC:
"That can potentially raise issues for children who are moving between parents or households and share custody situations. . . . 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,"
By applying the 2021 child tax credit over the course of the year, it could effectively give alternating parents the benefit of two years of dependency credits.
The relief bill also included a provision requiring the IRS to develop an online portal to help distribute the advance payments. Maag and others believe this portal should allow parents to update their tax information and direct which parent should receive the increased tax credit.
Because mistakes are inevitable in a project this big and administered this quickly, the new law also creates a safe harbor for anyone making up to $40,000 (or $60,000 for couples filing jointly). They won’t be required to repay any overpayment of the credit. However, higher income families need to be on the lookout for credits they weren’t anticipating and shouldn’t have received. Since the IRS has been using direct deposit for many of the stimulus payments, some parents may not even realize they have received the money before it is spent.
COVID-19 has brought unexpected challenges to everyone in 2020 and 2021. Many parents have struggled to balance virtual learning and working from home, while others have had to scramble for child care as they maintained their positions as essential workers. Still others have found themselves unemployed and with limited income for more than a year.
Every family’s best use for the 2021 child tax credit will be different. Unfortunately, co-parents may not agree on who should receive the money, or how it should be spent. Still, filing a motion may have only limited benefits since the money could be gone before the matter comes before a judge.
The best option for families at odds over their tax credit may be mediation. At mediation, you and your co-parent can sit down with a trained facilitator to work through the details of how the tax credit payments will be used. Mediation can be very affordable compared to filing a motion in court, and it can often resolve the matter more expediently. Mediators are trained to help parties reach their own best resolution, while at the same time raising possible solutions neither parent may have otherwise considered.
At NSSSB, we help many couples and co-parents who come to us resolve their child-related disputes through mediation. Our Ann Arbor divorce mediators can help you answer the question of who will claim child dependencies and receive child tax credits, with or without attorney support. Click here to connect with our mediators.