By Carolyn Daly, Esq., Founder and Managing Partner of Daly & Associates, LLC with help from special guest contributor Barbara Bel, CPA
The new stimulus bill sounds like a great deal: extra money the government is giving you, including your children, as long as your income is below certain thresholds. There’s just one problem: who does the IRS give the money to? To better understand the benefits and potential threats to parents, let’s examine what is in the American Rescue Plan Act of 2021.
Stimulus Funds – where is my money?
The Rescue Act is the third COVID bill to grant “stimulus funds” to individuals, and it’s the largest award yet: $1,400 per person, including children. There are, once again, caps – you may not receive any stimulus funds if your income is over $80,000 if you file Single, $120,000 if you file Head of Household, and $160,000 if you file married. The IRS is in charge of distributing these payments, and will do so based on your 2019 tax returns (unless you filed 2020 taxes). Like with the last set of payments, the IRS attempts to pay these funds by way of direct deposit.
This presents the first challenge for those who are recently divorced: what if you filed joint taxes in 2019 and/or 2020? Did previous stimulus funds get deposited into a joint account? Who has access to that account now? If one spouse received all of the funds and refuses to share those funds, what action you should take? To file a motion and recover those funds can cost you more than $1,400.
For each child or other dependents, you receive $1,400 (again, provided you meet the income requirements). If you are divorced, the IRS will not split the funds. Instead the IRS pays to whoever claimed the children as dependents. This could produce a windfall to one parent. It may not be worth filing a motion to recover the funds. If your dependents are eligible for all stimulus payments, that means for each child the IRS has paid $2,500 over the past year. If you have multiple children and all the payments went to a single parent, it may be worth filing a motion, although that’s still a costly decision to you.
Temporary Increase to Child Tax Credit set to cause havoc
If you thought the stimulus payments were difficult, they’re nothing compared to the new rules on child tax credits. Previously, qualifying individuals received up to $2,000 per qualifying child as a credit against taxes owed (up to $1,400 of the $2,000 was refundable if you did not owe). However, the Rescue Act changed the rules for tax year 2021 only. While this may not impact your 2020 taxes, how you file in 2020 may impact who receives money in 2021, so it’s important to start thinking of this issue now.
First, the maximum credit has been increased, and is also different depending on the age of your children. Assuming you meet income requirements, for each child up to 5 years old by December 31, 2021, you will receive a $3,600 credit, which is fully refundable if you do not owe taxes for 2021. For each child between the ages of 6-17 you will receive a $3,000 credit, also fully refundable if you have no income for only 2021.
The changes don’t stop there. The Biden Administration wants to get these credits out as soon as possible. They have thus directed the IRS to begin making monthly payments of up to ½ of the benefit amount beginning in July of 2021. In other words, instead of claiming a $3,600 credit for a 4 year-old child on your 2021 tax returns that you have to file by April 15, 2022, you will instead receive $300 per month for each month (July-December 2021), and then claim the additional $1,800 on your 2021 returns next year.
There are a number of issues with this new plan, the first one being logistical. The IRS has said they cannot guarantee the system will be up and running in July, so it is unclear whether or not the monthly payments will happen as planned. Now that the tax filing deadline is May 17th, this gives the IRS even less time after tax season to implement new programs. The bigger issue is with the money itself. It is customary in divorce cases that parents alternate the deduction, meaning that the parent claiming a child in 2020 is not the same parent claiming the child in 2021. When the IRS pays these advances, they will be paying the parent who claimed the child in 2020 meaning, in most cases, they may be paying the wrong parent.
There is also an issue because this is a “one time” change to the child tax credit. While the purpose of alternating the deduction is so that each parent gets the same benefits over a two-year period, the parent who is allowed to claim the child in 2021 may actually get more money assuming the advanced monthly payments are made to that parent, but again, it is probably not enough to make it worth the cost to file a motion.
In households with multiple children, the issue may be the amount of the credit now is different based upon a child’s age. It is common in a household with two children for each parent to claim one child each year. If one of those children are under 6, that parent may be receiving a higher amount for the tax credit than the other parent, when the plan was for the parents to receive an equal exempt amount.
While these changes currently only apply to 2021, there is already a strong push to make them permanent. Parents and attorneys must thus begin preparing for multiple future scenarios – scenarios such as what to do if the changes do become permanent, or do not. According to Barbara Bel, CPA and tax partner at PKF O’Connor Davies who helped with this article, the new Congressional changes impact cash flow in divorce and the negotiations on who gets the child exemptions.
Who claims the exemption and what happens as a result, are not an IRS problem. It will fall upon the divorced parents, and possibly their accountants and attorneys, to handle these issues. It is therefore essential to know what is in the new law, and what implications it can have for your clients. Here at Daly & Associates, we have worked with our network of outside advisors to understand how this new law will impact our clients, and we are ready to help you work through it as well.
If you have questions and would like to set up a consultation, call us at (973) 292-9222 or e-mail email@example.com. We’re working “Daly” for you!
Barbara Bell is a Tax Partner with PKF O’Connor Davies’ Harrison, New York Office and a Certified Public Accountant. See more at Barbara Bel | PKF O’Connor Davies (pkfod.com)