The American Rescue Plan Act Of 2021: Tax Credits, Stimulus Checks, And More That Advisors Need To Know!

*** Editor’s Note: The Internal Revenue Service has delayed the April 15 tax filing deadline to May 17.

When President Biden was inaugurated, his administration pledged to take action to implement relief for the ongoing challenges of the coronavirus pandemic, quickly proposing a new "American Rescue Plan" to cover everything from vaccination funding to direct family relief. As is common with such legislation under a new administration, what followed in the weeks thereafter was an ongoing debate about the appropriate size and scope of relief legislation and what should be included and not. Culminating in one version of the legislation that was approved by the House, another in the Senate (which most notably eliminated the provision to increase the Federal minimum wage), and then a final version that was reconciled between the two and has now been approved and is being sent to President Biden for his imminent signature.

Ultimately, the American Rescue Plan will amount to $1.9T, spanning a wide range of relief from $350B set aside for state and local government support, $90B to various transportation and infrastructure programs, $170B for schools to update their capabilities for the pandemic environment (including $130B for K-12 and $40B for higher education institutions), and nearly $85B for various coronavirus testing, contact tracing, and vaccination efforts.

Of particular interest to financial advisors and their clients, though, is a slew of "individual tax relief" provisions, from a new round of stimulus checks ("Recovery Rebates"), a significant expansion in the Child Tax Credit, health insurance relief in the form of both expanded Premium Assistance Tax Credits for purchases from state insurance exchanges along with a new provision permitting several months of "free" COBRA coverage for those who are involuntarily terminated (funded back to employers via a payroll tax credit), and more.

2021 Recovery Rebates (Stimulus ‘Checks’)

One of the central pieces of the American Rescue Plan is a third round of ‘stimulus checks’. Officially referred to as 2021 Recovery Rebates, the latest round of stimulus checks serves as an advance receipt of a 2021 income tax credit.

And critically, while 2021 Recovery Rebates share a number of similarities with their 2020 Recovery Rebate counterparts (as authorized by the CARES Act and the Consolidated Appropriations Act), there are also a number of meaningful differences.

The ‘Base Amount’ (not an official term) of a taxpayer’s 2021 Recovery Rebate, as authorized by the American Rescue Plan, is calculated by multiplying $1,400 times the total number of eligible individuals, which includes not just taxpayers themselves but also any dependents of the taxpayer.

Example 1: Sue and Reed are a married couple who file a joint income tax return. They have a 20-year-old son in college, and a 15-year-old daughter in high school, both of whom are dependents.

Accordingly, the ‘Base Amount’ of Sue and Reed 2021 Recovery Rebate is 4 × $1,400 = $5,600.

The criteria to determine the number of individuals eligible for the rebate is one of the key differences between the 2021 Recovery Rebate and its 2020 predecessors, as the ‘Base Amount’ for both of last year’s 2020 Recovery Rebates (under both the CARES Act and the Consolidated Appropriations Act) was calculated using only the number of taxpayers and the taxpayer’s children for whom a Child Tax Credit could be claimed.

Accordingly, for the 2020 Recovery Rebates, only taxpayers and their children under 17 (a requirement to be able to claim the Trial Tax Credit in 2020) were considered when calculating the amount of the taxpayer’s 2020 Recovery Rebates.

The decision to ‘swap’ “children for whom a Child Tax Credit can be claimed” with “dependents” for inclusion as an eligible individual in the American Rescue Plan creates a Recovery Rebate formula that is significantly more inclusive.

In particular, the change is a big ‘win’ for parents with older dependent children (age 16 and older), such as those who are in their final years of high school or in college.

Additionally, taxpayers who claim elderly and/or infirm family members as dependents will also benefit from the revised criteria for Recovery Rebate eligibility.

Example 2: Breanna is a single taxpayer. She lives with her four-year-old son and her 75-year-old mother, both of whom she claims as dependents.

Accordingly, the 'Base Amount' of Breanna’s 2021 Recovery Rebate is 3 × $1,400 = $4,200.

New (Faster) Income Phaseouts For 2021 Recovery Rebate Stimulus Checks

While the inclusion of all dependents in the calculation of the Base Amount of the 2021 Recovery Rebate will come as welcome news to many clients, another change from how the 2020 Recovery Rebates were calculated is likely to be received much less favorably by others. More specifically, taxpayers will see their base 2021 Recovery Rebate phased out much more quickly under the American Rescue Plan than they did for their 2020 Recovery Rebates authorized under the CARES Act and the Consolidated Appropriations Act.

Under both the CARES Act and the Consolidated Appropriations Act last year, a taxpayer’s base Recovery Rebate was reduced by $5 for every $100 they were over their applicable threshold. Accordingly, the phaseouts of the Recovery Rebates authorized by those laws were gradual. And the bigger a taxpayer’s base Recovery Rebate was (because, for instance, they had more qualifying children), the greater the amount of income it took to completely phase them out of receiving a Recovery Rebate (because the larger base amount meant there were more $5 increments to be lost before it was reduced to $0).

By contrast, the Recovery Rebates authorized by the American Rescue Plan are completely phased out over extremely narrow, uniform-by-filing-status phaseout ranges. In other words, taxpayers with the same filing status have the same phaseout range, regardless of the size of their base Recovery Rebate.

Those phaseout ranges are as follows:

• Single Filers and Married Filing Separate: $75,000 - $80,000
• Head of Household: $112,500 - $120,000
• Married Filing Joint: $150,000 - $160,000

Example 3: Recall Sue and Reed from Example 1, who are filing a joint income tax return claiming two dependents, and who have a 2021 base Recovery Rebate of 4 × $1,400 = $5,600.

If Sue and Reed have Adjusted Gross Income (AGI) of less than $150,000, they will be entitled to the full base Recovery Rebate amount of $5,600.

If, on the other hand, they have an AGI of $160,000 or more, they will be completely phased out of receiving any 2021 Recovery Rebate. And of course, if their income falls between $150,000 and $160,000, their base Recovery Rebate will be phased out proportionally.

Since Sue and Reed have an AGI of $156,000, which is ($156,000 – $150,000) ÷ ($160,000 - $150,000) = 60% through the phaseout range, they will lose 60% of their base Recovery Rebate.

Accordingly, they would be entitled to a Recovery Rebate of $5,600 minus ($5,600 × 60%) = $2,240.

100%+ Marginal Tax Rates Via Recovery Rebate Income Phaseouts

The extremely narrow, almost cliff-like phaseout ranges created by the American Rescue Plan have the potential to produce some pretty unusual, and perhaps unintended, consequences. For instance, certain taxpayers may be better off (i.e., they may have more after-tax income) by earning less just to have a lower AGI! Or viewed another way, certain taxpayers can actually face a marginal tax rate of more than 100% over the phaseout range!

Example 4: Scott and Hope are married and file a joint return. They have three young children (all dependents) and take care of Scott’s parents, who they also claim as dependents.

Accordingly, Scott and Hope have a base Recovery Rebate of 7 × $1,400 = $9,800.

Now, suppose Scott and Hope have an AGI of $150,000 and claim the standard deduction. Prior to the application of any credits (such as the Child Tax Credit), the couple would have a 2021 Federal tax bill of $18,975. Since their AGI does not exceed the minimum Recovery Rebate phaseout threshold for married filing joint taxpayers ($150,000 to $160,000), they would be entitled to their full $9,800 Recovery Rebate credit, reducing their net tax liability to $18,975 - $9,800 = $9,175.

Imagine, however, that right before the end of the year, Scott receives a $10,000 bonus, such that their AGI jumps from $150,000 to $160,000. Normally, earning $10,000 more would be good news. But not here.

In this situation, the additional $10,000 of income increases Scott and Hope’s tax bill, prior to the application of any credits, to $21,175 (an increase of $2,200). Accordingly, by virtue of the bonus, Scott and Hope have an additional $10,000 (Scott’s bonus) – $2,200 (the increase in tax caused by the additional bonus income) = $7,800 in net, after-tax dollars.

Sounds good… until you realize that by jumping from $150,000 of AGI to $160,000 of AGI, Scott and Hope’s base Recovery Rebate is fully phased out! That loss of $9,800 of credits means that, in effect, Scott’s your-end bonus actually cost the couple $9,800 (the full Recovery Rebate credit with no bonus) – $7,800 (the net after-tax bonus, with no Recovery Rebate credit) = $2,000!

Or viewed another way, the couple earned another $10,000 of income, but their tax bill rose from $9,175 to $21,175, which is a $12,000 tax increase, or a marginal tax rate of 120% on Scott’s bonus!

2021 Recovery Rebate Paid Now Based On Prior Year’s AGI, But Still A 2021 Credit

Given the changes to the way a taxpayer’s Recovery Rebate is phased out, it is more important than ever to understand the mechanics behind the way the Recovery Rebate is paid or potentially ‘trued up’ on a client’s income tax return at the end of the year.

Under the American Rescue Plan, there are as many as three ‘checkpoints’ that the IRS will use to determine if an individual is entitled to a 2021 Recovery Rebate.

In some cases, a taxpayer may receive the full amount of the Recovery Rebate at ‘Checkpoint 1’ provided their 2019 or 2020 tax return is filed, and their AGI is equal to or less than the phaseout threshold, thereby essentially rendering the additional ‘Checkpoints’ 2 and 3 meaningless (at least for them).

Others will fail Checkpoint 1 (because their income was above the phaseout threshold on their 2019 and 2020 tax returns) and have to wait until the Additional Payment Determination Date in ‘Checkpoint 2’ (explained below), or until after they file their 2021 tax returns ‘Checkpoint 3’ to receive some or all of their 2021 Recovery Rebate. Still, others may receive portions of their 2021 Recovery Rebate at each of the three Checkpoints! And, of course, some high-income clients will not receive any Recovery Rebate at any ‘Checkpoint’.

‘Checkpoint 1’: Most Recent AGI On File With IRS (When The IRS First Processes 2021 Recovery Rebates)

Like its predecessors, 2021 Recovery Rebates will be paid in advance (e.g., by direct deposit into a client’s bank account, through a check or debit card mailed to the client's address on file with the IRS, etc.) based on the most recent AGI information the IRS has on file, which can be determined by tax returns filed for 2020 (if already filed) or 2019 (for most taxpayers who have not yet filed 2020 returns). This is effectively ‘Checkpoint 1’.

Given that we’re still relatively early in the 2021 tax filing season, most taxpayers have not yet filed their 2020 tax returns. Accordingly, the most recent AGI information that the IRS has on file for most clients will be their 2019 AGI. Nevertheless, there will be some early-filing clients for whom 2020’s AGI will be the most recent on file (and who, as a result, will jump right to ‘Checkpoint 3’ after ‘Checkpoint 1’, as explained further below).

Either way, if the most recent AGI on file with the IRS is equal to or less than the lower limit of the client’s phaseout range (e.g., $75,000 for single filers, $150,000 for joint filers), the IRS will send the client the full amount of their base Recovery Rebate. Accordingly, such clients need not worry about ‘Checkpoint 2’ or ‘Checkpoint 3’!

For clients with AGI within the phaseout range (who will be paid a ratable portion of their base Recovery Rebate) or above the phaseout range (who will receive no Recovery Rebate at this time), subsequent checkpoints represent another bite at the Recovery Rebate ‘apple’.

‘Checkpoint 2’: The Additional Payment Determination Date (For Those Taxpayers Who Have Not Filed Their 2020 Tax Returns Yet)

For many taxpayers who have yet to file their 2020 tax returns, their AGI in 2020 may be significantly less than their AGI from 2019 (in no small part due to the pandemic for which the American Rescue Plan is supposed to provide relief). This reduction in AGI would potentially allow them to receive a (larger) 2021 Recovery Rebate, which will be determined once their 2020 tax returns have been filed. Accordingly, the American Rescue Plan introduces something called the Additional Payment Determination Date.

In short (and applicable to the majority of taxpayers whose most recent AGI information on file with the IRS is still their 2019 AGI), individuals filing their 2020 tax return prior to the Additional Payment Determination Date will have their Recovery Rebate amount recalculated based on the newly reported 2020 AGI. And if using 2020 AGI produces a higher Recovery Rebate compared to the amount initially calculated using 2019’s AGI, the IRS will send an additional stimulus ‘check’ to the taxpayer after filing their 2020 return to ‘true up’ the difference in the appropriate 2021 Recovery Rebate.

Per the American Rescue Plan, the Additional Payment Determination Date is the earlier of:

• 90 days after the 2020 calendar year filing deadline; or
• September 1st, 2021

Advisors should pay particularly close attention to clients who had temporarily low incomes in 2020. For instance, some low-earning clients may have been temporarily out of work or had hours reduced due to the pandemic that have now been restored. Business-owner clients may have seen dramatic decreases in profits for 2020, which are now largely expected to recover for 2021.

While October 15th, 2021 remains the extended filing deadline for these individuals to file their 2020 tax returns, there is a potentially huge incentive to file that tax return much sooner. If 2020 represented a ‘blip on the radar’ and was indeed an unusually low-income year for a client, it may represent the only year with an income low enough for them to qualify for a Recovery Rebate Credit.

If that return is filed by the Additional Payment Determination Date, they will receive a 2021 Recovery Rebate credit based on that income. If, however, they file their 2020 return after the Additional Payment Termination Date, they will forfeit the opportunity to use ‘Checkpoint 2’ and 2020’s unusually low income, and instead, will go directly to ‘Checkpoint 3’.

In other words, for those whose 2020 income was, in fact, lower than their 2019 income, allowing them to get a bigger stimulus check, they can either simply file their 2020 tax return by the normal (April 15^th) deadline or, if an extension is necessary, file within 90 days thereafter (or September 1^st if later). Don’t wait until the maximum October 15^th deadline for an extension and risk missing Checkpoint 2 (especially if income will be higher again in 2021, as discussed further below).

‘Checkpoint 3’: Filing Of A Taxpayer’s 2021 Tax Return

While prior years’ (2019 and/or 2020) AGI are being used to determine how large a 2021 Recovery Rebate a taxpayer should receive in advance, the credit remains a 2021 income tax credit.

Accordingly, the third and final ‘Checkpoint’ used to determine if an individual will receive a 2021 Recovery Rebate Credit is the filing of their 2021 income tax return.

If an individual’s 2021 AGI is lower than the (2019 and/or 2020) AGI(s) used to calculate the 2021 Recovery Rebate paid to them in advance, and that income is low enough to produce a larger 2021 Recovery Rebate credit, the credit (or remaining amount not already received) will be applied on their 2021 income tax return.

Accordingly, such a taxpayer will receive a larger income tax refund or will see the amount owed on their 2020 tax return reduced.

No Clawback Of 2021 Recovery Rebate Credit Paid At Any ‘Checkpoint’

One critically important planning consideration is that the ‘Checkpoints’ described above represent a one-way opportunity to increase the amount of a taxpayer’s 2021 Recovery Rebate Credit.

Any amounts correctly paid based on the taxpayer’s income on file with the IRS at the time of payment can be kept by the taxpayer. There is no clawback on a taxpayer’s 2021 tax return of previously paid 2021 Recovery Rebate amounts, even if the taxpayer’s 2021 income is high enough to completely phase them out of receiving such credit. Which makes it especially important for those with income that was lower in 2020 to ensure they file in time to satisfy Checkpoint 2 (by the earlier of 90 days after their tax filing deadline, or September 1^st, but not by just waiting until the latest possible due date for their extension!).

Temporary Enhancements To The Child Tax Credit For 2021

The American Rescue Plan includes a number of significant changes to the Child Tax Credit for 2021 that have the potential to dramatically lower the tax bills of families with young children. These changes include increases in the maximum amount of the credit, the maximum age of a qualifying child, increased ‘refundability’, and provisions for advance payment of the credit during 2021.

Increase In The Amount Of The Maximum Child Tax Credit For 2021

One significant change to the Child Tax Credit, effective in 2021, is an increase in the maximum amount of credit available per child. In general, the new IRC Section 24(i)(3) increases the maximum amount of the credit to $3,000 (up from $2,000) per qualifying child for 2021. And even better, the enhanced maximum credit is further increased to $3,600 per qualifying child under the age of six (as of December 31st, 2021).

Example 5: Tony and Pepper are married taxpayers with two children, ages eight and four. Therefore, they are eligible for a maximum Child Tax Credit of $3,000 (for the eight-year-old) + $3,600 (for the four-year-old) = $6,600 in 2021.

Tony and Pepper have $140,000 of AGI in 2021, which is less than the credit threshold established for joint filers.

Accordingly, they will receive the full $6,600 amount as a Child Tax Credit for 2021.

Not all clients with children age 17 and under will qualify to receive these enhanced 2021 Child Tax Credit amounts, though. That’s because the increased Child Tax Credit amounts authorized by the American Rescue Plan (i.e., the amount in excess of $2,000 per qualifying child) are subject to phaseout ranges at significantly lower income amounts than the standard Child Tax Credit.

More specifically, Section 9611 of the American Rescue Plan creates new IRC Section 24(i)(4), which phases out the temporary 2021 increases in the Child Tax Credit by $50 for each $1,000 that a taxpayer exceeds their applicable threshold. The applicable thresholds are as follows:

• Joint Filers: $150,000
• Head of Household: $112,500
• All other filers: $75,000

Example 6: Natasha and Bruce are married taxpayers who also have two children, ages eight and four. Therefore, they too are eligible for a maximum Child Tax Credit of $3,000 (for the eight-year-old) + $3,600 (for the four-year-old) = $6,600 in 2021.

Natasha and Bruce, however, have an AGI of $175,000 in 2021, which exceeds the $150,000 threshold for joint filers.

They are, therefore, $175,000 – $150,000 = $25,000 over their threshold for the enhanced 2021 Child Tax Credit. This is equivalent to 25 increments of $1,000.

Accordingly, their actual Child Tax Credit amount for 2021 will be $6,600 – [25 ($1,000 increments) × $50 (phaseout reduction per $1,000 increment)] = $5,350.

While the phaseout ranges described above reduce the 2021 enhanced amounts of the Child Tax Credit (the amount per child in excess of $2,000), they do not impact the ‘regular’ Child Tax Credit amount of $2,000.

Rather, the $2,000 per child ‘regular’ Child Tax Credit amount continues to be phased out by $50 for every $1,000 a taxpayer is over their ‘regular’ phaseout AGI of $400,000 for Joint Filers and $200,000 for single filers.

Example 7: Steve and Peggy are married taxpayers who also have two children, ages eight and four. Therefore, they too are eligible for a maximum Child Tax Credit of $3,000 (for the eight-year-old) + $3,600 (for the four-year-old) = $6,600 in 2021.

Steve and Peggy, however, have an AGI of $225,000 in 2021, which again exceeds the $150,000 threshold for joint filers.

They are, therefore, $225,000 – $150,000 = $75,000 over their threshold for the enhanced 2021 Child Tax Credit. This is equivalent to 75 increments of $1,000.

Subtracting 75 × $50 = $3,750 from Steve and Peggy’s maximum 2021 Child Tax Credit amount of $6,600 would leave the remaining Child Tax Credit amount of $2,850.

Notably, though, only $6,600 – $4,000 = $2,600 of the maximum 2021 Child Tax Credit amount is in excess of the ‘regular’ Child Tax Credit amount of $4,000. Accordingly, only $2,600 of the maximum credit amount can be phased out due to income in excess of the special, lower AGI limit for 2021, and they would still be eligible for a $4,000 Child Tax Credit.

Furthermore, Steve and Peggy’s AGI is less than the $400,000 ‘regular’ AGI phaseout, and therefore, they will be entitled to keep that Child Tax Credit amount of $6,600 – $2,600 = $4,000 for 2021.

Children Age 17 And Under Qualify For The Child Tax Credit For 2021

In general, in order for taxpayers to receive a Child Tax Credit for one of their children, the child must be under the age of 17 (i.e., 16 or under) as of the end of the year. The American Rescue Plan temporarily increases the maximum age, so that children under the age of 18 (i.e., 17 and under) qualify for 2021.

More simply put, parents who have one or more children turning 17 years old in 2021 will be able to continue receiving a Child Tax Credit for those children (subject to income phaseouts), whereas normally, such children would have already aged out of being eligible for the credit.

The Child Tax Credit Is Fully Refundable For 2021

Prior to the Tax Cuts and Jobs Act of 2017, the Child Tax Credit was a non-refundable credit. When the Tax Cuts and Jobs Act doubled the credit amount per qualifying child from $1,000 to $2,000, however, it also made up to $1,400 of that amount refundable (i.e., able to be received back as a tax refund if the credit makes the household’s total tax liability negative for the year).

The American Rescue Plan takes this one step further, making the full $3,000 per child (and $3,600 per child under age 6) of the 2021 Child Tax Credit amount refundable. The increased credit amount, along with the fully refundable feature, will make for a powerful combination for many families.

Consider that, according to the US Census Bureau, the median household income in 2019 was $68,703. In 2021, the same income (assuming all income is ordinary income and the standard deduction is taken) would produce a tax liability for a married couple filing a joint income tax return, before credits, of $4,834.

Suppose that such a couple has three children, ages 4, 7, and 9. The result?

The couple’s cumulative Child Tax Credit of $3,600 (for the four-year-old) + $3,000 (for the seven-year-old)+ $3,000 (for the nine-year-old) = $9,600, by itself, would completely wipe out their 2021 tax liability, and still leave them with a refund of $9,600 (total refundable Child Tax Credit amount) – $4,834 (total tax liability) = $4,766!

A Portion Of A Taxpayer’s 2021 Child Tax Credit Amount May Be Paid In Advance

Section 9611(b) of the American Rescue Plan creates new IRC Section 7527A, Advance Payment Of Child Tax Credit. In this section, the IRS is generally instructed to pay taxpayers 50% of their estimated Child Tax Credit amount for 2021 in equal installments from July 1st, 2021, through December 31st, 2021.

In general, IRC Section 7527A(b)(2) requires the IRS to use a taxpayer’s filing status, income, and the ages and number of children from 2020 to determine the advance payment amount. If a taxpayer has yet to file their 2020 tax return by the time they begin to receive their advance payments, though, the IRS will use the same information from the taxpayer’s 2019 return.

Once an individual’s 2020 return is filed, however, the IRS may use the information on that return to update the remainder of the client’s 2021 advance Child Tax Credit payment amounts.

In some ways, the advance payments of a taxpayer’s 2021 Child Tax Credit might feel a lot like additional stimulus checks. But there is one huge difference between the advance payment of a taxpayer’s 2021 Child Tax Credit and any stimulus check a client receives: if the advance of a taxpayer’s 2021 Child Tax Credit amount exceeds their actual 2021 Child Tax Credit amount, the excess is generally subject to a clawback on the client’s tax return.

Mechanically speaking, the amount paid as an advance payment will continue to be treated as the taxpayer’s Child Tax Credit, but their 2021 tax liability will be increased by an amount equal to the excess of the advance payments over what would have been their Child Tax Credit amount if the advance payments had not been made.

Example 8: Nick is a Head of Household taxpayer with two children, ages 8 and 10. Nick is an extremely successful restauranteur, generally earning $500,000 or more each year from his Big Kahuna Burger chain of restaurants.

In 2020, however, as a result of the pandemic, many of Nick’s restaurants were shuttered for large portions of the year, and his income dropped to $100,000. He has already filed his 2020 tax return, so this is the most recent information the IRS has on file.

Based on Nick’s 2020 income tax return, on which he reported two children eligible for the Child Tax Credit and income below the $112,500 Head of Household phaseout AGI for the enhanced 2021 Child Tax Credit, the IRS will assume that he will be entitled to a 2021 Child Tax Credit of $3,000 + $3,000 = $6,000.

Accordingly, by default, the IRS will pay Nick 50% × $6,000 = $3,000 of his 2021 Child Tax Credit in advance, from July through December 2021.

Suppose, however, that Nick’s business bounces back in 2021, and once again, his AGI is $500,000. At that income level, he would normally be fully phased out of receiving a Child Tax Credit for 2021. But he already received $3,000 for the credit in advance!

As a result, Nick’s ‘regular’ tax liability for 2021 will be increased by $3,000. In short, he has to pay back the excess Child Tax Credit he previously received as an advance but, in the end, wasn’t actually eligible for in 2021.

Partial No Clawback Rule For Child Tax Credit

While clawbacks, like the one described in the example above, are the general rule, certain taxpayers with more modest income levels will be eligible for at least somewhat of a reprieve.

Taxpayers whose AGI levels are less than yet another threshold amount, as listed below, will be eligible for a safe harbor and will be permitted to keep up to $2,000 of overpayments per child that was erroneously paid in advance.

Example 9: Scott and Jean are married taxpayers who have already filed a joint tax return for 2020. Jean has a 3-year-old child from a previous marriage whom she claims as a dependent in even tax years (e.g., 2020).

Since the couple has already filed their 2020 tax return, the IRS will use that return as the reference year to determine how much, if any, 2021 Child Tax Credit should be paid in advance during 2021.

As a result, the IRS assumes that Scott and Jean will receive a 2021 Child Tax Credit of $3,600 (since Jean’s child is younger than age 6, Jean is eligible to receive the $3,600 credit) and will, therefore, pay 50% × $3,600 = $1,800 of that credit in advance from July through December 2021.

But 2021 is an odd year, and as such, Scott and Jean will not be claiming the child as a dependent on their return (who is instead being claimed by her father Logan this year). Generally, as discussed above, this would result in the $1,800 paid in advance being clawed back on the couple’s tax return.

Suppose, however, that the couple’s income for 2021 is only $55,000, which is below the lower limit of the couple’s applicable safe harbor phaseout range (which, as listed below, begins at $60,000), they would be entitled to keep up to $2,000 of the credit paid in advance. That’s more than the $1,800 amount that was actually paid, so there would be no clawback of prepaid 2021 Child Tax Credit on the couple’s 2021 tax return.

In turn, though, the safe harbor of $2,000 per child is reduced (and ultimately eliminated) over a phaseout range that begins at and is equal to the lower threshold amount.

Accordingly, the phaseout ranges for a taxpayer’s safe harbor are as follows:

• Single filer: $40,000 - $80,000
• Head of Household: $50,000 - $100,000
• Joint filer: $60,000 - $120,000

Example 10: Assume the same facts as in Example 9 above, except that Scott and Jean have AGI of $84,000 for 2021.

As a result, they find themselves within their applicable safe harbor phaseout range and are [$84,000 (2021 AGI) – $60,000 (phaseout lower limit)] ÷ $60,000 = 40% of the way through their phaseout range.

Therefore, the $2,000 safe harbor amount must be reduced by 40% × $2,000 = $1,200. Recall, however, that Scott and Jean received $1,800 of advance Child Tax Credit payments during 2021.

Accordingly, they will have $1800 – $1200 = $600 of that amount clawed back on their 2020 tax return.

Temporary Enhancements To The Child And Dependent Care Tax Credit For 2021

The American Rescue Plan brings even more good news for parents with young children, as the Child and Dependent Care Tax Credit is getting some major upgrades for 2021. The credit is calculated by multiplying a taxpayer’s eligible expenses by their “Applicable Percentage”, and both the expense amount and percentage factor will be increased for 2021.

As a result, many taxpayers will receive dramatically larger Child and Dependent Care Tax Credits this year. Plus, those potentially much larger credit amounts will be fully refundable!

The changes made by the American Rescue Plan aren’t good news for all taxpayers, though. In fact, certain high-earning clients will find where once they received a relatively small Child and Dependent Care Tax Credit, none will be available for 2021.

Increase In The Maximum Amount Of Expenses Eligible To Be Used In The Calculation Of The Child And Dependent Care Tax Credit For 2021

Prior to the changes that the American Rescue Plan will make for 2021, the ‘regular’ Child and Dependent Care Tax Credit has been calculated using a maximum of $3,000 of expenses when the taxpayer has one qualifying child and $6,000 of expenses when the taxpayer has two or more qualifying children. Qualifying children are those children who are under the age of 13 for the entire year.

Under the American Rescue Plan, the maximum amount of expenses eligible to be used in the calculation of the Child and Dependent Care Tax Credit is more than doubled in 2021, to $8,000 of expenses when a taxpayer has one qualifying child and $16,000 of expenses when a taxpayer has two or more qualifying children!

Changes To The ‘Applicable Percentage’ For The Child And Dependent Care Tax Credit For 2021

It’s one thing to increase the maximum potential Child and Dependent Care Tax Credit (for 2021), but it’s another to enable taxpayers to actually ‘see’ those increased credits on their 2021 tax returns.

Notably, the actual Child and Dependent Care Tax Credit to which a taxpayer is entitled is calculated by multiplying the amount of the taxpayer’s eligible expenses (such as daycare) with what is known as their “Applicable Percentage”.

The ‘regular’ (i.e., pre-2021) maximum Applicable Percentage is 35%. That percentage, however, is quickly reduced to as little as 20%, phasing down as the taxpayer’s AGI exceeds $15,000 (regardless of filing status).

More specifically, for every $2,000 amount (or portion thereof) a taxpayer’s AGI exceeds the $15,000 threshold, the Applicable Percentage is reduced by 1% (to as low as the 20% ‘floor’ Applicable Percentage amount). Accordingly, by the time a taxpayer has $45,000 in income, they have reached the 20% Applicable Percentage floor.

However, under the American Rescue Plan, the maximum Applicable Percentage is increased to 50%. Furthermore, the 50% Applicable Percentage does not begin to be phased out until the taxpayer’s AGI exceeds $125,000 (regardless of filing status)! As a result, many more taxpayers will be able to receive the maximum Child and Dependent Care Tax Credit in 2021.

Which means that, under the American Rescue Plan, a taxpayer with AGI under $125,000 would have an Applicable Percentage of 50%. But as a taxpayer’s AGI exceeds the $125,000 threshold, the ‘regular' phaseout formula applies. As before, the ‘regular’ phaseout formula reduces the Applicable Percentage by 1% for every $2,000 (or portion thereof) the taxpayer is over the phaseout threshold until the Applicable Percentage equals 20%. Accordingly, as a taxpayer’s AGI increases from $125,000 to $185,000 under the American Rescue Plan, their Applicable Percentage phases out from 50% to 20%. Upon reaching an AGI of $185,000, their Applicable Percentage is phased out to the 20% floor (which is actually more of a plateau than a floor for 2021, as discussed further, below).

As shown in the chart below, due to the combination of the increased amount of expenses eligible for inclusion in the calculation of the credit, and the increase of the maximum Applicable Percentage, the maximum Child and Dependent Care Tax Credit a taxpayer can receive in 2021 is dramatically higher than it was in 2020. In fact, that maximum amount has nearly quadrupled!

With credit amounts that high, many taxpayers would normally be unable to take advantage of the full benefit of the maximum credit, as the Child and Dependent Care Tax Credit is generally a non-refundable credit. The American Rescue Plan, however, changes that, too, making the full amount of the credit refundable!

High-Earning Taxpayers Can Be Fully Phased Out Of The Child And Dependent Care Tax Credit For 2021

While the American Rescue Plan’s changes to the Child and Dependent Care Tax Credit for 2021 will be welcome news for an overwhelming majority of taxpayers, advisors’ highest-earning clients will find the legislation contains a rather unwelcome surprise.

As noted earlier, the ‘regular’ pre-2021 Child and Dependent Care Tax Credit rules create a minimum Applicable Percentage floor of 20%. Accordingly, even the highest earners are generally able to claim a 20% × $3,000 = $600 Child and Dependent Care Tax Credit if they have one qualifying child, and a 20% × $6,000 = $1,200 Child and Dependent Care Tax Credit if they have two or more qualifying children.

That, however, won’t be the case for 2021.

In keeping with the Biden campaign promise not to increase taxes for those making less than $400,000 per year, the American Rescue Plan introduces a second phaseout point of $400,000 of AGI (for all filing statuses). Once a taxpayer’s AGI exceeds $400,000, their 20% Applicable Percentage is decreased by 1% for every $2,000 (or portion thereof) of income that exceeds that mark.

Accordingly, clients with AGI exceeding $440,000 will receive no Child and Dependent Care Tax Credit in 2021, despite having been eligible for at least some credit amount in prior years.

American Rescue Plan Enhancements To Unemployment Compensation

As those who followed the American Rescue Plan’s legislative journey through Congress will recall, the single most debated aspect of the bill was its provisions related to unemployment compensation.

Interestingly, the House-approved unemployment compensation-related provisions were significantly scaled-back by an amendment introduced by Rob Portman (R-OH), after Joe Manchin (D-WV) backed the proposal, along with all 49 Senate Republicans… only to be re-expanded later the same day, after all 50 Senate Democrats, including Joe Manchin(!) supported another amendment, introduced by Ron Wyden (D-OR).

Ultimately, the final provisions of the American Rescue Plan extend many of the benefits that have been in place since the passing of the CARES Act last March, as well as designate up to $10,200 of unemployment compensation received in 2020 tax-free.

More specifically, the following Federally subsidized unemployment compensation benefits have been extended:

• ‘Regular’ Unemployment Compensation – As a result of the pandemic, many individuals have experienced short-term periods of unemployment. However, as of the end of February 2021, nearly 4.1 million Americans were considered “long-term unemployed”, meaning they have been out of work for 27 weeks or more. To aid states in supporting such individuals, the American Rescue Plan extends Federal subsidies to states providing unemployment compensation (in excess of the ‘normal’ period for which state unemployment compensation may be received) to individuals through September 6th, 2021.
• Pandemic Unemployment Assistance – Certain workers, such as self-employed individuals, are generally ineligible for unemployment compensation. However, due to the nature of the pandemic, the CARES Act created the Pandemic Unemployment Assistance program to provide unemployment benefits for such individuals. The American Rescue Plan extends the program through September 6th, 2021.
• Federal Pandemic Unemployment Compensation (FPUC) – Under this provision, the ‘regular’ weekly unemployment compensation amounts received by an individual (which varies, rather significantly, from state to state) will continue to be increased by an additional $300 through September 6th, 2021.

In addition to the unemployment-compensation-related programs described above, the American Rescue Plan also extends a full Federal reimbursement for the first week of Unemployment Compensation benefits for states with no elimination period (generally one week) and a 50% subsidy for certain temporary short-time compensation programs (for workers who have seen a reduction in hours).

Up To $10,200 Of 2020 Unemployment Compensation Per Worker May Be Tax-Free

Section 9042 of the American Rescue Plan includes another potential benefit for individuals who received unemployment compensation for some or all of 2020. More specifically, provided a taxpayer’s AGI is less than $150,000, up to $10,200 of unemployment compensation received in 2020 will be tax free.

There are, however, a number of important nuances to consider with respect to this provision, including the following:

• It appears that the $150,000 AGI limit applies uniformly to all filing statuses.
• It appears that the $150,000 AGI limit is a true ‘cliff’ threshold - A plain reading of the American Rescue Plan indicates that a taxpayer with $149,999 of AGI can have up to $10,200 of unemployment compensation excluded from their gross income. If, however, the same taxpayer earns just a single dollar more, the full amount of the unemployment compensation received in 2020 will be taxable.
• It appears that, in the case of joint filers, each spouse can receive up to $10,200 of unemployment compensation tax-free, permitting up to $20,400 for the household (as long as they remain below the cliff phaseout threshold).
• The $150,000 AGI cliff phaseout now EXCLUDES unemployment compensation received when calculating total MAGI. The IRS recently revised its stance and issued new guidance after originally including unemployment compensation when calculating total MAGI.

Example 11: Peter and Mary Jane are married taxpayers who file a joint tax return. In 2020, Peter had earnings of $125,000. Meanwhile, Mary Jane had earnings of $20,000, as well as unemployment compensation of $15,000.

Exclusive of unemployment compensation, Peter and Mary Jane have a total income of $145,000 ($125,000 Peter’s earnings + $20,000 Mary Jane’s earnings). The $15,000 of unemployment compensation is not included in total MAGI.

Therefore, their joint MAGI is $145,000 which is < $150,000. So, Mary Jane can exclude $10,200 of her $15,000 unemployment compensation on their 2020 tax return.

Increased Federal Support For Health Insurance Via COBRA Subsidies And Enhancements To The Premium Assistance Tax Credit

Even in ‘good’ times, most Americans would agree that having quality health insurance is an important aspect of financial, physical, and mental health. During a pandemic, however, such coverage is even more important.

In an effort to increase the number of Americans who can continue to afford such coverage, the American Rescue Plan provides for substantial COBRA subsidies in the event that an employee is laid off, as well as for enhancements to the existing Premium Assistance Tax Credit for health insurance policies purchased by lower-income taxpayers via a state-run health insurance Exchange.

COBRA Subsidies In 2021 For Terminated Employees

About three-quarters of Americans who don’t have health coverage via Medicare or Medicaid have health care coverage provided by their employer. In most cases, that coverage is heavily subsidized by the employer. Accordingly, in the event that a taxpayer loses their job, the cost of maintaining coverage under their employer’s policy, via COBRA – which can be as much as 102% of the total (unsubsidized) cost of coverage – is often unmanageable.

For those who are or have been involuntarily terminated from employment, the American Rescue Plan includes a pretty incredible benefit. Section 9501 of the American Rescue Plan allows such individuals to maintain their existing health insurance, via COBRA, from April through September 2021 at a cost of $0!

Premiums for such coverage are to be paid by the taxpayer’s former employer and will be reimbursable for the employer in the form of a refundable payroll tax credit.

Additionally, at the discretion of (former) employers, qualifying individuals will have up to 90 days after receipt of notice from their group health plan to change their coverage option, provided the newly selected coverage option meets minimum requirements and is no more expensive than the coverage they had when they were terminated.

Temporary Enhancements To The Premium Assistance Tax Credit

Section 9661 of the American Rescue Plan modifies the maximum amount of income a taxpayer is required to spend on a policy purchased via a state-run health insurance Exchange (i.e., an Obamacare policy) before Premium Assistance Tax Credits (PATCs) pick up the rest of the cost. The changes are applicable for both 2021 as well as 2022.

The graphic below details the special enhanced rates for 2021 and 2022, as well as the ‘regular’ rates that apply:

There are several things worth noting with respect to the temporary changes in the Premium Assistance Tax Credit. For one thing, under the American Rescue Plan, taxpayers with household income up to 150% of the poverty line will have the entire cost of eligible coverage paid for by Premium Assistance Tax Credits. Normally, such individuals would have to spend up to 4% of their income to secure the same coverage.

But modest-earning taxpayers are not the only ones to see Premium Assistance Tax Credits increased under the American Rescue Plan. Rather, there is relief available for higher earners as well.

Note that while Premium Assistance Tax Credits are ‘normally’ limited to individuals who have a household income that is no higher than 400% of the poverty line, under the American Rescue Plan, the cost to higher-earning taxpayers (with an income of 400% of the poverty line or higher) of an eligible plan is also now capped at no more than 8.5% of their income.

In essence, then, the household income limits for Premium Assistance Tax Credits have been eliminated (though since premiums are still capped at a percentage of income, high-income taxpayers would still likely have only a limited credit, if only because 8.5% of a high income is still too high to be eligible for a credit for additional health insurance premiums above that threshold). Still, though, given the relatively high cost of certain qualifying coverage, such credits have the potential to significantly reduce overall tax liability for certain taxpayers.

No Clawback Of Excess Premium Assistance Tax Credits Paid In 2020

In addition to increasing the Premium Assistance Tax Credit amount for many taxpayers in 2021 and 2022, the American Rescue Plan Act also provides relief for taxpayers who received advance 2020 Premium Assistance Tax Credits payments in excess of what the actual 2020 Premium Assistance Tax Credit amount should have been.

In general, such overpayments are clawed back by increasing a taxpayer’s income tax liability by the excess payment, subject to certain statutory limits. Section 9662 of the American Rescue Plan Act temporarily pauses this clawback feature for 2020 overpayments only.

Special Rule For Individuals Receiving Unemployment Compensation In 2021

Section 9663 of the American Rescue Plan Act provides a final Premium Assistance Tax Credit-related break. Under this section, taxpayers who receive (or who are approved to receive) unemployment compensation for at least one week during 2021 will automatically be treated as though their household income does not exceed 133% of the poverty line. And as noted above, individuals with such income are eligible for Premium Assistance Tax Credits equal to the full cost of the second least expensive Silver Plan available via their state Exchange.

Interestingly, there does not appear to be any phaseout range or maximum income amount associated with this provision. Accordingly, even an extremely high-earning individual who is terminated from employment after earning several hundred thousand dollars, or more, in 2021, and who subsequently receives unemployment compensation, also in 2021, would seem to be treated as though they had income below 133% of the poverty line for purposes of this provision.

Of course, such individuals are also much more likely to have employer-provided health insurance, which they may prefer over the available Exchange-based policies… especially if they can continue to receive that coverage at no cost via subsidized COBRA through September 2021 (as described above).

To that end, the net ‘play’ for many employees with employer-provided health coverage who are terminated this year prior to September will likely be to continue receiving fully subsidized COBRA coverage through September, and then to make a decision whether they want to continue paying for that coverage on their own, or switch to what at worst will be a highly subsidized Exchange-based policy.

Of course, there are always exceptions. For instance, recall that the COBRA subsidy is ‘only’ available to cover the cost of the policy in force at the time of the taxpayer’s termination of employment. Perhaps that policy has higher out-of-pocket costs than what could be purchased via a state-run Exchange at little to no cost. In such cases, it may be best to forgo the ‘free’ COBRA subsidy (because while the insurance may be free, the co-pays, co-insurance, deductibles, etc. could be significant, if healthcare is needed) and opt for an Exchange-based policy from the get-go that further limits potential out-of-pocket costs at a time when cash-flow may be tighter-than-usual.

Student Debt Forgiven From 2021 Through 2025 Will Be Income Tax-Free

The American Rescue Plan Act doesn’t include any student loan forgiveness, a provision that many had hoped to see. It does, however, contain a provision that strongly alludes to the prospect of future debt forgiveness on the horizon.

As while certain exceptions exist (such as debt forgiven via the Public Service Loan Forgiveness (PSLF) program, certain debt related to a principal residence forgiven in a short sale, and debt discharged in bankruptcy), in general, when an individual has debt that is discharged, the amount of the discharged debt becomes taxable income to the individual (as though they had received ‘bonus income’ that they used to pay off the balance of the loan).

But now, Section 9675 of the American Rescue Plan Act adds to that list, at least temporarily, by amending Section 108 of the Internal Revenue Code to exclude the discharge of student debt from income, provided the debt is forgiven between 2021 and 2025. The provision applies to both Federally backed student debt, as well as private student loans.

In short, this appears to ‘prime the pump’ for (near) future student debt relief, as absent such a provision, discharging some individual’s student debt could have created an even more painful immediate cash-flow (due to what would have been a potentially significant tax bill) problem for some borrowers.

Notably, President Biden has indicated a willingness to forgive up to $10,000 of student debt per borrower, via Executive Order. Many Democrats have pushed for more substantial relief, but so far, President Biden has suggested that he prefers more substantial relief be provided through legislative action.

Other Notable Changes Made By The American Rescue Plan Act

Beyond the changes described above, there are a number of other provisions of the American Rescue Plan Act of which financial advisors should be aware. Such changes include the following:

• Employee Retention Credit (ERC) Changes – The Act extends the life of the Employee Retention Credit (ERC). Previously scheduled to expire at the end of June, it will now remain available throughout 2021. The Act also introduces the ability for certain startup businesses – defined as those businesses established after February 15, 2020, with annual receipts of up to $1 million – to qualify for the credit, as well as a provision for “Severely Financially Distressed Employers” – defined as businesses whose revenues are off by 90% – to account for virtually all wages paid as “qualified wages” for purposes of calculating their ERC.
• Extension of Limitation on Excess Business Losses for Noncorporate Taxpayers - Under current law, individual taxpayers are prohibited from using certain business losses to offset other, nonbusiness income on their tax returns. The provision limits a joint filer to offsettting no more than $500,000 of non-business income with business losses, while limiting single filers to using no more than $250,000 of losses for the same purpose. The provision was set to expire at the end of 2025 but is now extended through 2026.
• Enhancements of the Earned Income Tax Credit (EITC) – The American Rescue Plan Act makes several changes to the Earned Income Tax Credit (EITC). Perhaps the most notable change is that, for 2021, the minimum age to claim the credit as a taxpayer with no qualifying children (known as the “childless EITC”) is lowered from 25 to 19. Other changes include a permanent repeal of restrictions preventing certain taxpayers with children who do not meet the child identification requirements from claiming the childless EITC.

What’s Not Included In The American Rescue Plan Act?

While the American Rescue Plan Act is packed full of important changes of which advisors and clients must be aware, questions will inevitably arise as to what did not make it into the final version of the law.

While there are an infinite number of things that are not included in the final version of the American Rescue Plan Act, the following is a brief rundown of some of the most notable non-inclusions:

• No RMD Relief – Despite financial markets being near all-time highs, the calls for additional RMD relief (e.g., an extension of the temporary waiver of RMDs that applied in 2020) have not gone away. But that doesn’t mean Congress is listening, either. To that end, the Act does not include any provision eliminating RMDs for 2021, or other years.
• No Elimination of Cost-of-Living Adjustments for Retirement Plan Contributions – In the House-passed version of the American Rescue Plan Act, a ‘sneaky’ revenue-raising provision was included that would have eliminated cost-of-living adjustments effectively increasing the maximum amount of money an individual could contribute to their IRA, 401(k), 403(b), or similar retirement account, beginning in 2030. Which, over time, would have had the effect of diminishing the real-dollar limits on retirement account contributions (as wages creep higher with inflation, but the retirement account contribution limits would have stopped inflation-adjusting alongside). The Senate version stripped this provision from the bill. For retirement savers who consistently max out their savings each year, this likely comes as welcome news. But the fact of the matter is that once a provision like this is out there, it’s likely to come up again… especially for the little extra revenue as needed to move a bill through Congress. So don’t be surprised if you see a very similar provision in another piece of legislation in the near future.
• No Minimum Wage Hike –The original version of the American Rescue Plan passed by the House of Representatives included a provision that would have increased the Federal minimum wage to $15 per hour over a number of years. This provision had to be removed from the Senate version of the bill to conform with the rules required under the “reconciliation” process that Senate Democrats are using to move the bill through with ‘only’ a simple majority.