Tom Talks Taxes - February 11, 2022

Advance child tax credit repayment safe harbor plus a Schedule K-2 and K-3 update

For tax year 2021 only, Congress decided to advance 50% of the enhanced child tax credit since it is fully refundable for most taxpayers. However, if the credit calculated on the return is less than the total advance payments, then the taxpayer will have to repay the difference. This is unlike the reconciliation for round 3 economic impact payments and the 2021 recovery rebate credit: taxpayers who received excess economic impact payments do not repay the difference.

There is one exception to the advance child tax credit repayment: Congress added a repayment protection safe harbor in §24(j)(2)(B) if a repayment is caused by a reduction in the number of qualifying children claimed on the 2021 return compared to the number used to calculate the advance payments.

If a taxpayer’s modified adjusted gross income (MAGI) is below the lower threshold, then the safe harbor fully applies, and the taxpayer’s repayment is usually eliminated. If a taxpayer’s MAGI is below the upper threshold, then the safe harbor partially applies, and the taxpayer’s repayment is generally reduced.

The thresholds, based on filing status, are as follows:

• $60,000 to $120,000 for married filing joint and qualifying widow(er),

• $50,000 to $100,000 head of household, and

• $40,000 to $80,000 single or married filing separately.

The safe harbor amount is $2,000 times the reduction in the number of qualifying children. If the taxpayer’s MAGI is in the phase-out range, then there is a pro-rata reduction in the safe harbor amount. The safe harbor calculation occurs in Part III of Schedule 8812, Credits for Qualifying Children and Other Dependents.

Here is a basic example: Scott is head of household with one qualifying child age 10. He alternates claiming the child with an ex-spouse pursuant to their divorce agreement. On his tax year 2020 return, he claimed the child; however, on the tax year 2021 return, he will not claim the child. Scott did not opt out of advance child tax credit payments and received $1,500 based on one qualifying child. Scott’s 2021 MAGI is $70,000.

Scott’s advance child tax credit repayment is calculated as follows:

1. The reduction in the number of qualifying children is one. (The number of qualifying children on which the advance payments were based is disclosed in Letter 6419, Advance Child Tax Credit Reconciliation, which the IRS sent to all taxpayers in January 2022).

2. The tentative safe harbor amount is $2,000 times one child, or $2,000.

3. The safe harbor amount is reduced because Scott is in the phase-out range. His MAGI is in the phase-out range by $20,000, or 40% of the phase-out range, so his safe harbor amount is 60% of $2,000, or $1,200.

4. Scotts advance child tax credit repayment is $1,500 less the $1,200 safe harbor amount, or $300.

Because married filing separate (MFS) taxpayers can use the repayment safe harbor, using the MFS status may create tax savings for married couples on 2021 tax returns, in conjunction with the 2021 recovery rebate credit reconciliation process.

Here is a basic example: Lynn and Susan are married with two children ages 4 and 8 and they all live together full-time. They filed a 2020 joint return with AGI of $110,000. Their 2021 joint return shows AGI of $115,000: $40,000 belongs to Lynn and $75,000 belongs to Susan. They did not opt-out of advance child tax credit payments and received $3,300 total. They also received a Round 3 economic impact payment of $5,600.

Married taxpayers who live together all year with their dependents can allocate the dependents to either spouse on MFS returns. The tiebreaker rules do not apply. See Notice 2006-86, Ex. 5 and Prop. Reg. §1.152-2(g)(4), Ex. 6.

If Susan claims both children, then they get an additional $3,050 in tax credits on separate returns:

Of course, that isn’t the whole story: we need to compare the increase in tax credits to the increase, if any, in the base income tax from the MFS status. The taxpayers should be presented these options so they can determine how they prefer to file their tax returns.

Let me be crystal clear: a joint return is an affirmative choice by two taxpayers and creates joint and several liability. There is nothing unethical in taxpayers choosing a filing status in order to optimize tax outcomes!

Schedule K-2 and K-3 Update

I recorded a free, 15-minute video with Kevin Todd, EA, CPA reviewing the Schedule K-2 and K-3 situation. In addition, with the video, there is a sample letter you can use with clients that I developed with Fred Stein, EA, CPA.

Amber Gray-Fenner wrote an article on the issue for Forbes. Check it out!

Congress is now getting involved: a letter from Republican senators asked the IRS to take actions to reduce the IRS backlog, including “Consider modifying the current implementation of Schedules K-2 and K-3 to focus on clearing the backlog instead of adding more complexity.”

Share Your Thoughts!

If you are a paid subscriber, use the comments section below to discuss and ask questions about the advance child tax credit repayment or Schedule K-2 and K-3 filing requirements.

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