Transcript

Steven Jarvis:

Welcome to the next episode of the Retirement Tax Services podcast, Financial Professionals Edition, I’m your host, Steven Jarvis, CPA, and in this show, I teach financial advisors how to deliver massive value to their clients through retirement tax planning. Today, we’re going to talk about the child tax credit payments that started hitting big accounts in July. Now, often on this show, I focus on topics that are geared towards advisors for their clients, but as we have today’s discussion, this is going to be one where you are going to want to think about what this means for your clients, but potentially for yourselves as well. So referred to by the IRS, as advanced child tax credit payments, the checks that hit your or your client’s bank accounts in July are prepayments of a portion of the child tax credit, the IRS expects taxpayers to be eligible for in 2021 and that amount will keep hitting your bank account for the rest of 2021. The expanded credit comes from the American Rescue Plan Act of 2021, and relative to the previous child tax credit, it represents a pretty significant change; while there is talk of trying to make the credit expansion permanent, what we are discussing today is currently only applicable for 2021.

So let’s start with the amount of the credit. The expansion made plenty of headlines, so you probably already know the amounts, but I want to make sure that we’re all starting from the same place as we have this discussion. In 2020, the child tax credit was $2,000 per dependent child with income limitations, phasing out the credit starting at 200,000 for single filers and 400,000 for married filing jointly. The expansion pushes the credit up to $3,000 for dependent children between the ages of 6 and 18, as of December 31st, 2021 – that’s a really important date and $3,600 for dependent children under the age of 6, again, as of December 31st, 2021. So that represents a 50% increase in the credit for kids 6-18 and an 80% increase for kids under the age of 6 at the end of this year. So let’s pause for just a second. So I can throw out my disclaimer on politics, which is the same approach you really should be taking with your clients. I’m not here to talk about whether this credit expansion is right or wrong or good or bad or effective or ineffective or any other debates that people want to have – I’m here to provide timely information that can be used at an individual level to help tax preparers and their financial advisors be intentional about their tax planning, set clear expectations, and whenever possible, not leave the IRS a tip. This really is the attitude you should take into your conversations with your clients as well, while I’m sure some of you are just fountains of political wisdom, your clients typically are coming to you for your help on their personal situation, not your answers to the world’s ills.

Navigating and Countering Potential Landmines [03:27]

SJ:

Okay, back to the child tax credit. The reason this is an important topic to address with your clients now – is that there are potential landmines as a result of Congress’s decision to prepay a portion of the credit. The first important thing to know is that automatic enrollment in the prepayment program is based on your most recently filed tax return. For many taxpayers, since the payments started in July of this year, that is going to be the 2020 tax return, but if 2020 is an extension and hasn’t been filed yet, your automatic enrollment and the amount of the payments will be based on your 2019 return. So in general, if on your most recently filed tax return, you claimed one or more dependents, who are still under the age of 18 and your income was within the required limits, a portion of your expected child tax credit will be prepaid monthly from July through December of 2021. Like I said, this happens automatically, so unless you went through the process of opting out, you will have started receiving these payments and you’ll keep receiving these payments. The phase-outs for the credit are broken into two pieces – the legacy $2,000 credit and the expanded $1000 or $1,600 credit, depending on the ages of your children. The expanded credit begins phasing out at 75,000 for single filers and 150,000 for those married filing jointly, the $2,000 legacy credit still begins phasing out at the 200,000 and 400,000 that I mentioned before for single and married filing jointly. The phase outs present our first potential landmine – if your income increase in 2021, compared to 2020 or 2019, if your 2020 return has not been filed, you are potentially receiving more in pre-payments than you are ultimately eligible for, and based on the current rules, you will owe the IRS for any amounts they send you that you are not eligible for. Now, this is a big change from the other stimulus checks that have gone out over the last year and a change that your clients may not be aware of. Many of your clients have gotten stimulus checks and they didn’t have to do anything about them, except decide how to spend them. If they received a check, it was their money – so how might this situation come up in practice? I was recently talking to an advisor who has been crushing it the last couple of years. In part, because of some great best practices he has implemented from the incredible team over at the Perfect RIA, so go check them out if you’re not familiar. So this advisor just started receiving prepayments in July, and it was something like $1,300 a month if I remember right and he likely will be eligible for very little, if any of it, at the end of the year, when his taxes are actually filed. Now this is happening for him because he extended his 2020 return and the prepayments were automatically calculated based on his 2019 return and this advisor has had some incredible growth since 2019, and actually just hit a hundred million in AUM, so hats off to him. It’s certainly a good problem to have, but if it’s something you aren’t paying attention to – you’re in for unpleasant surprises, come tax time; depending on where he ends up in the phase outs, he could end up receiving nearly $8,000 from the IRS that he will have to send back when he files his taxes – if you or your clients end up in this situation, I would recommend you do the same thing this advisor told me he was doing, which is, put the payments in a savings account and wait until tax time to resolve it with the IRS.

Steven’s Advice Against Opting-Out of Receiving Payments [06:45]

SJ:

You can of course, opt out of receiving the payments and I’ll include a link in the show notes of where you can do that. But for two reasons, I wouldn’t recommend opting out. One, for how often the rules around COVID stimulus efforts have shifted and changed, I would wait and see what happens until we get closer to the 2021 deadline, which on behalf of myself and all my CPA friends, I sincerely hope will actually be April 15th this next year. Now this is not a prediction of any kind, I don’t have any insider information about what Congress may or may not do related to this tax credit, but I think it’s worth waiting just to see what happens, there’s no penalty for receiving those payments, even if you’re ultimately not eligible for them, you just have to repay them based on current rules. The other reason I would hold off on opting out of those prepayments is that normally it’s the IRS taking interest free loans from taxpayers, it’s not very often we have the opportunity to be the recipient of an interest free loan from the IRS, you of course have to be very intentional if this is the approach you take, because that bill will come due. As far as the opting out goes, as I said, the IRS has a portion for you to manage your child tax credit for 2021, you do have to upload a photo ID to register your account and this may 100% be user error on my part, but it took me several attempts before the site actually accepted the picture I was taking of my license; ultimately it was the second attempt with a photo I’d already used, that was accepted, so no idea on this one, maybe try turning your computer off and then on again, before you register. I only throw that out there so as you go to register or if you’re working with clients who are trying – just that, you’re kind of, forewarned that there’s some steps in that process. So you’re setting up that account just so I could talk about what it looks like on this podcast – you can add a third reason to not opt-out of receiving payments, even if you might have to repay a portion of it, and that was – it was way more effort than I really wanted to put in to get that all set up and validated and my ID, confirmed. One last thing on the income side of this, this expansion significantly changes a shadow tax, you need to consider for any tax planning strategies in 2021 that accelerate income. So a few episodes ago we talked about shadow taxes or these different phase outs and limitations on deductions and credits or taxes that come into play at certain income thresholds. Traditionally, we focus on what a person’s marginal tax rate is, but there are other implications as our income moves up through these different levels. So for sure clients, with dependent children, the phase outs for the credit being impacted have been more than cut in half, so accelerating income could still be the right choice in a client situation, but make sure you are intentional with the plan and have considered all the implications, not just the marginal tax rate. There are all sorts of variations of how the numbers play out in these situations but this is something to look at for yourself or any clients who had big increases in their income compared to recent years. So the opposite side of receiving payments, you may not ultimately be eligible for is not receiving payments, even though you are eligible, this would most likely happen if your income drops significantly in 2021 or you or your clients that have had a child in 2021. So as of the recording of this podcast, there was not an option to update your eligibility, to add the birth of a child, but that option is supposed to be forthcoming and we’ll be on that same portal, I mentioned before.

Realistic Expectations and Eliminating Surprises [10:00]

SJ:

The other landmine you need to consider, related to helping your clients – have realistic expectations and eliminating surprises come tax time. The advanced payments are designed to prepay half of the total credit you’re projected to be eligible for, not half of the expanded credit but half of the total credit, especially for your clients that have consistent income year to year and expect a certain refund each year, this could cause unfortunate surprises come tax time. While in a perfect world, we would all get our withholdings dialed in, we aren’t in that bucket of giving the IRS interest free loan for the year, and our tax bill in April would be close to zero – we all know that isn’t reality. There are many taxpayers who use their tax refund as a forced savings account of sorts, or even go so far as to plan ahead for their refund to cover certain expenses like property taxes. If your clients don’t understand the impact of these prepayments – April might be a little unpleasant. Let’s go through an example. Let’s assume that Bob and Sue are married and file a joint return and have two dependent children in that age 6-18 bracket; so for each of their dependent children, they qualify for a $3,000 tax credit or $6,000 in total. Last year, Bob and Sue would have received $4,000 in child tax credits, which has a big impact on how much tax they paid for the year and whether they made a payment or got a refund in April. Now for 2021 half of the $6,000 they’re eligible for or $3,000 is going to be prepaid, leaving them 3000 to offset their tax bill at tax time. Now that’s a $1000 less than the impact that would’ve been in 2020. With two kids, this might not seem like a huge impact, I know we’re only talking about a thousand dollars and in the grand scheme of things, it’s not going to make or break their retirement, but remember taxes are emotional – so this is an opportunity for you to deliver value in the form of taking away surprises and helping them have clear expectations. Even better, if you already prepare mid-year tax projections for your clients, there isn’t much of a lift to add this consideration to the process, to help your clients get really clear on what they should expect to happen this year. If you don’t currently do mid-year tax projections, take this as motivation to get started – they are a great way to add value to your clients throughout the year, and set yourself apart from other advisors, they also help you really get dialed in on other tax planning strategies that you recommend for your clients and allow you to do this in a lot more specific way. Doing mid-year tax projections can be a powerful service to talk to prospects about as well, when you are explaining the value to them, of working with you and the benefit to the processes that you have in place. Just in case you are curious what your child tax credit should be using current-year numbers, instead of your most recent tax return, I’ll include a link in the show notes to an online calculator that you can use to figure out exactly what that would be.

Action Items [12:41]

SJ:

All right, let’s talk about action items. The first action you need to take is to have an intentional approach to this and any other tax law changes that may impact your clients – even if it’s a simple communication that just says, “so you’re aware of this change is happening and we will make sure we consider how it impacts you as we go through the rest of the year” It doesn’t have to be an exhaustive piece of content that you put together, it just needs to be enough to let clients know you have them cover it, and ideally pointing them to additional resources or recommending next steps that they can take. The next action item is to review or have someone on your team, review your CRM, to see whether you have clients who will be impacted by this. I would start by looking for clients with children under the age of 18, and also look for clients whose income has been increasing. Now I know that you’re all great advisors and you know your client base really well, but this is one of those times that you need to actually take the steps and not just try and remember the exact situation of all 70 or 100 or 150 of your clients that you have, it’s a little tough to really commit those things to memory and it’s really easy to convince ourselves that we remember the details better than we really do. Now, this may be something that you simply address in your next round of in-person client meetings or Zoom meetings, or however you’re meeting with your clients these days, but however you decide to address it, be intentional and not reactive, and make sure you have a plan. The last action item is of course, to leave a five-star review, wherever you get your podcasts and tell a friend how much you’ve been benefiting from listening to the Retirement Tax Services podcast. Almost every week, I get new emails from advisors who have found the first episode of our podcast, so we know our audience continues to grow as well, right along with our impact from this show. So we really appreciate everyone’s spreading the word on this. If you have questions or recommendations for future topics or guests, feel free to send us an email@advisors@rts.tax, we love knowing that what we are talking about is specifically what you are interested in! Until next time, good luck out there and remember to tip your server, not the IRS!