The Advance Child Tax Credit: Changes Coming?

Professor Jacob Goldin of Stanford Law School discusses proposed changes to the advance child tax credit in draft legislation recently released by House Democrats.

This transcript has been edited for length and clarity.

David D. Stewart: Welcome to the podcast. I’m David Stewart, editor in chief of Tax Notes Today International. This week: more extra credit.

When we last talked about the advanced child tax credit in July, which we’ll link to in the show notes, the IRS was beginning to roll out those payments. Since then, four batches of payments have gone out, with the latest being sent to 36 million families.

How has the rollout gone? What should practitioners and taxpayers keep an eye out for in the future?

Here to talk more about this is Tax Notes contributing editor Marie Sapirie. Marie, welcome back to the podcast.

Marie Sapirie: Thanks for having me.

David D. Stewart: Let’s start off with a recap of the history of this advanced child tax credit and what’s happened over the last several months.

Marie Sapirie: The advanced child tax credit was enacted in the American Rescue Plan Act [P.L. 117-2] earlier this year. It’s currently a one-year expansion of the existing child tax credit that has been in the code since the late 1990s. Over the past few months, Congress has been working on the budget reconciliation bill, which is where the legislators will decide whether or not to extend the expansion beyond December.

David D. Stewart: As they’re working to extend these tax credits, I understand there’s some division amongst the Democrats. Could you tell us about that?

Marie Sapirie: The dividing lines have become clearer in recent days. The expansion of the credit made the credit fully refundable, which removed the requirement that a taxpayer have income in order to receive the full amount of the credit. Previously only part of the credit was refundable. Senator Joe Manchin, D-W.Va., wants that requirement — that credit recipients have income — added to the expanded credit for 2022.

He has also said recently that he wants a much lower income cap, above which the expanded credit would not be available. He recently said that the income cap should be at $60,000 in household income. For comparison, the American Rescue Plan Act began to phase out the expanded credit at $150,000 for married couples filing jointly, and the Tax Cuts and Jobs Act phaseout began at $400,000.

The New Democrat Coalition considers the expanded child tax credit a top priority in reconciliation. They released a statement on October 18 in support of extending the credit through 2025. They want the credit to stay fully refundable. They said that scaling the credit back or limiting its accessibility would hurt middle-class families.

David D. Stewart: Now, you recently spoke with someone about the child tax credit. Could you tell me about your guest and what you talked about?

Marie Sapirie: I spoke with professor Jacob Goldin of Stanford Law School. He has written extensively about the child tax credit and previously worked in the Office of Tax Policy at the Treasury Department. We talked about the changes that are in the draft legislative text released by House Democrats in September.

David D. Stewart: All right. Let’s go to that interview.

Marie Sapirie: Thank you, Jacob, for joining me today to talk about the advanced child tax credit.

Jacob Goldin: Yeah, thanks for having me here.

Marie Sapirie: The American Rescue Plan Act of 2021 expanded the child tax credit in several major ways. The maximum amount of the credit increased from $2,000 per child to $3,000 for children over age six and $3,600 for children under six. The credit was made fully refundable so that eligible families do not need to meet an income requirement in order to receive the full amount of the credit.

The American Rescue Plan Act also directed the IRS to advance half of the credit in monthly installments, which the agency began doing in July. Those changes all expire at the end of December.

The budget reconciliation bill draft that Congress is currently working on includes an extension of those two main elements, as well as a number of other modifications to the credit, which we’ll talk about today.

To set the stage for the proposal that Congress is currently constrained, would you give us a brief overview of the development of the child tax credit to this point to put the proposed changes in context?

Jacob Goldin: Yeah, absolutely. The child tax credit is one of these policies that has been expanded over time. It started out mostly as a nonrefundable credit, so benefiting more middle-income taxpayers. Over time, a portion of it has become refundable.

Prior to the 2017 tax reform, the maximum credit amount was $1,000 per taxpayer, per kid. The amount of the credit that was refundable phased in based on the taxpayer’s earned income.

Like the earned income tax credit, a taxpayer who had no earned income, who wasn’t working basically, didn’t qualify for any child tax credit or CTC. When taxpayers earned more income, they qualified for more.

The TCJA tweaked a little bit the refundability formula so that families could start to qualify for the child tax credit at $2,500 of earned income as opposed to $3,000 before. It also doubled the maximum credit amount from $1,000 to $2,000.

For families who qualified for the full amount, it was a big change. The families, though, who were still excluded were those who were earning less than $2,500. Families that didn’t get the full benefit amount— for example, if you have two kids and are married, I think the threshold was about $30,000. If you earned less than $30,000, you wouldn’t qualify for the full amount of the benefit. 

The credit that is currently in place for 2021, like you mentioned, is fully refundable. Even the lower-income households, the households who are earning zero or below the $2,500 amount are still entitled to the full credit.

Marie Sapirie: The draft tax bill for reconciliation released by the House Democrats in September would make a number of changes to the administration of the credit. I was hoping to get your thoughts on those changes.

Some of the proposal applies for 2022 as an extension of the 2021 credit. There are other rule changes that would apply from 2023 to 2025. Could you explain the purpose of those different set of rules? How that works and the transition period there?

Jacob Goldin: Sure. Next year, 2022, is really envisioned as a transition year. 2022 doesn’t change much of the functioning of the rule from what we have right now. In particular, it’s basically an annual credit at heart in 2022. The determination of whether a child is a taxpayer’s qualifying child for the credit is based on an annual all or nothing level. We can talk through the qualifying child tests, which are basically all annual for 2022.

What are the changes for 2022? One of the big changes is increasing the safe harbor amount.

For 2021 only half of the child tax credit was paid out in advance. As a protection for taxpayers who got paid credit amounts as monthly advanced payments, but who didn’t actually qualify for those payments based on their full year situation, taxpayers were protected by the safe harbor from having to repay the full amount. But because it was only half of the annual credit that was being paid out in advance in 2021, the safe harbor didn’t have to be so high.

For 2022 it’s envisioned that the full credit amount will be paid out every single month in advance. That means in order to protect parents from repayment obligations, the safe harbor amount has to be higher. It has to cover the full credit amount. For the lowest-income households, 2022 would have a safe harbor equal to the full credit amount per child.

Now, the flip side of that is that when you have a high safe harbor, you can make it pretty tempting for taxpayers to try to game the rules. They can strategically decide who reports the kid is with them. One parent maybe would try to get the advanced monthly payments. Then the other parent would say, “No, no, no, the kid actually lived with me.” If you had an absolute safe harbor, there wouldn’t be any way for the IRS to claw back those payments, which is problematic for lots of reasons like including program integrity.

Another change that was made for both 2021 and 2022 was to tighten up the safe harbor a little bit. If taxpayers, through fraud or I think the standard is intentional disregard of the statute or regulations, are claiming a child in error, then in those cases, they’re not going to get the safe harbor benefits.

Those are the major changes for 2022.

Marie Sapirie: For the changes from 2023 on, there’s a new term in the proposal, the specified child. Would you take us through that concept and definition and help us to understand what it means for taxpayers?

Jacob Goldin: Yeah, absolutely. Unlike 2022, which is really just a tweak but keeping with the basic structure for how kids qualify for the child tax credit, things look very different for 2023 through 2025 and presumably onwards, if it’s extended. The idea is basically with the credit that’s being paid out monthly, you want to have a monthly idea of eligibility.

Let me briefly review what the current annual qualifying child rules are. Then I can talk through how the specified child test that’s proposed for 2023 onwards would differ from that.

To claim a kid for the child tax credit today, in 2021 and historically, the child needs to be the taxpayer’s qualifying child. There are a number of tests for that. I won’t go through all of them, but some of the important ones are that the taxpayer has to live with a child for over half of the year, so 183 days or more. The taxpayer also has to be a close enough relative to the child.

The relationship test is the relative one and the residency tests. Starting with the residency tests, this is an annual test. It’s all or nothing. If the kid lives with you for 180 days, you don’t qualify to claim that child for the entire year. There are exceptions, but that’s sort of the general rule.

The reason why that’s a problem when you have a credit that’s being paid out monthly in advance is that kids can move households during the year. Kids can and do move households. If you have a child who’s living with taxpayer A for like January, February, March, April of the year, and then moves to taxpayer B’s house instead, under an annual test, A wouldn’t qualify to claim that child for the year.

What would that mean? Well, under a strict annual test without a safe harbor, A would have to pay back those four months of advanced credits that A received. That’s a problem.

It’s a problem from a policy perspective. It’s usually bad policy to make households pay back money that they’ve already received and may have already spent.

It’s bad politics. In countries like the United Kingdom, when child allowances were first introduced, there were lots of political backlash with households being forced to pay back money they already received.

Lots of the design changes I think you can understand as being driven by a desire to avoid having to make families pay back money they’ve already received.

How do they do that? How does the law move away from an annual test?

Basically, one of the big changes is that for the expanded child tax credit, at least for 2023 onwards, the specified child definition replaces the qualifying child definition. A child is a taxpayer specified child month by month. You qualify to claim a kid basically at the month level instead of for a whole year.

What does the residency test look like at a month by month level? Basically it’s the analogs. The kid has to live with the taxpayer for more than half of the month. If they do, then they satisfy the residency test for that taxpayer for that month. 

What about the relationship test? That was one of the other big requirements under current law to claim a child as a qualifying child. Here the specified child rules also move away from the current law.

One of the concerns with the relationship test right now is that there are kids who are not being raised by a close enough relative and who are therefore mechanically excluded from benefiting from these tax benefits. A kid being raised by a cousin, for example, or informally fostered by like a close family friend or a neighbor. Those kids right now are not able to be claimed by anyone for the child tax credit.

Part of the desire of expanding the credit is to make it really universal so that almost all kids are able to qualify. I think it seems like one of the goals here is by moving away from the relationship test to make sure that those kids aren’t left out.

How does it do that? Basically the relationship test is eliminated as a requirement to claim a child for a month. In its place is a new test that’s imposed, which is this care-taking requirement. The rule is that a taxpayer, in order to claim a child for a month, not only has to live with a kid for that month, but also has to provide uncompensated care for the child for that month.

That raises the immediate question, what is uncompensated care? The law provides a facts and circumstances set of analyses. It points to a number of factors and those are the ones that govern that.

What are those factors? It’s the things that you would expect, like supervision of the daily activities and needs of the child, maintenance of the secure environment for the child. It could include who takes care of the kid when the kid is sick? Who drives them to the doctor? Things along those lines.

Those are the two big ways. To summarize, the expanded child tax credit moves away from the qualifying child test, which is annual, and switches to the specified child test, which is evaluated month by month. In addition to sort of moving to monthly analogs of those annual tests, it moves away from the relationship test and imposes instead a caretaking requirement.

Marie Sapirie: In terms of the administration of the month to month, in situations where a child is a specified child of taxpayer A and then moves to taxpayer B’s house, I assume that through the child tax credit portals is how taxpayers will inform the IRS of those changes. Is that correct?

Jacob Goldin: That’s the idea. You want the credit to be able to follow the child. When the child moves between houses or residences, you want to give the taxpayers a way to alert the IRS to those changes in situations.

Marie Sapirie: In situations where the notification doesn’t happen, how does that process work?

Jacob Goldin: That’s a good lead in to this idea of presumptive eligibility, which is one of the other major new pieces that’s in this legislation.

Stepping back, think of a case where the child moves from household A to household B. But the parents don’t tell the IRS right in time. So, household A keeps on receiving the payments for say some number of extra months.

That’s probably we all know in practice a realistic scenario. When kids are moving households, there’s lots going on. Often it’s a period of instability. Alerting the IRS to the change might not be the first thing on the family’s mind, the family whose kid just moved out.

Conceptually there’s three approaches the law could take here.

The law could require household A to pay back the payments and let household B sort of retroactively claim the payments for the month since the child moved in.

Another option is you could basically let household A keep the payments and also let household B retroactively claim those months. That would be like a safe harbor approach.

The third option is you could let household A keep the payments, and basically household B wouldn’t be able to retroactively go back and claim the months since the kid moved in. They would only be able to get the payments going forward.

What the draft does is take a middle ground between those approaches. In 2022 it’s a safe harbor, and that’s like the second of those approaches. You basically let the old household not have to pay back the money because of the safe harbor, and the new household could go back and claim it. But there are some concerns about gaming, that it would be an easy rule for taxpayers to exploit in the long run. To basically double the amount of payments going out the door without the IRS being able to claw it back, it would be very expensive. That’s probably a downside of having just a full, safe harbor policy in place.

What about between those other two options? Well, basically the question is who the onus should be on to report the change in the child’s circumstances to the IRS.

Big picture that the bill envisions is that the onus would be on the new household, household B, to report to the IRS that the child has moved in to that household. From that point on, once the new household reports that, payments would stop going to the old household, and the new household would be entitled to payments going forward.

Now there’s a little bit of softening on the edges. There would be a grace period. If household B took a few months, like three months to alert the IRS to the change, they would be able to go back and claim those three prior months, and household A wouldn’t have to pay those back. In cases of hardship, household B would also have some flexibility to retroactively claim previous months since the child has moved in. But in none of those cases would household A really have to pay back payments that it received as long as some basic requirements are met.

Marie Sapirie: In terms of establishing presumptive eligibility, could you walk us through the requirements for establishing that with the IRS?

Jacob Goldin: Yeah. Presumptive eligibility is this idea that once a household establishes presumptive eligibility, they won’t have to pay back payments that they received from the IRS for at least some period of time until they are required to reassert their eligibility again.

The way that a taxpayer establishes presumptive eligibility as spelled out in the bill legislation is they have to have a reasonable expectation and intent that the taxpayer will continue to be eligible to claim the specified child for the current month, as well as the two following months.

The taxpayer has to expect the kid is going to keep living with them for three months. They’re going to care for the kid for three months and going forward. If they do that, they’ll be able to start getting advanced payments for that child. If after that amount of time, it turns out the kid has moved away, but they keep on getting a month or two of advanced payments, they won’t have to pay those back to the IRS.

Marie Sapirie: The proposal also includes rules for the reconciliation of the credit, which you’ve touched on, and the monthly advanced payments. Are there additional details about how that would work?

Jacob Goldin: The main issue for the rules there is about presumptive eligibility. The idea is that if a taxpayer establishes presumptive eligibility, they’re not going to have to pay back advanced payments they receive based on their child’s switching locations.

Similarly, with the exceptions I talked about, if a child moves from one household to a new household, the new household generally won’t be able to go back and claim months for the child living with them until they tell the IRS the child is now there. That’s one reason why households might need to reconcile is if children move locations.

The other big reason why households might need to reconcile advanced payments they receive is if their income changes during the year. For example, this is not how the law works, but you can imagine the law might work this way. As a basic point, is if your income goes up too much, you hit the phaseout and you don’t qualify for as much of the child tax credit. If you received the full child tax credit as advanced payments, you might have to pay some of it back.

Again, I think the drafters of this legislation, it seems from this bill, were really concerned about forcing families to pay back money they’ve already received. They avoid that not only for changes from kids moving households, but also for fluctuations in income.

The way they’ve done that is to say your income that’s relevant for determining the phaseout is not necessarily your income in the current year. It’s the lowest of your income in the current year and the two prior years. Basically the years that your advanced payments were calculated based on.

For example, if a household has very low income in one year, gets a full payment amount, gets a very high paying job, and then is subject to the phaseout in a subsequent year, they won’t necessarily have to pay back the excess advanced payments to the IRS. Basically, there won’t be excess advanced payments to the IRS the way the statute is written because they won’t face the phaseout.

The phaseout is based on the minimum of their current year’s income, as well as their prior year’s income, including the year that they have lower income. That again is avoiding another source of potential reason why a taxpayer would have to reconcile and would have to have some of their benefits clawed back to the IRS.

Marie Sapirie: With that review of the proposal, what do you see as the major implications of these changes for both the taxpayers who receive the credit and practitioners who are going to be helping families navigate it?

Jacob Goldin: I think the biggest change for taxpayers and practitioners is that they’ll now need to inform the IRS through a portal if a new child moves into their household.

If they start caring for a child midway through the year, it is in their interest to tell the IRS about that change so that not only can they start getting advanced monthly payments for that child, but in order to also establish their eligibility to get those months for that child at the end of the year.

If they don’t do that, basically there’s a risk that some other household will continue to receive advanced monthly payments for that child, instead of the new household where the child now lives.

Marie Sapirie: The implementation of the proposal would be the IRS’s job, as it has been so far. The statute indicates areas where regulatory guidance will likely be needed. What are some of the main areas for the IRS and Treasury to address, and what can we be looking forward to in additional guidance? Should the draft proposal become law?

Jacob Goldin: There are a couple of big areas where Treasury guidance will definitely be needed here. One is about what counts as a hardship exemption. Again, the basic rule is that when a child moves to a new household, the onus is on the new household to report the child’s presence to the IRS to start qualifying for benefits. But I mentioned in some cases, the new household will be able to claim months before they report the child’s presence to the IRS. One of those big categories of cases is if there’s a hardship.

Certainly domestic violence would count in the situation. That’s one of the cases that everyone’s talking about. If a victim of domestic violence flees from an abuser with her children and doesn’t immediately report the child’s or children’s presence to the IRS, this hardship exemption would allow her to do that retroactively. But the full scope of this hardship exemption is something that would need to be fleshed out through IRS and Treasury regulation.

Another example of a place where guidance is needed is about how exactly the IRS and Treasury will adjudicate disputes between claimants for one child. What their processes will be, what the procedures will be, and what sort of standards they’ll use in those cases.

If two taxpayers both claimed that a child is living with them for a month, some of this is spelled out in the statute about how the IRS might pause payments. Or they might continue payments, but now the taxpayer is on notice that if it turns out the kid isn’t with them, they’re going to have to pay back the money that they’ve received. But those exact procedures are going to require a lot more detail than what’s been specified so far.

Marie Sapirie: Well, thank you, Jacob, for joining the podcast today.

Jacob Goldin: Thanks for having me.