Child Tax Credit Definition: How It Works and How to Claim It

Child Tax Credit Definition

Investopedia / Joules Garcia

What Is the Child Tax Credit?

The Child Tax Credit is a tax benefit granted to American taxpayers for each qualifying dependent child. Designed to help taxpayers support their families, this credit was greatly expanded for 2021 taxes by the American Rescue Plan Act of 2021.  

The Child Tax Credit decreases taxpayers’ tax liability on a dollar-for-dollar basis. The American Rescue Plan increased the maximum annual credit from $2,000 per child (under age 17) in 2020 to $3,000 per child (under age 18) or $3,600 (children younger than 6) for 2021 and made the 2021 credit fully refundable.

In addition, beginning in July 2021, the Internal Revenue Service (IRS) distributed the Child Tax Credit to eligible taxpayers in advance payments on a monthly basis. Because it is fully refundable, parents don’t have to owe taxes to receive it.

Key Takeaways

  • The Child Tax Credit is a refundable tax benefit claimed by filing Form 1040 and attaching Schedule 8812 to the return.
  • To qualify for the credit, the taxpayer's dependent must generally be age 18, be a specific relative, have lived with the taxpayer for more than half the year, and provide no more than half of their own financial support.
  • For 2020 taxes, the tax law allowed a credit against income tax of up to $2,000 per eligible child (under age 17) that was partially refundable for some taxpayers.
  • For 2021 taxes, the credit was $3,000 (children under age 18) or $3,600 (children under age 6) per eligible child for American taxpayers—it was fully refundable and could be received in monthly advance payments.
  • Legislation to extend the increased credit for 2022 was not passed—thus, the credit will revert back to $2,000 and be partially refundable on an annual basis for tax year 2022.

How the Child Tax Credit Works

The Child Tax Credit for the 2021 tax year differs from the credit allowed in 2020. The 2021 changes, mandated by the American Rescue Plan, are limited to just that single tax year. For 2022 taxes, the credit will revert to the rules in effect for 2020, with some inflation adjustments. Here's a look at the credit rules and how they vary across years.

In 2020

For 2020, eligible taxpayers could claim a tax credit of $2,000 per qualifying dependent child under age 17. If the amount of the credit exceeded the tax owed, then the taxpayer generally was entitled to a refund of the excess credit amount up to $1,400 per qualifying child. The refundable portion of the credit—i.e., the additional Child Tax Credit—was designed to help taxpayers whose tax liabilities were too low to benefit from part or all of the credit. 

For 2020, a special “look-back” rule allowed taxpayers to determine the amount of their credits on the basis of their 2019 income. This special provision was particularly important for taxpayers whose difference in earnings from 2019 to 2020 affected their eligibility for 2020 credit.

The 2020 credit was subject to a phaseout at the rate of $50 for each additional $1,000 (or fraction thereof) above a high-income threshold of modified adjusted gross income (MAGI). MAGI is defined as adjusted gross income (AGI) increased by the amount of certain income exclusions, deductions, and credits.

The threshold level was set at $400,000 for a joint return and $200,000 in other cases. Taxpayers entitled to claim the Child Tax Credit were permitted to adjust their income tax withholding and/or calculate their installment tax payments to reflect their allowed credit amounts.

IRS Letter 6419

In Jan. 2022, the IRS will send Letter 6419 to inform taxpayers of the total amount of advance payments of Child Tax Credits distributed to them in 2021—information that they will need for their 2021 tax returns.

For 2021

For 2021, the credit increased and the age for a qualifying child extended to those under 18. The credit amount rose to $3,000 (children under age 18) or $3,600 (children younger than 6) and became fully refundable to the extent that it exceeded the taxes owed.

The credit phaseout generally remained $50 for each $1,000 (or fraction thereof) of modified adjusted gross income above a MAGI threshold. However, the MAGI threshold amounts for the credit phaseout were substantially reduced for 2021.

For a joint return or surviving spouse, the threshold was $150,000; for heads of households, $112,500; and for all others, $75,000. Thus, in 2021, a family with annual MAGI of $150,000 and three children, ages 2, 5, and 11, is entitled to total Child Tax Credits of $10,200, payable in advance payments of $850 per month. 

Advance payments: The Child Tax Credit for 2021 introduced a new feature: advance payments. Taxpayers could receive direct advance payments of their Child Tax Credits, in amounts of $250 or $300 per qualifying child depending on age. The U.S. Treasury distributed payments on a monthly basis beginning in July 2021. The advance payment program enabled taxpayers to use their benefits during the year.   

Taxpayers who were entitled to the credit for 2021 and wanted to receive advance payments as early as possible could confirm the direct deposit information for their bank through an online portal. For taxpayers who filed 2020 tax returns, the 2021 direct deposit payments were based on their 2020 income and information about dependent children. Non-filers for 2020 could receive the advance payments by registering in 2021 on an online IRS portal.

Eligible taxpayers who received advance payments for the last six months of 2021 are entitled to claim the balance of their annual credits on their 2021 tax returns. Because the advance payments represent early receipt of the tax benefits from the credits, the advance payments are not taxable income.

Underpayments or overpayments: If taxpayers received too little or too much in advance payments, then these will be reconciled, with the credit amount and refund—if any—claimed on tax returns for the 2021 year. Any shortfall in advance payments would add to the credit allowed on taxpayers’ 2021 tax returns.

Taxpayers whose advance payments exceed the allowable credit generally must pay back the excess with their tax returns. However, for lower-income taxpayers, a “safe harbor amount” of their repayment will be waived or reduced. Taxpayers who were U.S. residents for more than half of 2021 and whose MAGI for 2021 fell below specified MAGI ceilings can qualify for “repayment protection” and will not be required to repay any excess.

The full repayment protection applies for taxpayers whose MAGI is not more than the following: $60,000 for joint returns and qualifying widows and widowers, $50,000 for heads of households, and $40,000 for single filers or married individuals filing separate returns. No repayment protection is available for taxpayers with MAGI of $120,000 for joint returns and qualifying widows or widowers, $100,000 for heads of households, and $80,000 for single filers and married people filing separate returns.

In Jan. 2022, the IRS will send taxpayers a Letter 6419 reporting the full amount of advance payments received by them in 2021. Taxpayers should refer to this letter when preparing their tax returns for 2021 and retain it in their tax records.

Online help: During 2021, taxpayers who received advance payments that are excessive or too low were able to have their payments adjusted by providing corrected and updated information—e.g., change in marital status or number of qualified children—through an online information portal. Taxpayers who weren’t required to file a tax return in 2021 and had a main home in the United States for more than half of 2021 could use the IRS Non-filer Sign-up Tool to be sure that the IRS had their information for sending the advance credit payments. Wage withholding could be adjusted to reflect Child Tax Credits and advance payments. Also, taxpayers could elect not to receive advance payments and wait until filing their tax returns to claim their credit amount.

The IRS website provides extensive information about the 2021 rules for qualifying for the Child Tax Credit, calculating its amount, and dealing with advance credit payment issues.

After 2021 

The rules in effect for 2020 will again become effective, with some inflation adjustments, for 2022 through 2025.

The Child Tax Credit is not considered income. Therefore, it does not affect other government benefits such as unemployment insurance, Medicaid, SNAP, SSI, or Public Housing.

Qualifying for the Child Tax Credit

To claim the Child Tax Credit, two qualifications must be met: The person receiving the credit must be a qualifying taxpayer, and the dependent child also must meet tax law requirements.

Qualifying Taxpayer

Although most taxpayers qualify for the Child Tax Credit by claiming credits with respect to their children or stepchildren, other family members also may qualify if the taxpayer provided more than half of their financial support during the tax year. A taxpayer may be entitled to credits with respect to siblings, grandchildren, nieces, and nephews if they meet the dependency, age, citizenship, and residency requirements. Adopted and foster children also can qualify for the credit.

Only one taxpayer can claim the Child Tax Credit, even if the qualifying child divides time between more than one household during the tax year. If one parent had primary custody of the child, that parent usually receives the tax credit. In cases of joint custody, the parents must reach an agreement about when each will claim the credit—in alternate years or according to some other formula.

In addition to meeting the applicable income and relationship qualifications for the Child Tax Credit, the taxpayer and qualifying dependent(s) must have Social Security numbers before the due date for the taxpayer’s tax return and must report them on the return. Taxpayers who make fraudulent claims for Child Tax Credits will be ineligible to claim such credits for 10 years. A taxpayer who is determined to have made an improper claim due to reckless or intentional disregard of rules and regulations (but not fraud) will be denied credits for two years.

Qualifying Child/Dependent

The tax law prescribes several factors that determine a child’s eligibility for the Child Tax Credit. To qualify, individuals must be U.S. citizens, U.S. nationals, or U.S. resident aliens and must meet the dependency, age, and residency requirements. They also must have lived with the person who is claiming the tax credit for more than half of the tax year and must be claimed as a dependent on that taxpayer’s return. The child must not have provided more than half of their own support during the year.

For both 2020 and 2021, eligible taxpayers can claim a nonrefundable tax credit of $500 for each dependent other than a qualifying child.

The IRS offers a useful tool to help taxpayers figure out if their child or dependent qualifies for the Child Tax Credit. 

SSN and ITIN

If you or your spouse do not have a Social Security number or ITIN number before the due date of your tax return, you are ineligible for the Child Tax Credit. In addition, if you have a qualifying child who does not have a required Social Security number, they are ineligible for the Child Tax Credit.

How to Claim the Child Tax Credit

Taxpayers may be able to claim the Child Tax Credit even if they don't normally file a Federal tax return. To claim the Child Tax Credit, a taxpayer must file Form 1040 (U.S. Individual Income Tax Return). In addition, a taxpayer must attach Schedule 8812 (Credits for Qualifying Children and Other Dependents).

Schedule 8812 is used to determine the amount of Child Tax Credit a taxpayer is eligible for and to calculate any additional taxes owed if a taxpayer received excess advance child tax credits in 2021.

Child Tax Credit: Impact on Policy and Poverty

The expansion of the Child Tax Credit for 2021 has important policy and economic implications. When the Child Tax Credit was first enacted, it was intended to benefit low- and moderate-income families. Since its enactment in 1997, it has benefited these taxpayers. At higher income levels, the credit is phased out gradually. However, the Child Tax Credit had been criticized regularly for providing little or no benefit to the poorest families, many of whom are not taxpayers and do not file tax returns.

Over the years, frequent amendments increased the Child Tax Credit amount and provided refunds that were limited in amount and scope; at one time, refunds were restricted to taxpayers with three or more children. High-income phaseouts continued, and credit disallowance rules addressed fraudulent, reckless, or improper claims. But, for years, the Child Tax Credit did not reach the poorest families.

In 2021, for the first time, the significant increase in the credit amount and the provision of total refundability extended benefits to the neediest families. According to the Center on Poverty & Social Policy at Columbia University, "...the sixth Child Tax Credit payment kept 3.7 million children from poverty in December (2021). On its own, the Child Tax Credit reduced monthly child poverty by close to 30%."

The expanded and fully refundable Child Tax Credit was enacted as part of the American Rescue Plan Act, a law formally targeted at relieving the economic problems created by the COVID-19 pandemic. It also addresses many limitations considered problematic in the earlier versions of the Child Tax Credit.

Beyond these origins, the revised credit with its advance-payment feature represents a broader recognition of the importance and the substantial cost of raising children and of the role that government can play in supporting families.

The enlarged credit constitutes an enormous financial commitment. Congressional Democrats strongly supported the increased Child Tax Credit. Although Republicans generally favored some expanded benefits for children, they criticized the version of the Child Tax Credit that was enacted for its cost and for the lack of any work requirement. The Biden administration undertook an extensive public educational and promotional program to maximize the credit’s use and benefits.

Who Is Eligible for the Child Tax Credit?

There are eligibility requirements for the taxpayer and the dependent. The taxpayer must meet certain relationship requirements with the dependent, and the taxpayer's income may limit their ability to claim the Child Tax Credit. The taxpayer must have a social security number, and only one taxpayer may claim the Child Tax Credit for any single dependent (even if that dependent can be claimed by other taxpayers).

It's often more difficult to meet the requirements for the qualifying child. The individual must be under the age of 18 at the end of the year, provide no more than half of their own financial support, and have lived with the taxpayer for at least half of the year. The qualifying child must be the taxpayer's son, daughter, stepchild, brother, sister, stepsibling, half-sibling, or a descendant of any of these.

Is the Tax Credit for 2021 the Same as the 2020 Credit?

No. Although there are some similarities, the 2021 child tax credit differs significantly from the 2020 allowance. First, the credit increases from $2,000 for children under age 17 in 2020 to $3,600 for each child under 6 years and $3,000 for each child age 6 up to age 17 for 2021. Also, beginning in July 2021, the credit was distributed in monthly advance cash payments. The 2020 credit was only partially refundable, the 2021 credit is fully refundable. The 2021 credit targets more to benefit low- and middle-income taxpayers.

Are the Advance Payments of the Child Tax Credit Treated as Taxable Income for 2021?

No. The advance payments are not treated as taxable income. Half the total credit amount was paid in advance monthly payments in 2021 and you claim the other half when you file your 2021 income tax return.

What Is the Child Tax Credit Income Limits for 2022?

For the 2021 Child Tax Credit claimed as part of 2022 tax returns, the credit is maximized for single filers making less than $75,000, heads of household making less than $112,500, and married filing jointly filers earning less than $150,000. These figures are based on the filer's modified adjusted gross income.

There are two phaseout limits for the Child Tax Credit. The first phaseout limits the Child Tax Credit amount for every $1,000 of modified adjusted gross income the taxpayer exceeds the amounts above. The first phaseout stops when the credit is reduced to $2,000 per qualifying child.

The second phaseout enacts the same reduction practice ($50 reduction for every $1,000 of modified adjusted gross income above threshold limits) starting at $400,000 for married couples filing joint returns and $200,000 for all other filing statuses.

How Do the Monthly Advance Payments of the Child Tax Credit Affect the Credit on the Tax Return for 2021?

The IRS estimated the advance payments based on the number of dependent children reported on a taxpayer’s prior year return. If taxpayers claim more or fewer eligible children for 2021, the total payment amount may be more or less than their actual credit. If, as will be the case for most taxpayers, the advance payments constitute less than a taxpayer’s entire annual child tax credit, the taxpayer can claim the remaining undistributed credit balance on their 2021 tax return.

If a taxpayer received advance payments that exceeded their total credit for the year, they may be required to repay the excess when filing their return. However, repayments for low-income taxpayers and repayments of small amounts generally will be waived.    

Article Sources
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