Families began receiving monthly Child Tax Credit (CTC) payments on July 15. For many, those regular payments—currently permitted through the end of the year—will combat poverty and help families keep current on monthly bills without having to borrow. But because the CTC depends on income, number of children, and marital status, some changes in family or financial circumstances such as a bump in salary, a child moving in with her other parent, or a wedding could result in a total annual credit that is smaller than the total advance payments. 

Unless those families opt out of the monthly payments, they could owe the IRS a big check at tax time—an obligation that often will be beyond their ability to pay. Fortunately, this can be avoided. 

Policies to limit overpayments

This year, caregivers can use the IRS website to opt out of receiving advance payments. For low- and middle-income families who take them, a safe harbor rule limits the amount they must repay. If Congress extends the expanded CTC after it is scheduled to expire in December, it should continue the opt-out option and expand the safe harbor. It also could allow families to receive a portion of the CTC in advance, without the threat of a large tax bill at the end of the year.

In a previous blog, I described other safeguards, including keeping the CTC fully refundable and allowing recipients to update their status annually with the IRS.

Allow families to receive less than their full CTC in advance

Almost any advance payment structure that determines eligibility at the end of the tax year risks distributing too much during the year and forcing recipients pay back the excess credits at tax time. Families are in the best position to decide whether the rewards from advance payment outweigh that risk.

The current system allows families two choices: They can have the full amount of the credit delivered monthly or choose to receive a single payment at tax time. But Congress could give families a third option: To combine smaller monthly payments with an additional annual payment at tax time. That could provide cash flow relief during the year and reduce the risk of an overpayment.

There is a precedent for this option: Prior to 2010, when taxpayers could receive periodic earned income tax credit (EITC) payments during the year, the maximum amount of the credit that could be advanced was capped at 60 percent of the expected credit for a one-child family. 

Implement a strong safe harbor to protect low-income families from surprise tax bills

Being responsible for updating family changes outside of tax time will be new for many taxpayers. Even with the best outreach efforts and prevention measures, some families will fail to provide the IRS with  the most up-to-date information on which to base their advance credits, potentially resulting in overpayments. 

A safe harbor could protect taxpayers from having a large tax bill when, say, a child moves from one parent to another or a couple marries. The one-year expansion of the CTC in the American Rescue Plan (ARP) as well as the advance premium tax credit both include a safe harbor that phases out as a taxpayer’s income rises. For example, CTC recipients may not have to repay any excess amount if their income is below $40,000 for singles, $50,000 for heads of household, or $60,000 for those who are married and filing jointly.   

Provide tiered overpayment protection based on family income

In situations where families incorrectly predict how many children will be living with them in the current year or a change in marital status reduces benefits, the IRS should protect against overpayments, especially for the lowest-income families. 

• For low-income families, IRS should fully forgive overpayments. The safe harbor in ARP protects up to $2,000 per child. In 2021, that makes sense because families receive just half of their CTC (which maxes out at $3,600) in advance. But in subsequent years, low-income families could be protected up to the full credit amount that is automatically advanced.
• Higher income families would be allowed to repay excess amounts over up to three years. This is similar in concept to net operating loss provisions that allow businesses to smooth out their tax liability over many years if they have a bad year. 

Life is not always predictable. Giving families more flexibility in how they receive CTC payments and providing relief if they are paid too much can be important safeguards for those who cannot always forecast how their lives will change in the coming year.  

This blog post benefitted from comments provided by the Economic Security Project and Georgetown Center on Poverty and Inequality. All views are my own.