In this post, we´re going to talk about ARPA, the American Rescue Plan Act, which recently became law, and FEIE (Foreign Earned Income Exclusion).
Have you received your third individual payment, EIP3, yet?
If you haven’t, possible reasons include:
- You have not filed your 2019 tax return yet.
- You have filed your 2019 tax return but the income was too high: if so, check if your 2020 income qualifies and hurry up to file your 2020 tax return if it does. Why?
- The IRS will stop mailing the third stimulus payments after July 14. Your 2020 tax return needs to be processed by that date for you to receive the third check in 2021.
The 2020 tax filing deadline is May 17 for US resident taxpayers and June 15 for Americans abroad.
My recommendation? Do not extend your 2020 tax return if it qualifies you for EIP3, the third stimulus payment, and your 2019 income was too high. File without delay!
You can’t avoid extending?
No need to panic. You will be able to claim the third check when you file your 2021 tax return. You will need to wait until April 2022 to do this, but the money won’t be lost. Just delayed.
Another provision in ARPA aimed at helping families with young children, is an expanded child tax credit available only in tax year 2021.
Under the expanded provisions, the 2021 child tax credit is fully refundable.
Why is this good? Because it grants taxpayers who normally do not owe US taxes access to the relief. A refundable credit is a credit that is paid back to the taxpayer in the form of a refund even if the taxpayer didn’t owe any US tax.
Normally tax credits reduce taxes dollar for dollar until the tax is reduced down to zero. But they don’t reduce taxes below zero.
Refundable credits do. That’s their superpower.
Let’s see use an example:
Imagine you owe $2,000 in taxes and have $1,000 in nonrefundable credits. Your after-credit tax is reduced down to $1,000 ($2,000 in tax – $1,000 in credits = $1,000 in net tax).
If instead you owe $500 in taxes and have $1,000 in nonrefundable credits, your $500 in taxes is reduced to zero but the other $500 in credits gets lost. ($500 in tax – $1.000 in credits = $0 tax and $500 in credits lost).
If the credit is refundable instead, the additional $500 reduce the tax balance to negative $500 and the IRS sends you a check for the $500 difference. No portion of the refundable credit is lost!
Usually, we only receive tax refunds when we pay too much money in.
But a refundable credit is one that creates a refund even when we have paid NO money in.
Sweet!
When I first read that the expanded child tax credit would be fully refundable, I thought, this is great! This credit will help lower income families, even if they live abroad, receive expanded assistance to cover the additional childcare and education expenses from having to take care for young children during the pandemic.
Fantastic!
Unfortunately, this will only be the case for families with American children living in the USA. Why?
Because the credit requires that, in order for it to be fully refundable, the taxpayer and their spouse, if filing a joint tax return, must have a principal place of abode WITHIN the U.S. for more than 6 months of the year. If they live abroad for six months or more, they are disqualified from the expanded 2021 child tax credit.
What does this mean for Americans with a foreign abode?
- If they don’t use the foreign earned income exclusion, Americans overseas are still eligible for the regular refundable portion of the child tax credit that we’ve had since 2018, worth up to $1,400 per qualifying child.
- If they use the foreign earned income exclusion, they are only eligible for the nonrefundable portion of credit, worth up to $2,000 per child.
- If they return to the US in 2021 and establish a US abode for at least six months, they are eligible for the entire credit, worth up to $3,600 per child under 6 and $3,000 per child between 6 and 17.
Any other important distinctions between the regular child tax credit and the 2021 expansion?
Yes, the income eligibility limitations are lower.
The expanded completely phases out at:
- $170,000 of MAGI for joint filers or qualifying widowers
- $132,500 of MAGI for heads of household, and
- $ 95,000 of MAGI for all other filing statuses
Did you notice the word MAGI for the income limitations?
MAGI = Modified Adjusted Gross Income
Modified Adjusted Gross Income = Adjusted Gross Income with the FEIE added back.
For purposes of the child tax credit, the FEIE does not provide any special advantage.
In case you have forgotten, FEIE = Foreign Earned Income Exclusion.
Does this sound like we have a bit of a conflict here with the FEIE? Yes, we do….
The FEIE can help you qualify for the EIP individual stimulus payments, but it can hurt you with the refundable child tax credits.
You can end up in a situation by which claiming the FEIE can help you obtain one of the benefits and lose the other, forcing you to choose between a refundable child tax credit or an EIP stimulus check.
What’s the math and when does it matter?
The math only matters for those families living overseas who do not normally owe any US income tax and have income that is too high to qualify for the third stimulus check, EIP3, without claiming the FEIE.
If they claim the FEIE, they will get the EIP3 and no refundable child tax credit. If they don’t claim the FEIE, they get the refundable child tax credit but not EIP3.
Which benefit is better?
It depends on the number of members in a family, their age, and on the personal circumstances of the family.
The EIP3 is worth $1,400 per family member regardless of age. For a family with 2 children, the EIP3 is worth $5,600.
The refundable child tax credit is $1,400 per child. For a family with 2 children, this can be worth $2,800 if the children are under age 13. If they are 13 or older, the children are too old and the stimulus EIP3 is all that matters, as there is no age limitation for children to receive the EIP3.
Since $2,800 is less than $5,600, the third stimulus EIP3 would seem to be the priority for this hypothetical family.
If the EIP3 is the priority, this family should claim the FEIE, right?
Well, not so fast. Actually, it depends.
Why?
Because the EIP3 is a one-time benefit, and the standard refundable child tax credit is an annual benefit, EVERY year, until the dependent child turns 13.
But, you may wonder, Can’t I just claim the FEIE in 2020 to get the EIP3 and not claim it in 2021 to get the additional child tax credit?
Unfortunately, it’s not that easy.
Once claimed, the FEIE must be claimed in all subsequent years, unless it is revoked. If the FEIE is revoked in 2022 to obtain the refundable child tax credit, it cannot be claimed again for a period of five years from the year of revocation without written permission from the IRS.
Written permission of the IRS comes in the form of something called Private Letter Ruling (PLR) and one much pay for such private rulings.
PLRs cost a pretty penny in IRS user fees and professional representation fees. The cost of a PLR can be as high as multiple tens of thousands of dollars, more than the benefit from the child tax credit itself!
If you have young children and you could receive the refundable child tax credit for multiple years, you may be better off giving up the 2021 EIP3 by not claiming the FEIE, to preserve the child tax credit for multiple years.
The younger your children and the more children you have, the more likely it is that it will be more advantageous for you not to claim the FEIE.
OK folks, this is all until the next post, in which we will be discussing Foreign Tax Credits, assuming no new tax laws are passed between now and then.
Take good care of one another and see you next time.
Much love, un abrazo y buena onda.
Marina