So you’ve done the impossible – retired with young children (or retired and then had children.)
Congratulations, you are eligible for a generous $2,000 Child Tax Credit (per kid.)
But if you no longer have earned income and/or already have a low/zero tax burden, you could miss out on thousands of dollars.
This is how to avoid that. (This is especially important now that we have doubled our potential for Child Tax Credits.)
The Child Tax Credit
In the Tax Cuts and Jobs Act of 2017 (my review) personal exemptions were eliminated in favor of increasing the Standard Deduction and the Child Tax Credit.
A credit reduces the tax you owe dollar for dollar – The Child Tax Credit (CTC) can eliminate up to $2,000 of tax per qualifying child. (This is not indexed for inflation, so it declines in value over time. Unless new legislation is passed, the CTC will revert to its pre-TCJA value of $1,000/child after 2025.)
Requirements for Child Tax Credit eligibility are basically that you have a kid who lives with you, but IRS Publication 972 (pdf) is more specific:
- Child is US citizen or resident alien and have not had their 17th birthday
- Child must have a Social Security Number
- Child lived with you and you provided more than 50% of their support
- Child is your son, daughter, adopted child, grandchild, stepchild or eligible foster child, your sibling, step-sibling or their descendant.
If Adjusted Gross Income is greater than $400,000 for Married Filing Jointly (or greater than $200,000 for everyone else) then the maximum CTC is reduced at a 5% marginal rate ($50 reduction for every $1,000 over the AGI threshold.)
Since too much income isn’t a problem for most people, nearly all households with children qualify.
Additional Child Tax Credit
If the CTC completely eliminates your tax burden, up to $1,400 per child is refundable… meaning not only do you owe zero tax but you get free money back. This is called the Additional Child Tax Credit (ACTC) and is calculated on Schedule 8812 (pdf.)
Unlike the core CTC, the ACTC is adjusted for inflation… and in theory can increase up to the maximum value of $2000 at some point in the future. Due to low inflation post-TCJA, the 2020 maximum ACTC remains at $1,400.
Eligibility for the ACTC requires that you have Earned Income in excess of $2,500. Households claiming the Foreign Earned Income Exclusion are also ineligible.
Once you reach the $2,500 earned income threshold, the ACTC increases at a rate of $0.15 per dollar earned. Thus a 1-child household will need to earn $11,833 to get the maximum refund. Multi-child households need to earn more.
For households with more than $4,200 in Additional Child Tax Credit (3+ children) the calculation is a little more complicated – but it is possible to get a refund / ACTC even with earned income of <$2,500 if you pay more in SS taxes than you benefit in EITC (exercise for the reader.)
Examples
1. Parker and Peyton have a toddler. In 2019 they earned $50,000 which resulted in total tax of $2,684. The Child Tax Credit of $2,000 reduced this dollar-for-dollar to $684. (For tax calculations, I used our Federal Income Tax Calculator.)
Total possible benefit with 1 child: $2,000
Actual amount received: $2,000 ✨
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2. Pat and Chris have 2 children ages 9 and 12. They earned $21,166.67 in 2019 and file taxes as Married Filing Jointly.
Since their total income is less than the standard deduction, they will owe zero tax. With no tax, their CTC will be $0.
However, they are eligible for the ACTC and will get 15% of the amount they earned over $2,500 up to $1,400/child. Or in this case, exactly $1,400/child.
Total possible benefit with 2 children: $4,000
Actual amount received: $2,800 ❌
Left on the table: $1,200 :(
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3. Jeremy and Winnie have 2 kids, a 5-year-old and an infant. They have multiple streams of income totaling ~$100,000, of which half is from self-employment that is excluded from taxation with the Foreign Earned Income Exclusion. The remainder is from qualified dividends and long-term capital gains which are taxed at 0%. In total, they pay zero tax.
With no income tax at all, they get $0 from the Child Tax Credit. By claiming the FEIE, they are ineligible for the ACTC.
Total possible benefit with 2 children: $4,000
Actual amount received: $0 ❌
Left on the table: $4,000 :(
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Maximizing the Child Tax Credit
For a household with children and at least 1 adult with a good income, getting a child tax credit is fairly straightforward.
But what if you don’t earn enough to get the full credit? Or you dislike earning an income? Or you accidentally earn some money, but you are outside the US and use the Foreign Earned Income Exclusion?
Then we need to do the abnormal and intentionally pay more taxes. Then we can use the CTC to reduce that tax burden back to zero.
Let’s update 2 of the examples above to do just that.
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Pat and Chris from Example #2 left $1,200 on the table because their earned income of ~$21k was too low to pay tax and the ACTC is limited to $1,400/child.
To maximize the CTC they need to increase their tax by $1,200.
One option is to do a ~$15,250 Roth conversion, increasing their AGI to $36,400.
This will increase their total tax to $1,200. The CTC will reduce this back to $0, and they will still get a refund from the ACTC of $2,800.
Total possible benefit with 2 children: $4,000
Actual amount received: $4,000 ✨
Left on the table: $0
Warning: the Roth conversion will increase their MAGI for ACA Premium Subsidy purposes. Learn more here.
Opportunity: Don’t forget to also maximize the Saver’s Credit
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Jeremy and Winnie in example #3 left $4,000 on the table. Even with $100k in income, they pay zero tax so they get no benefit from the CTC. Because they claim the FEIE, they are ineligible for the ACTC.
Instead, they do a combination of things to increase their tax bill by $4,000. Options include:
- Roth conversion – same as example 2
- Harvest short-term capital gains – short-term capital gains are taxed the same as earned income, in this case at 22%.
- Harvest long-term capital gains – long-term capital gains are taxed at beneficial rates from 0% to 20%, or 15% at these income levels.
- All of the above
Now with $4,000 in tax due, the CTC can reduce this back to zero.
Total possible benefit with 2 children: $4,000
Actual amount received: $4,000 ✨
Left on the table: $0
Summary
For households with low tax burden and/or low earned income, getting the maximum Child Tax Credit benefit requires intentionally increasing the amount of tax owed. The CTC can then reduce this back to low/zero.
The common early retirement tax minimization tools of Roth conversions and Capital gain harvesting are useful here. (Related: which is better, Roth Conversions or Capital Gain Harvesting?)
Can you take it if you have shared custody and agreement to claim every other year on taxes but don’t have the kid 50% of the time?
I don’t have first hand experience with this, so just going off what I have read – the parent that has custody of the child the most gets the tax credits and other filing benefits (head of household, EITC, dependent care expenses, etc…) But, with the TCJA the custodial parent can assign the CTC to the noncustodial parent using form 8332.
Long time reader, first time commenter (love your work btw)…In the example 2, and modified example 2, isn’t the net benefit the same? They still receive $2800 into their pocket either way. The only difference is the amount of the credit realized, which is the whole point of the article. What’s the advantage to taking the entire credit then if it makes no difference to the amount refunded? Is there an advantage in the future?
>Is there an advantage in the future?
Yes. The IRS paid all the tax on your Roth conversion.
Hello,
I’ve been pondering the EITC for a bit for retirees. I have a comment and question(s).
From the IRS website, https://www.irs.gov/pub/irs-pdf/p5334.pdf, your investment income (which includes interest, dividends, rents, royalties, and capital gains) should be $3,600 or less. So you can harvest capital gains up to the max, which is limiting.
Also, would roth conversions be counted as part of the income since it’s not earned income from W2 wages or personal business? For example, can I have 1 child and have $1 in income, and convert roth ira to get the $2,000 in tax credit?
The EITC and Retirement don’t go well together. It requires earned income.
For the CTC, there is no W2 requirement to get the $2,000 CTC as long as you owe $2,000 in tax for the credit to offset. Yes, a Roth conversion can be used to generate that tax – this is Example 2 above.
Great post! Just for clarification, you say: “Eligibility for the ACTC requires that you have Earned Income in excess of $2,500. Households claiming the Foreign Earned Income Exclusion are also ineligible.” Modified Example 3 works because, while you are claiming the FEIE and this makes you ineligible for the ACTC, it does not make you ineligible for the standard CTC? Is that correct?
Correct
Thanks for the great post! I learned a lot. It’s amazing how complicated a seemingly simple $2k/kid tax credit is in practice ($2.5k min income requirement + 15% phase-in).
I really like your Roth conversion solution. With 5 kids and $10k of CTC available, that’s a lot of potential tax-free Roth conversions at play.
Optimizing with respect to CTC, Saver’s Credit, ACA subsidy, etc. quickly becomes a very difficult problem. I’ve built a decent, but imperfect, model of the tax code here: https://frugalprofessor.com/2019-tax-calculator/, but it would be nice to incorporate these more nuanced versions of the tax code into it.
Coincidentally, this NBER working paper showed up in my RSS feed this morning:
https://www.nber.org/papers/w27940#fromrss
Who Benefits From the Child Tax Credit?
Jacob Goldin, Katherine Michelmore
The Child Tax Credit (CTC) provides a cash transfer of up to $2,000 per child under age 17 to millions of families in the United States. Using the Current Population Survey, we examine the aggregate effects and distributional implications of the rules governing children’s eligibility for the credit. While approximately 90% of all children qualify for at least a partial CTC, we document striking disparities in eligibility by income and race. The vast majority of children living in households in the bottom decile of the national AGI distribution are completely ineligible for the CTC and the majority of filers in the bottom thirty percent are eligible only for a partial credit. In contrast, virtually all children living in households in the top half of the income distribution qualify for the full credit amount. Approximately three-quarters of white and Asian children are eligible for the full CTC, compared to only about half of Black and Hispanic children. We use our results to estimate the distributional effects of a range of reforms to the CTC eligibility rules. Our results suggest that reforming the credit to include a larger share of children would more evenly distribute the credit’s benefits across children of different races and incomes.
A final sentence should be added to the abstract: Readers of GCC’s blog who strategically optimize for the CTC are among those who benefit.
Making the CTC fully refundable would be a good policy change – it’s part of Biden’s tax plan.
Finding the sweet spot with all of the nuances of each individual credit + State taxes is no easy task. Size of TIRAs is also a factor, converting 100% of Traditional accounts to Roth is also not ideal. Conveniently ACA / CTC are both 15% over a wide range… but not so wide that it would work for max CTC for 5 kids.
The wizard has spoken……
I always enjoy these nitty-gritty posts the best.
Cheers!
haha, ignore the man behind the curtain
I hope TurboTax already calculates all of this and maximize it.
I sure don’t have any idea how one can fully understand and fill the 100+ tax forms in the IRS website that might apply to your situation- only tax rats!
Nice post
I believe the politically correct terminology is tax masta.
Turbotax will calculate what your CTC is. It won’t tell you how to make it bigger… in part because your AGI is fixed after December 31st, and you probably don’t start using TT until February.
Anyway to make this work if you are purposely keeping income as low as possible for ACA premium tax credits?
Maybe. As low as possible isn’t necessarily ideal – the sweet spot is often between 200% – 250% FPL.
As MAGI increases, ACA subsidies decrease at a 15% rate. CTC subsidies increase at the same 15%. Net net it could be still cheap Roth conversion space.
Pardon me but surely there a super-computer program for working out the optimal path through the USAn tax maze?
Theseus used a ball of thread to navigate the labyrinth.
Keep right?
I just use Excel
In arrogant ignorance I once tried to create a useful “Whole Of Life Finances” Excel model starting simply from single person’s active and passive income and the tax rules applying thereto. Much as you have done in the past.
A multi-dimensional computation problem.
Add more rules (add more dimensions) and the number of computations to adequately delimit the outline of the ‘elephant’ exponentially increases exponentially.
Excel is good for delimiting small portions of the ‘elephant’ but not the biggest picture over the fullness of time – which is very difficult perhaps near impossible.
My approach is to ignore 99% of the elephant since it doesn’t apply and then out of laziness only model the relevant portions (perhaps 10% of the remaining 1%.)
We pretty closely resemble scenario 2 except kiddo are older.
We have opted to leave this money on the table because of how converting impacts FAFSA, healthcare, and state income tax liability. I would rather convert less to Roth and forgo that money only to create a $750-$1000 state tax liability, higher healthcare premiums, and shrink my older son’s Pell Grant.
In 2020 we have opted to realize more income as it looks like during the 2022-2023 school year we have no kids in higher ed.
Any tax credit can also offer the same benefit. It can be the electric car tax credit, solar energy installation tax credit, or the foreign taxes tax credits. These credits can be a tax free way to Rothify pre-tax assets.
For sure.
Since I’ve been asked about the CTC for people without earned income I wrote about that particular credit.
So if I have an $85k pension, which is unearned income as I understand it, that means I’d need to get a job for $2,500 per year in income to qualify for the $4k in tax credits?
If your $85k pension generates $4k in taxes, the CTC can reduce that to zero. Earned income is required only for the ACTC.
This blog “Maximizing the Child Tax Credit (even without earned income)” has a misleading title. It led one reader to think you could get a CTC even w/o earned income by creating a STCG. Perhaps it needs to be titled “even w/o ENOUGH earned income”?
Perfect, said reader reached the correct conclusion: You can get a CTC even w/o earned income be creating a STCG.
Would withdrawals from a 457 also qualify you for the CTC?
Any income qualifies you for a CTC as long as you owe tax for the CTC to offset.
You must have earned income for the ACTC – W2 or self-employment.
Thanks for the tips. I’m still in the accumulation period (i.e. not FIRE’d yet) but I imagine at least one of my 6 kids will still be in the <17 window by the time I do hit FIRE, at which point I'll be able to apply the technique here (assuming the tax law doesn't morph some more).
But still, great for the entertainment and thought exercise value.
If not, you can always make it 7 ;)