Federal and state income tax payments are the single largest cash outlay for many households. If there was ever a year that you need to begin your income tax planning early – 2021, is it. We had a large number of legislated changes to the tax code that will impact 2021. At the same time, Congress is contemplating making a huge number of potential changes to raise taxes to pay for as much of the proposed safety-net expansion spending as possible.
In this post, I will highlight what I believe are the most important developments. As I always do, I suggest that you reach out to your tax professional to discuss planning opportunities for the enacted law changes and how they impact you and to prepare yourself for the proposed changes.
2021 Key Changes
There have been numerous changes to the tax law for 2021. What follows are the changes most likely to impact our subscribers. I have tried to summarize the changes to make you aware of the new limits, available credits or deductions.
The Child Tax Credit
There are big changes for the 2021 child tax credit. The American Rescue Plan, which was enacted in March 2021, provides a one-year expansion of the child tax credit for the 2021 tax year. One of the biggest changes is to the amount of the credit and that the 2021 credit is fully refundable. Children who are 17 years old also qualify for the 2021 credit.
Child and Dependent Care Tax Credit
The American Rescue Plan also made significant improvements to the child and dependent care credit. But, again, the changes only apply to the 2021 tax year. For 2021, the credit is fully refundable.
Recovery Rebate Credit
Unfortunately, some people who were eligible for a third stimulus check didn't receive a payment or got less than what they should have received. For those people, relief may be available in the form of a 2021 tax credit known as the recovery rebate credit on their 2021 tax return.
Required Minimum Distributions for Qualified Plans
Required minimum distributions (RMDs) from qualified retirement plans are back for 2021. Seniors were allowed to skip their RMDs in 2020 without having to pay a penalty. Anyone who is at least 72 years old by the end the year is required to take an RMD for 2021.
Earned Income Tax Credit
More workers without qualifying children will be able to claim the earned income tax credit (EITC) on their 2021 tax return, including both younger and older Americans.
Taxable Unemployment Compensation
The American Rescue Plan made up to $10,200 of 2020 unemployment compensation ($20,400 for married couples filing jointly) exempt from federal income tax for households with an adjusted gross income less than $150,000. For 2021, if you received unemployment, it will be fully taxed as if it were wages.
Charitable Gift Deductions
For the 2020 tax year, you were permitted an "above-the-line" deduction for up to $300 per household of charitable cash contributions. Only people who did not itemize their deductions could take this deduction. However, for 2021, one deduction is allowed per person, which means married couples can deduct up to $600 on a joint 2021 tax return.
Flexible Spending Accounts (FSAs)
Health and dependent care flexible spending accounts (FSAs) generally run on an annual use-it-or-lose-it basis. There are limits to the amount you can contribute each year and how long after year-end you have to claim reimbursement for expenses incurred. However, because of difficulties some families faced during the pandemic, some temporary rules were put in place to add even more flexibility to FSAs. You will need to check out these new rules to see if they help your individual situation.
Health Insurance Premium Tax Credit
The health insurance premium tax credit helps eligible Americans cover the premiums for health insurance purchased through an Obamacare exchange. The American Rescue Plan enhanced the credit for 2021 and 2022 to lower premiums for people who buy coverage on their own.
Medical Expense Limitation
The 7.5%-of-adjusted gross income threshold for being able to deduct medical expenses won't be raised to 10% for 2021.
New Tax Proposals
As I write this post, Congress has over two dozen proposed major tax changes under consideration some of which will impact 2021 with most being effective for 2022 and beyond. Here are the major items being discussed:
Raising the top individual income tax rates on higher earning individuals and households for 2022.
Raising taxes on capital gains and dividends for the highest earning individuals and households
Increasing estate taxes levies on inherited assets by eliminating the so-called stepped-up basis
Creating permanent changes to improve the childcare credits and health insurance subsidies
Increasing the corporate income tax rate from 21% to 28%.
I will look to keep you up to date with the actions Congress is taking on these changes, along with the effective dates. It will be a busy fourth quarter with all this debate and potential new legislation.
Summary
Income tax payments are a large, if not the largest, cash outlay for most households. It is fair and reasonable personal financial management practice to work to legally minimize these payments. I encourage you to start your year-end 2021 tax planning as soon as possible. The effort may save you a lot of cash.
Like what you're reading? You can receive additional articles and ideas right to your inbox every week that are focused on improving your financial life. Subscribe to our free Moneysavers today!