In continued response to the effects of Covid-19, we have seen numerous changes in tax law signed into tax law during 2021. As we near the end of the year, it is an excellent time to review this year’s changes and consider available tax-planning strategies to avoid any potential surprises on your tax return.
2021 TAX HIGHLIGHTS
RECOVERY REBATE CREDIT – 3RD STIMULUS PAYMENT
- Under the American Rescue Plan Act (ARPA), the IRS issued the third round of stimulus payments for up to $1,400 ($2,800 if married filing jointly) plus $1,400 for each qualifying child. Similar to previous payments, the third round of payments are credits against your 2021 taxes paid in advance and subject to income limitations. Depending on the payment amounts you received and your 2021 income, you may be entitled to an additional credit amount upon filing your 2021 tax return.
CHILD TAX CREDIT
- The American Rescue Plan Act (ARPA), enacted in March 2021, increased the Child Tax Credit from $2,000 to $3,600 for each child under six and $3,000 for each child ages 6-17. To allow families immediate benefit, the IRS began issuing a portion of the credit to families in the form of an advanced monthly payment equal to half of the credit. For 2021, the Child Tax Credit is gradually phased out for taxpayers with incomes over $150,000 if married filing jointly or $112,500 if filing as head of household.
- While the monthly payments may be nice, taking the advanced Child Tax Credit payments now will reduce the amount you get at tax time. Furthermore, if you are within the phase range and your 2021 income exceeds your 2020 income, you may have an increase in taxes due or a reduced refund in April. We recommend you opt out of the November and December payments by visiting the IRS online portal.
CHILD AND DEPENDENT CARE TAX CREDIT
- The American Rescue Plan Act (ARPA) made significant changes to the child and dependent care credit. The credit is fully refundable for the 2021 tax year only, with the maximum credit percentage of qualifying expenses increased from 35% to 50%. The increased credit allows up to $8,000 in expenses for one child/disabled person (up from $3,000 in prior years) and $16,000 for more than one (up from $6,000).
- In addition, the full credit amount is available to families making less than $125,000 a year (instead of $15,000 per year). Families making more than $125,000 per year will be subject to phase-outs but will receive partial credit. Families making more than $438,000 per year will be fully phased out from the credit.
- Individuals should review their year-to-date realized capital gains and losses to determine an appropriate year-end planning strategy for capital gains and losses. Tax rates on capital gains depend upon the amount of taxable income for the year.
- High-income earners whose modified adjusted gross income exceeds $250,000 for joint filers, $125,000 for separate filers, and $200,000 for all other filers are subject to an additional 3.8% net investment income tax on unearned income.
- If you have net realized capital losses or loss carryovers from 2020, you may consider recognizing capital gains to offset realized losses and loss carryforwards.
- If you have net realized capital gains, consider selling securities with unrealized losses to offset capital gains, investing in a qualified opportunity fund, and tax implications of netting short-term and long-term capital gains and losses.
- Required Minimum Distributions. The Secure Act of 2019 pushed the age of taking required minimum distributions (RMDs) back from 70 ½ to 72. Last year, the CARES Act allowed for the deferral of 2020 RMDs. RMDs have resumed for the 2021 tax year and must be taken by December 31 unless a taxpayer turns age 72 during the year.
- Qualified Charitable Distributions. Taxpayers at least 70 ½ may contribute up to $100,000 annually to charities directly from their IRAs and exclude the contribution amount from their gross income. QCDs count towards their RMDs.
- Contributions. If you have not yet fully funded your retirement plan (i.e., 401k, IRA, SEP), you want to consider doing so before the end of the year (or April 15, 2021, for IRAs and SEP plans).
- Roth Conversions. If you believe your income will be lower this year than in future years, consider converting your Traditional IRAs to Roth IRAs and paying the tax now while you are in a lower tax bracket.
TAX-ADVANTAGE SAVING FOR HEALTH CARE
- HSA. Individuals covered by a qualified high-deductible health plan may contribute pretax income to an employer-sponsored Health-Savings Account or make deductible contributions to the HSA with after-tax dollars. For 2021, the annual limitation on contributions to an HSA is $3,600 for individuals with self-only coverage and $7,200 with family coverage, plus an additional $1,000 for individuals ages 55 or older. If you have not yet maximized your HSA contributions for 2021, you have until April 15, 2021. Distributions from an HSA are tax-free to the extent they are used to pay for qualified medical expenses.
- FSA. Individuals should review the amount of money used for qualified medical expenses and adjust the amount set aside for 2022.
ITEMIZED VS. STANDARD DEDUCTION
- STANDARD DEDUCTION: For 2021, the standard deduction amounts are $25,100 for joint filers, $18,800 for heads of households, and $12,550 for all other filers. The additional standard deduction for the elderly and the blind equals $1,700 for singles and heads of households aged 65 or older or blind, and $1,350 for married persons ($2,700 if both spouses are over 65) who are age 65 or over or blind.
- ITEMIZED DEDUCTIONS: In addition to the high standard deduction amounts, there is still a $10,000 limitation on the deduction of state and local taxes (state income tax, real estate taxes, and auto registration tax), and miscellaneous itemized deductions continue to be nondeductible.
- BUNCHING STRATEGY: One strategy to maximize deductions is to develop a bunching strategy for charitable contributions and medical expenses. This strategy involves accumulating charitable contributions from two or more years into one year. For example, a taxpayer may not have made any of their regular charitable contributions in 2020 but instead doubled the normal amount in 2021 to help surpass the standard deduction amount.
- CHARITABLE CONTRIBUTIONS: Taxpayers who don’t itemize may take up to a $300 above-the-line deduction for cash contributions. For 2021, the above-the-line deduction has increased to $600 for couples married filing jointly. The special deduction applies regardless of an individual’s income level.
PROPOSED TAX CHANGES FOR 2022 (Build Back Better Act)
Although President Biden’s “human” infrastructure bill, known as the Build Back Better Act, has passed the House Ways and Means Committee, it remains tied up in negotiations by Senate Democrats. With little likelihood of support from Republicans, Democrats need a “yes” vote from all Senate Democrats to pass the reconciliation bill. Until Senate Democrats successfully pass the bill, the exact contents of the bill remain unclear. However, the final bill will certainly contain significant tax changes for corporate and individual taxpayers.
Based on the House Ways and Means Committee bill, most of the provisions will apply to tax years beginning after December 31, 2021. As you think about your 2021 tax position and the effect of potential tax law changes, you may consider accelerating income into 2021 or deferring deductions into 2022.
WILL THE CHANGES IMPACT YOU?
- Increase in the Top Marginal Tax Rate from 37% to 39.6%: Applies to taxpayers with taxable income equal to or exceeding $400,000 (single filers) or $450,000 (for married couples filing jointly)
- Top Capital Gain Rate Increase from 20% to 25%: Applies to long-term capital gains and qualified dividends of taxpayers with taxable income over $400,000 (single filers), $450,000 (married couples filing jointly), and $425,000 (head of household filers). The maximum rate of 25% would be effective for gains recognized after September 13, 2021.
- Expansion of the 3.8% Net Investment Income Tax (NIIT):
- Under current law, the 3.8% NIIT applies to “net investment income” of individuals, estates, or trusts that have a modified adjusted gross income (MAGI) above defined thresholds for the tax year. Net Investment Income generally includes interest, dividends, capital gains, rental and royalty income, nonqualified annuity income, and income from businesses that are passive activities to the taxpayer.
- The proposed legislation expands the scope of NIIT to apply to all business income of taxpayers with taxable income greater than $400,000 (single filer) or $500,000 (married couples filing jointly). Essentially, all earnings from a pass-through business will be subject to either the 3.8% self-employment Medicare tax or the 3.8% NIIT, regardless of whether the income is from a passive or nonpassive activity.
- Individual Retirement Accounts:
- The proposal would prohibit Roth conversions for both IRAs and employer-sponsored plans for single taxpayers with taxable income over $400k, married couples filing jointly with taxable income over $450,000, and heads of households with taxable income over $425,000. This provision would apply to distributions, transfers, and contributions made in tax years beginning after December 31, 2031.
- The proposal would also eliminate “Back-Door Roth” conversions, where a taxpayer makes nondeductible (after-tax) IRA contributions and then converts those contributions to a Roth. This provision would be effective for tax years beginning after December 31, 2021.
Please contact us if you would like to discuss any of these planning opportunities. We look forward to serving you.
Written By Leah Swenson, DHA CPAs
Due to IRS rules, we must inform you that this written communication is not intended to be used, and cannot be used, by any taxpayer for the purposes of avoiding penalties under the Internal Revenue Service Code or promoting or recommending to another party any transaction or matter addressed herein.