Tax reform is inevitable. Tax code changes happen every year, but 2021 is a bit different. Besides the usual minor changes that happen every year, the economic effects of the coronavirus pandemic are bound to affect your tax season.
2021 Tax Code Changes
Every year, the Internal Revenue Service (IRS) makes several inflation-related tax code changes. First, here’s what to keep in mind for the 2021 tax season:
- You must file your 2020 returns by Tax Day Thursday, April 15, 2021
- The IRS increased income tax brackets for 2021 to account for inflation.
- The COVID-19 tax breaks and incentives will affect your taxes this year.
Here’s a more comprehensive look at these tax issues.
1. Same Tax Rates but Higher Income Tax Brackets
Even when there are no major tax law changes, the tax brackets are likely to increase with inflation.
Depending on your taxable income, there are seven marginal tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. You can end up in a different tax bracket, which means you’ll pay a different tax rate on your income.
Here are the revised tax rates and tax brackets, for tax year 2021, for individual single tax payers and married couples filing jointly:
- 10%: for incomes of $9,950 or less ($19,900 or less for married couples filing jointly);
- 12%: for incomes over $9,950 to $40,525 (filing jointly: over $19,900 to $81,050);
- 22%: for incomes over $40,525 to $86,375 (filing jointly: over $81,050 to $172,750);
- 24%: for incomes over $86,375 to $164,925 (filing jointly: over $172,050 to $329,850);
- 32%: for incomes over $164,925 to $ 209,425 (filing jointly: over $329,850 to $418,850);
- 35%: for incomes over $209,425 to $523,600 (filing jointly: over $418,850 to $628,300);
- 37%: for incomes greater than $523,600 (filing jointly: over $628,300).
2. Higher Standard Deduction Amounts – Tax Code Changes
Standard deductions reduce your taxable income amount. The standard deduction is a portion of the total income earned subtracted or deducted to reduce your tax bill. It is a flat-dollar direct deduction of your adjusted gross income (AGI). It is the same for all taxpayers and is determined by the IRS and regularly adjusted for inflation.
In your tax return, you can select either the standard or itemized deduction. Itemized deductions are tax-deductible expenses allowed by the IRS to reduce your taxable income. Taxpayers can include certain state and local tax deductions if they choose to itemize.
If your standard deduction is less than your itemized deduction, it’s better to itemize. Otherwise, it would be best if you took the standard deduction.
For 2020 taxes to be filed by April 2021, the standard deductions are as below:
- $12,400 for single taxpayers and married taxpayers filing separately (up by $200)
- $18,650 for heads of households (up by $300)
- $24,800 for qualifying widow(er)s and married taxpayers filing jointly (up by $400)
How do these standard deductions apply to you? Let’s say you’re a single tax filer with a gross income of $72,800 in 2020. By taking a standard deduction, you can reduce your taxable income by $12,400 to $60,400, thereby paying less tax and saving money.
Keeping in mind that standard deductions increase to account for inflation, here’s the standard deductions for 2021 taxes (for taxes filed in 2022):
- $12,550 for single taxpayers and married taxpayers filing separately
- $18,800 for heads of households
- $25,100 for qualifying widow(er)s and married taxpayers filing jointly
Note: The IRS has a special, higher standard deduction for taxpayers aged 65 and over and blind people, regardless of age. If you’re 65 or older, single, or the head of a household, your standard deduction goes up to $1,700 (for 2020 taxes). For married couples jointly filing, with one party aged 65 or older, your standard deduction rises by $1,350. If both parties are 65 and above, the deduction rises by $2,700.
People with vision impairment are eligible for the same extra deduction. $1700 for single filers or heads of households, $1,350 for married filers where only one partner is blind, and $2,700 for married filers where both parties are legally blind.
These figures are $50 higher in 2021 than they were in 2020.
3. Tax Code Changes to Individual Tax Credits
There are two main ways to save money on your taxes – tax deductions and tax credits. Whereas tax deductions reduce the amount of your income subject to federal income tax, tax credits reduce your tax bill dollar-for-dollar.
Here’s a look at some of the most popular tax credits and how much they could save you on your income tax return in 2021.
The Earned Income Tax Credit
The Earned Income Tax Credit (EITC) gives considerable tax reductions for low-income taxpayers and has also been adjusted to account for inflation.
The maximum credit amount for families with three or more children is $6,728 (up from $6,660 in 2020). For 2021, those with no qualifying children are eligible for a maximum credit of $543, $3,618 for those with one qualifying child, and $5,980 for those with two children.
The credit amount varies by the number of qualifying children and income amount. Qualifying children include adopted kids, grandkids, siblings, nieces, nephews, and foster children as long as they’ve lived with you for more than half the year.
The income limits are slightly up from 2020, beginning at $15,980 to $51,464 for single individual taxpayers depending on the number of children. For married couples jointly filing, limits begin at $21,920 of their adjusted gross income to $57,414, depending on the number of children.
The maximum credit allowed for adoption expenses is $14,440 in 2021, up from $14,300 in 2020.
According to the IRS, millions of taxpayers leave this credit unclaimed each year. Don’t be one of them. The good thing about EITC is that even if you don’t owe taxes, you can still get the IRS’s credit amount as a refund.
The Lifetime Learning Tax Credit
The Lifetime Learning Credit (LLC) is designed specifically for students and lets you claim qualified tuition expenses. The great thing about this tax credit you don’t have to be enrolled for undergraduate or graduate classes to qualify; even professional development courses will do.
For the tax year 2021, taxpayers earning less than $59,000 are eligible for a 20% tax credit on eligible expenses up to $10,000 if they’re single. These numbers have remained unchanged for single filers. However, for joint filers, the income limit amount to be eligible for the LLC is $119,000, up from $118,000 in 2020.
The IRS has also extended the provision that allows employers to contribute up to $5,250 to an employee’s student loan. These contributions are tax exempt.
4. Retirement Planning
Retirement accounts are crucial tax planning tools. You can get valuable tax deferrals and deductions to help boost your retirement accounts.
In 2021, single low-income taxpayers who make retirement contributions are entitled to a non-refundable tax credit.
The Saver’s Tax Credit is intended to encourage low- to middle-income taxpayers to save money for retirement. If your adjusted gross income is lower than the IRS’s threshold for your tax filing status, you can get a credit of 10%, 20%, or 50% of your qualified retirement contributions.
The 2021 income limits have increased slightly from several years ago. Single filers should be eligible to claim credit for up to $2,000 of contributions at a rate of:
- 50%: with an income of up to $19,750 (up to $39,500 for joint filers);
- 20%: with an income of up to $21,500 (up to 43,000 for joint filers); and
- 10%: with an income of up to $33,000 (up to 66,000 for joint filers)
Married joint filers are eligible for a tax credit of up to $4,000.
5. Alternative Minimum Tax
The alternative minimum tax (AMT) determines the percentage of taxes that a taxpayer must pay the IRS, no matter how many deductions or credits they may be eligible for.
The AMT applies to taxpayers who earn above certain income thresholds. In 2021, the AMT is $73,600 and phases out between $523,600 and $818,000 for unmarried individuals. For joint filers, the exemptions will be $114,600 and will phase out between $1,047,200 and $1,505,600.
6. Medical Expense Deductions
Thresholds have been increased for medical savings accounts in 2021. A medical savings account is a tax-deductible savings account used to cover health expenses without incurring taxes.
Participants with self-only coverage will have a minimum annual deductible of $2,400 that will max out $3,600. Participants with family coverage will have annual deductibles ranging from $4,800 to $7,150. These limits have been increased by $50 from the tax year 2020.
Also, those with health savings accounts can enjoy increased contribution limits. These limits typically increase year by year due to inflation, and 2021 is no different. In fact, contribution limits have risen by $50 to $3,600 for self-only policies and by $100 to $7,200 for family policies.
7. Increased Business Allowances
The three-martini lunch tax break is back. You can now deduct business lunches and beverages as business expenses. These expenses are now fully deductible, thanks to the Consolidated Appropriations Act of 2021. The tax deduction applies to restaurant meals and even delivery and carryout meals.
8. Capital Gains
A capital gain is an increase in a capital asset’s value, usually realized when it is sold.
If you have a capital gain you held onto for longer than a year, you qualify for a lower tax rate on that portion of your income. Regular tax rates will apply if you don’t hold onto the asset for longer than a year.
For 2021, the taxable income level that triggers maximum capital gains tax is $445,850 for an individual and $501,600 for a married couple jointly filing. At these income levels, the tax rate is 15%. Above these set ceilings, the capital gains rate is 20%.
9. Gifts and Estate Taxes
For high-net-worth individuals, the estate taxes exclusion determines how much tax-exempt wealth you can pass on to your descendants. The IRS has increased the estate tax exclusion amount to $11,700,000 from $11,580,000 for a decedent dying in 2021.
The annual gift exclusion remains unchanged from 2020 at $15,000. This means that you can gift as many people as you’d like up to $15,000 each without incurring any tax.
Things to Remember in 2021
In 2020, the US government introduced the Coronavirus Aid, Relief, and Economic Security (CARES) Act to cushion people and the economy against the effects of the coronavirus pandemic. The provisions within this Act, including the tax incentives, will affect your business taxes in 2021. Here are some things to keep in mind as you file your taxes:
- Your stimulus checks do not count as taxable income. Think of stimulus checks as a refundable tax credit.
- The Paycheck Protection Program allowed small businesses to stay afloat and were designed to be “forgiven.” This is great news, indeed. You can deduct eligible business expenses paid for using these loans from your taxable income.
- You’ll have to pay income taxes on unemployment benefits. Usually, you can choose to have taxes withheld from your benefits. If you did so, you have nothing to worry about. If not, you’ll have to pay quarterly estimated taxes or set enough money aside to pay your taxes by Tax Day.
One last thing: the COVID-19 social distancing regulations meant that millions had to work from home. If you’re self-employed, you could be eligible for home office deductions. It’s probably a good idea to reach out to a tax professional to help you figure out how this could affect your tax return.
Get a Head Start on Your 2021 Taxes – Contact FMA, CPA Firm in Clearwater to Learn about Tax Code Changes
Are you looking for trustworthy business advisory services to help you out with your business taxes? FMA CPA has years of experience providing personal tax services and business tax services. Our certified public accountants will make sure your tax return is accurate and thorough.
You want your taxes done well and done right. We have got you covered on this front. We’ll walk you through the entire process, providing tax tips and the financial tools to help your business thrive. Get in touch today for a free consultation.