Spring has sprung, and while the bees are busy gathering pollen from the flowers, here at TaxAudit we are busy gathering information about the current filing season and what’s coming up in the year ahead. With 2020 behind us and a new tax year in front of us, you might be thinking that with the increased vaccinations in the U.S. and decreasing coronavirus cases, that everything is “returning to normal.” But those of us who work in taxes know that there’s not much that is normal in tax law this last year. With the economy still sputtering due to the coronavirus, Congress and the new Biden administration have been working toward stimulating the economy to get unemployed Americans back to work, and they're doing this through tax laws. And, of course, anytime we talk about new tax laws, we just add to the confusion most taxpayers experience when they are trying to do their tax returns.
So, what new laws have been passed recently? You may recall that in 2020, three large tax bills were passed. The Families First Coronavirus Relief Act (FFCRA) and the Coronavirus Aid, Relief, and Economic Security Act (CARES) were passed early in the pandemic. These bills contained many tax provisions, many of which were to expire at the end of 2020. However, in December 2020, the Consolidated Appropriations Act extended many expiring provisions. And then on March 11, 2021, Congress signed into law the American Rescue Plan Act of 2021 (ARPA). This new tax law not only extended some provisions of the prior coronavirus response bills, but also added some new provisions for 2021 and 2022. Some provisions in this new law were made retroactive to the beginning of 2020. This was done to help struggling Americans and were targeted to the middle class.
We will attempt to explain some of these new changes that you need to be aware of for this upcoming tax year, and how they may benefit you if you have not yet filed your 2020 tax return. We are only going to cover the major changes to individual tax laws so, if you have a business, you may want to talk to a professional on how to take advantage of changes which impacted small businesses.
Recovery Rebate Credits and Economic Stimulus Payments
Probably the most popular provision in this new tax law is a third economic stimulus payment to be paid to taxpayers in the amount of $1,400 per person, including dependents. These payments, commonly referred to as Economic Stimulus Payments, are, in reality, a credit against the taxes due in 2021. The previous two rounds of economic stimulus payments, which were paid last spring and winter, were also advanced payments of a credit that could be claimed on your taxes for 2020. In other words, if you didn’t receive an advance payment when they were issued, you could claim them (if you qualified) on your 2020 tax return. For the third round of payments, there have been a few changes in how this payment will be paid. For starters, many more taxpayers will
not qualify for the third round of payments, as the payment phases out much faster than with the prior payments. This means that third round of stimulus payments is reduced to $0 at a much lower income level than the previous two payments, although the phase-out begins at the same income level:
- Single/Married Filing Separately: $75,000 - $80,000 (The first two stimulus payments phased out completely at $99,000.)
- Head of Household: $112,500 - $120,000 (The first two stimulus payments phased out at $136,500.)
- Married Filing Joint: $150,000 - $160,000 (The first two stimulus payments phased out at $198,000.)
The calculation of the third economic stimulus payment is based on your 2020 tax year filing (if you have filed) but is a credit against 2021 taxes. This is because ARPA was passed when the 2020 filing season was already in full swing. If the 2020 return has not been filed, the IRS will pay it based on the 2019 return income.
For example, John is a single taxpayer who has adjusted gross income for 2019 of $85,000. Under the first two stimulus payment rounds, John would have received a partial stimulus payment for both the first and second stimulus. But under the third round of payments, John would receive nothing in advance as his income exceeds the $80,000 top amount for his filing status. When John files his 2021 tax return, he can claim a partial Recovery Rebate Credit if his income for 2021 dropped below $80,000, or a full $1,400 if his income drops below $75,000.
As mentioned earlier, the third stimulus is $1,400 per person, unlike the prior two stimulus payments. Older dependents who are over the age of 17, such as college students or dependent parents, are now eligible for a full $1,400. Essentially, this means that the $1,400 is available to everyone who has a Social Security number regardless of age or dependency status. And like the prior payment, individuals who are not required to file a return, such as Social Security recipients, will receive their payments as well. Like the prior stimulus payments, the third stimulus payment has no repayment requirement if the taxpayer receives the advance payment but does not actually qualify for it based on their 2021 income. However, if you receive a payment for someone who passed away before January 1, 2021, that will need to be repaid.
Earned Income Tax Credit
The American Rescue Plan Act included several enhancements to the Earned Income Tax Credit (EITC), but these enhancements are generally applicable only to the 2021 tax year. The biggest change is for low-income, childless taxpayers, where the law increased the amount of EITC they can receive to $1,502 and increases the amount of income at which the credit is maximized. The law also changed the age ranges for claiming the EITC, reducing the lowest age from 25 to 19 years of age, and removing the 65 years of age “cap” on receiving the credit. Full-time students are still not eligible to receive the credit. Additionally, the EITC is only available to taxpayers who are not claimed as a dependent by another person.
Another change for just the 2021 tax year is that taxpayers whose income decreased in 2021 income from their 2019 income can elect to use the 2019 income to compute the credit, which should provide them with a higher EITC. This provision is similar to one that was included in the Consolidated Appropriations Act which had a similar provision that applied only to 2020 tax returns.
One other big change in ARPA is for taxpayers who are separated from their spouses. Under prior law, a taxpayer who had to file a Married Filing Separate return was ineligible to claim the EITC unless they could qualify as “unmarried” and use the Head of Household filing status. This was a high bar to reach for many taxpayers. Under ARPA, a taxpayer who files separately from their spouse may claim the EITC providing they live with a qualifying child for more than one-half of the year, and that they do not share an abode with their spouse at any time during the last six months of the year, or has a separation decree (but not a divorce decree) and is not a member of the other spouse’s household at the end of the year. This change is permanent, so it applies to 2021 and subsequent years.
Another significant change which is permanent is the increase in the amount of investment income that an individual can receive and still qualify for the EITC. Under previous law, the amount of investment income you could receive was $3,650. Under ARPA that has been increased to $10,000 for 2021 and will be adjusted for inflation after that. Investment income is taxable interest and dividends, tax-exempt interest, net nonbusiness rent and royalty income, net capital gains, and net passive income. The EITC was also expanded to include taxpayers living in U.S. possessions (US Virgin Islands, Guam, the Commonwealth of the Northern Mariana Islands, American Samoa, and Puerto Rico).
Increased Child Tax Credit and Additional Child Tax Credit
Another benefit for families under the new law is an increase in the amount of the Child Tax Credit that can be received for each child. The credit was also extended to Puerto Rico and American Samoa.
Under prior law, the Child Tax Credit was limited to $2,000 per child, with $1,400 of that as a “refundable” credit, meaning that even if you had no tax liability you would get $1,400 back per qualified child. The $1,400 portion is sometimes referred to as the Additional Child Tax Credit since it was not dependent on the taxpayer’s tax liability to receive the benefit.
For 2021, the credit amount per child is increased to $3,000 (up to $3,600 for children under 6 years of age), and the credit is
fully refundable for most taxpayers. Also, the maximum age for a qualifying child for the credit increases to children who are under the age of 18 at year end, so a 17-year-old child will now qualify. This credit, like the economic stimulus payments, is phased out as your adjusted gross income increases, decreasing by $50 for every $1,000 your income goes over the following threshold:
- Single: $75,000
- Head of Household: $112,500
- Married Filing Joint: $150,000
Once the Child Tax Credit is reduced to $2000, the credit remains at that level until your income hits the next threshold when it starts to phase out again at the same $50 reduction for every $1,000 of excess income. The credit remains fully refundable, however, and is not limited to the prior $1,400 refundable amount. The second threshold amounts are $400,000 for joint filers and $200,000 for all other filers, the same as they were under prior laws.
Some taxpayers may be eligible to receive a portion of their Child Tax Credit as an advance payment, paid in monthly installments from the IRS, although exact details on this are still pending. The advance payments will likely be paid based on information in a taxpayer’s 2019 or 2020 tax return. Certain taxpayers who claimed a dependent in 2019 or 2020 but that person is no longer their dependent have a “safe harbor” if they are receiving advance payments of the Child Tax Credit, meaning they may not be required to pay back up to $2,000 per child of any excess credit. However, this safe harbor is also income limited, so a taxpayer with higher income is more likely to be required to pay back the advance credit. If the taxpayer earns less than the following amounts, they are fully covered under the safe harbor:
- Single/MFS/Qualified Widow(er): $40,000 (safe harbor is eliminated at $80,000)
- Head of Household: $50,000 (safe harbor is eliminated at $100,000)
- Married Filing Joint: $60,000 (safe harbor is eliminated at $120,000)
Taxpayers with income between the lower and upper amounts will have a partial repayment requirement, while those above the upper threshold amount will be required to repay any advances in full. Taxpayers can opt-out of the advanced payments and may want to do so if they anticipate that their qualifying dependents will be reduced from prior years.
You may want to check the IRS website to see if you are eligible for the advance payments and to determine whether or not you want to take them. However, the IRS has not yet updated their website for this law change.
Child and Dependent Care Credit
Under the American Rescue Plan, the amount that a taxpayer can claim for the Child and Dependent Care Credit is significantly enhanced, but only for 2021. Under the prior law, the credit was limited to your tax liability, meaning if you had no tax liability you did not receive the benefit of this credit. For 2021 only, the credit is fully refundable, so a taxpayer does not need to have a liability to receive the credit amount. There is also a higher limit on the amount of qualifying expenses, now $8,000 for one qualifying dependent or $16,000 for two or more qualifying dependents (essentially, taxpayers will receive a $4,000 credit for one dependent, and $8,000 for two or more qualified dependents). If you file a joint return, both you and your spouse must have at least the same amount of earned income as you have in expenses to qualify for the full credit. The credit percentage was also increased from 35% of eligible expenses to 50% of eligible expenses. The percentage is decreased by 1% for every $2,000 that your adjusted gross income exceeds $125,000. Once the percentage reduces to 20%, it stays there until your adjusted gross income reaches $400,000, when it again reduces by 1% for every $2,000 over that limit.
For taxpayers who receive employer-provided dependent benefits, for 2021 the amount of the maximum income exclusion for these benefits has been increased to $10,500 for most taxpayers, or $5,250 for married taxpayers who file separately from their spouse. This provision basically doubles the amount of the exclusion under the prior law.
Unemployment Income Exclusion
One of the most popular retroactive provisions in ARPA is the exclusion of up to $10,200 of unemployment compensation received during 2020 on a taxpayer’s federal tax return. Many taxpayers were unaware that unemployment compensation was taxable income for federal (and some state) purposes. Since the FFCRA and CARES Act increased the amount of unemployment compensation by $300 to $600 per week, many taxpayers found they had fairly large tax liabilities resulting from their unemployment compensation when they prepared their 2020 tax returns earlier this year.
This new law exempts up to $10,200 of unemployment compensation for many taxpayers ($20,400 for married taxpayers if both received unemployment). Like most of the provisions, the higher your income is, the less likely you will qualify for this benefit. Taxpayers who have over $150,000 will no longer qualify for the exclusion, and this is a “hard” limit, meaning you qualify for the same exclusion under this dollar amount, but do not qualify for any exclusion if you are over it. There is no gentle phase out of the exclusion. But the exclusion’s income limit is based on the return, not the taxpayer, so married taxpayers who are over the $150,000 threshold on a joint return may want to calculate their tax return both as married filing joint and as married filing separate to determine if splitting the income results in a greater tax benefit.
Additionally, the new law extended the additional $300 weekly unemployment benefit by extending the extra unemployment benefit included in previous bills.
For taxpayers who have already filed their 2020 federal tax returns before the exclusion went into place, the IRS has announced that they will automatically recalculate your taxes if you included all of your unemployment compensation as income. As a result, taxpayers who have already filed and would have qualified for the $10,200 exclusion should be receiving refund checks from the IRS. It is not known, at this time, when these refund checks will be issued. Taxpayers who have already filed and who determine that they would have been better off filing separate returns can file
superseding returns (not amended returns) to change their filing status from married filing jointly to married filing separate
if they do so before the extended filing deadline (May 17, 2021). Be warned, however, that once the extended filing deadline has passed, you can no longer change your filing status from joint to separate.
Student Loan Exclusion
The act also includes an expanded exclusion from income of forgiven student loan amounts, applicable to loans discharged after 2020 and before 2026. Under prior law, forgiven loans were only excludable given certain conditions such as the death or disability of the borrower. This expansion allows for the exclusion to apply to any discharge of student loans for any reason during the period and applies to private student loans as well.
Premium Tax Credit Repayments Suspended
The Premium Tax Credit (PTC) saw another change in the law, and these changes are applicable to both 2021 and 2022. The PTC is the healthcare insurance subsidy that many low-income Americans can receive to help them pay for healthcare insurance under the Affordable Care Act (or ACA, also known as Obamacare). ARPA modified the affordability percentage used in calculating the credit under the ACA to make the credit available to individuals with incomes above the 400% of the federal poverty line. For 2021, advanced premium tax credits in the form of insurance premium subsidies are also available for individuals receiving unemployment compensation. These provisions will allow more taxpayers to maintain their health insurance during the pandemic.
Most importantly, for 2020 the Act eliminated the recapture provisions for taxpayers who received too much in premium tax credits (based on their income) and would have had to pay those back when they filed their 2020 federal tax return. The law suspended all the reconciliation requirements, so no taxpayers are required to pay back their PTC amounts for
2020 only.
Like the exclusion or unemployment compensation, many taxpayers may have filed their 2020 federal tax returns already when this provision was implemented in mid-March, and their return would have shown a payback of their PTC. The IRS stated recently that these taxpayers are also not required to file amended returns to eliminate the PTC payback from their tax calculations, as the IRS will review returns already filed and eliminate the payback amount from any outstanding liability. If the taxpayer has already repaid the PTC when they filed, they will receive a refund.
Conclusion
As you can see from these changes, there are several tax benefits which you might want to anticipate before you file your 2021 tax return next year. While this blog only discusses some of the major changes for individuals, there are also many that will impact businesses and employers, such as the expansion of the Paycheck Protection Program and various sick and family leave credits. If you own your own business, you may want to visit the IRS website to review these changes to see if you can benefit from them. While you can generally rely on your tax software to get the numbers right, even that can’t always help. It is very likely that another tax bill may pass before the end of 2021, so stay tuned for further developments!