Key Tax Law Changes for Tax Year 2021 (Part 1)

1. The Consolidated Appropriations Act, 2021:

At the end of 2020, the Consolidated Appropriations Act, 2021 became law. With its passage, several included tax provisions will affect how Americans prepare their taxes for at least one more year.

The package includes many extensions of expiring deductions and credits, extensions, and expansions of certain tax relief provisions provided as part of the national response to the pandemic and various disaster tax relief provisions.

Among the many included items, the law provides:

·    $600 advance payments of a tax credit per taxpayer ($1,200 for married filing jointly) plus $600 for each qualifying child. The credit, like the first stimulus checks, phases out starting at $75,000 of modified adjusted gross income ($112,500 for heads of household and $150,000 for married filing jointly)

·    an extension of the ability for businesses to deduct 100% of certain meal expenses

·    a clarification that personal protective equipment is a deductible expense for qualified teachers as part of the $250 qualified educator tax deduction

·    an extension of the $300 deduction for cash charitable deductions if you claim the standard deduction. For 2021, the deduction is increased to $600 for joint filers.

·    clarification that gross income will not include an amount equal to any forgiven amount of a Paycheck Protection Program (PPP) loan and that expenses paid with forgiven PPP loans are fully deductible.

2. Adjustments for inflation:

As the prices of the goods and services we buy gradually go up over time, typically, so do our incomes. If the income tax system did not account for this expected change, income taxes would often grow at a faster rate than incomes, likely causing unexpected financial stress. The income taxes assessed in 2021 are no different. Income tax brackets, eligibility for certain tax deductions and credits, and the standard deduction will all adjust to reflect inflation.

For most married couples filing jointly, their standard deduction will rise to $25,100, up $300 from the prior year. For most single taxpayers and married individuals filing separately, the standard deduction rises to $12,550, or half that of married filers. Most taxpayers filing as head of household will see their standard deduction increase to $18,800. See Standard Deductions Later.

3. Planned tax increases for 2021:

As mentioned previously, income tax brackets, eligibility for certain deductions and credits, and the standard deduction will all see increases in 2021 on account of inflation. One change made since the Tax Cuts and Jobs Act became law, though, is how the tax code calculates inflation.

Namely, instead of tying inflation to the traditional consumer price index, tax reform now measures inflation using something called “chained” CPI.

Essentially, this new figure measures inflation in a different, often slower way that accounts for consumers’ tendency to shy away from items that undergo a large price increase. For taxpayers, this means they could more easily get pushed into a higher marginal tax bracket than before tax reform because of cost-of-living paycheck increases or annual raises that outpace the chained CPI.

4. Deductions and credits phaseout adjustments:

In line with the adjustments for inflation, many tax deductions and tax credits will have their phaseouts adjusted to account for these changes. Some phaseout changes to note are:

·    Earned Income Tax Credit: The maximum credit for filing jointly as a married couple and claiming three or more qualifying dependents amounts to $6,728 in 2021, with the credit completely phased out at $57,414 of adjusted gross income (AGI). If you are a single filer with no dependents, you can receive a maximum credit of $1,502 with your phaseout beginning at $11,610 of AGI.

·    The Alternative Minimum Tax: Higher exemptions and income phaseouts will occur in 2021.

·    IRA contributions: Contribution amounts remain the same in 2021, but phaseout levels for taking deductions for these contributions increase as follows:

·    For active participants in employer retirement plans, phaseout for making individual retirement account (IRA) contributions will occur at AGIs between $66,000 and $76,000 for single and head of household filers, $105,000 and $125,000 for joint returns

·    For those with IRAs who do not actively participate in another plan but their spouse does, phaseout will now range from $198,000 to $208,000 for those that are married and filing a joint return. For a married individual filing separately, the phase-out range is not subject to an annual cost-of-living adjustment and remains between $0 to $10,000.

·    Phaseouts do not apply if neither the taxpayer nor the spouse has a workplace retirement plan

5. Planned changes to the alternative minimum tax:

Congress designed the Alternative Minimum Tax (AMT) to keep wealthy taxpayers from using too many tax credits, deductions, and other loopholes to avoid paying taxes.

Because the AMT’s exemptions did not automatically update for inflation, an increasing number of middle-income taxpayers got hit with the AMT until a permanent, annual update got put in place starting in 2013. Now, the AMT exemption amount automatically adjusts with inflation, allowing many taxpayers to avoid the tax.

In 2020, the exemption amount came to $72,900 and began to phase out at $518,400 ($113,400 for married couples filing jointly for whom the exemption began to phase out at $1,036,800).

In 2021, these amounts will change to $73,600 with phase-out beginning at $523,600 ($114,600 for married couples filing jointly with a phase-out beginning at $1,047,200), respectively.