The American Rescue Plan Act (ARPA), P.L. 117-2, introduced many new tax changes when it was enacted in March. Some retroactively affected 2020 returns, and many more will affect this 2021 tax returns, so now is the time to get ready for next year’s tax filing season.
Economic Impact Payments: ARPA enacted a new round of economic impact payments that were sent to qualifying individuals in 2021. Just like 2020’s two rounds of stimulus payments, the economic impact payments were set up as advance payments of a recovery rebate credit. ARPA created a new Sec. 6428B that provides individuals with a $1,400 recovery rebate credit ($2,800 for married taxpayers filing jointly) plus $1,400 for each dependent (as defined in Sec. 152) for 2021, including college students and qualifying relatives who are claimed as dependents.
- For single taxpayers, the credit and corresponding payment begin to phase out at an adjusted gross income (AGI) of $75,000, and the credit is completely phased out for single taxpayers with an AGI over $80,000.
- For married taxpayers who file jointly, the phaseout begins at an AGI of $150,000 and the credit ends at AGI of $160,000.
- For heads of household, the phaseout begins at an AGI of $112,500 and is complete at AGI of $120,000.
- Children who are claimed as dependents by their parents, or who can be claimed as dependents by their parents, are not eligible individuals for purposes of the 2021 EIP3 payment.
Eligible taxpayers who did not receive a payment can claim a recovery rebate credit on their 2021 tax returns.
Child Tax Credit: ARPA expanded the Sec. 24 child tax credit and provided for advance payments of the credit. Under ARPA,
- The credit is fully refundable for 2021
- 17-year-olds are eligible as qualifying children
- ARPA increased the amount of the credit to $3,000 per child ($3,600 for children under 6)
- The increased credit amount phases out for taxpayers with incomes over $150,000 for married taxpayers filing jointly, $112,500 for heads of household, and $75,000 for others, reducing the expanded portion of the credit by $50 for each $1,000 of income over those limits
- The new law also directs the IRS to automatically pay 50% of the credit in monthly payments beginning July 15
- A new online site is available for taxpayers to check eligibility and opt out of the monthly advance payments
Taxpayers generally have to reconcile the advance payment amount they receive in 2021 with the actual credit amount on their tax return and increase their tax by the excess of the advance payment amount over the actual credit allowed. But taxpayers whose modified AGI for the tax year does not exceed 200% of the applicable income threshold ($60,000 for married taxpayers filing jointly) will have the increase for an excess advance payment reduced by a safe harbor amount of $2,000 per child.
Child and Dependent Care Credit: ARPA made various changes to the Sec. 21 child and dependent care credit, effective for 2021 only, including making it refundable.
- In 2021, the credit is worth 50% of eligible expenses, up to a limit based on income, making the credit worth up to $4,000 for one qualifying individual and up to $8,000 for two or more. Credit reduction starts at household income levels over $125,000. For households with income over $400,000, the credit can be reduced below 20%.
- ARPA also increased the exclusion for employer provided dependent care assistance to $10,500 for 2021.
Premium Tax Credit: ARPA expanded the Sec. 36B premium tax credit for 2021 and 2022 by changing the applicable percentage amounts in Sec. 36B(b)(3)(A). A special rule was added that treats a taxpayer who has received, or has been approved to receive, unemployment compensation for any week beginning during 2021 as an applicable taxpayer.
Unemployment: As the COVID-19 pandemic persists throughout 2021, some taxpayers may continue to receive extended unemployment compensation under ARPA. It would be wise for such taxpayers to withhold taxes from benefits received in 2021 to help avoid owing taxes when they file their 2021 tax return. Federal law allows all recipients to choose to have a flat 10 percent withheld from their benefits to cover part or all of their tax liability. Recipients must fill out Form W-4V, Voluntary Withholding Request, and provide it to the agency paying the benefits if they wish to withhold federal tax from their benefits.
- It is possible that future legislation may allow taxpayers to exclude a similar amount of benefits from their 2021 tax returns, but to err on the side of caution, it is best to withhold taxes to help prevent any surprises when the 2021 federal tax return is due.
Charitable Contributions: Taxpayers may deduct up to $300 of cash contributions per return made to qualified charitable organizations as an above the line deduction if they do not itemize deductions. 20 The Form 1040 instructions clarified that the $300 deduction is per return, by stating, “if you don’t itemize deductions on Schedule A (Form 1040), you (or you and your spouse if filing jointly) can take a charitable deduction of up to $300 for cash contributions made in 2020 to organizations that are religious, charitable, educational, scientific, or literary in purpose.” This provision applies to tax years beginning after December 31, 2019.
- The CAA 2021 extends the $300 above-the-line deduction through 2021.
- The maximum deduction amount is increased to $600 for married filing joint taxpayers beginning in 2021
Tax Extenders – Consolidated Appropriations Act of 2021 (CAA 2021)
Business Meals Deduction: The CAA 2021 temporarily increases the 50-percent limit on the business meals deduction to 100 percent. To qualify for the increased deduction, expenses must be paid or incurred in 2021 and 2022 for business meal food and beverage expenses, including delivery and carry-out meals, provided by a restaurant.
Medical Expense Deduction: The 7.5-percent-of-AGI threshold was in place for tax years 2017, 2018, and 2019. The medical expense deduction floor was set to increase to 10 percent of AGI in 2020 prior to the passage of TCDTRA. The TCDTRA makes the 7.5-percent-of-AGI threshold for the medical expense deduction floor permanent for itemizers claiming unreimbursed medical expenses. This provision is applicable for tax years beginning after December 31, 2020.
Residence indebtedness: The TCDTRA extends the exclusion from gross income of discharge of qualified principal residence indebtedness through 2025. It also reduces the maximum exclusion amount from $2,000,000 to $750,000 (for married filing jointly filers).
Lifetime Learning Credit: The TCDTRA repeals the deduction for qualified tuition and related expenses and increases the income limitation phase-out range for the Lifetime Learning Credit. Starting in tax year 2021, the Lifetime Learning Credit phase-out range will increase to 80,000-$90,000 for single filers, and $160,000-$180,000 for joint filers, the same phase-out ranges as the American Opportunity Tax Credit.
Educator Expense Above-the-Line Deduction:
- For purposes of the $250 educator above-the-line deduction, the CAA 2021 expands eligible educator expenses to include personal protective equipment, disinfectant, and other supplies used for the prevention of the spread of COVID-19.
- The Tax Cuts and Jobs Act of 2017 (the Act) significantly changed the exclusion for years 2018-2025.
- The gift tax applicable exclusion amount for gifts made in 2021, estate tax applicable exclusion amount for decedents dying in 2021, and generation-skipping transfers made in 2021 is indexed to $11,700,000.