14 Changes for The 2021 Tax Year

A lot of changes have happened in the past couple of years. It could have been either because of the pandemic or because of technological advancements. Tax laws are no exception.

The pandemic was financially tough on everyone. Hence, the US government introduced changes that were applicable to the 2021 tax year that helped people ease their financial burden. They include refunds, deductions, and exemptions.

Here is an overview of tax changes for the tax year 2021 that you need to keep in mind while filing:

1. Tax rates and thresholds for 2021- The seven brackets remain the same, but the threshold has increased for the tax year 2021.

The thresholds change for the tax year 2022 as well. The same will not apply when you file next year.

2. Long Term Capital Gains Tax Rates– If you have held an asset for more than a year, then you will owe one of three tax rates depending on your total income.

Since the thresholds are adjusted according to inflation, they are again different for the tax year 2022.

Short-term capital gains do not have a separate tax rate; they are taxed at the same rate as your income. So their tax rate depends on your overall income and your filing status.

3. Standard Deductions– It is the portion of your income that is not subject to tax. You can use this to reduce the amount of tax you owe. This is applicable only if you do not itemize your deductions. The IRS has set the standard deductions for 2021 according to inflation as follows:

There is an additional standard deduction of $1,350 for an aged (65 and over) or a blind individual.

4. Tax on Federal Unemployment Benefits–There was a temporary change in rules in 2020 wherein those who received unemployment benefits were also eligible for a huge tax break. This was a part of the $1.9 trillion stimulus package which was signed as pandemic-related relief. Those who received benefits did not need to pay taxes for up to $10,200 received in benefits.

This tax break does NOT apply to the 2021 year. So if you received this huge tax break last year, you will not receive it this year. All unemployment benefits that you received in the 2021 tax year will be fully taxable without any exclusion. If you did not arrange for taxes to be withheld upfront, then you will owe the IRS some tax when you file the 2021 return.

5. Earned Income Tax Credit– Lower-income taxpayers can reduce the amount of tax paid on a dollar-for-dollar basis by claiming this credit. Since this is a refundable credit, you can get a refund even if your tax bill is $0 and have no tax liability for the tax year.

The two criteria that you must meet are:

• you cannot be claimed as a dependent or a qualifying child on someone else’s returns
• you need to have lived in the US for more than half of 2021.

The maximum Earned Income Credit amount increased to $6,728 for qualifying taxpayers who have three or more qualifying children, up from a total of $6,660 for the tax year 2020. For the tax year 2021, you can claim the EITC even if you do not have any qualifying children.

One crucial change for the tax year 2021 and beyond is that you can claim the EITC as long as your investment income does not exceed $10,000.

6. Alternative Minimum Tax– It applies to higher-income taxpayers wherein it limits the tax breaks they can take and makes sure that they pay a minimum amount regardless of the tax breaks. These taxpayers need to calculate their tax liability twice-once under regular income tax, and once under AMT rules. They then will have to pay the higher amount.

Incomes above the exemption amounts trigger the AMT. Two rates apply here – 26% and 28% (which rate you pay depends on how high your AMT taxable income is).

For 2021, the exemption amount for single filers is $73,600 and the income at which exemption begins to phase out is $523,600.

The exemption amount for those married filing jointly is $114,600 and the income at which exemption begins to phase out is $1,047,200.

7. IRA contribution limits– The limit up to which contributions to an IRA can be deducted is at $6,000 for the year 2021. Those aged 50 and above can contribute an additional $1,000.

In the case of a traditional IRA, if you are an active participant in an employer retirement plan, the deduction phase-out for AGI is between $66,000 and $76,000 for single individuals, and between $105,000 and $125,000 for joint returns.

For Roth IRA, the 2021 income phase-out has been increased to AGI between $125,000 and $140,000 for single filers, and between $198,000 and $208,000 for those filing joint returns.

8. Health savings accounts- It helps pay for expenses that are not covered in your insurance. Healthcare costs increase at a rate faster than inflation does. This means that out-of-pocket expenditure on health will be more. So an increase in HAS contribution limit, no matter how small, will count. The annual limit on HSA contributions for 2021 is $3,600 for self-only and $7,200 for family coverage. That is a 1.5% increase from 2020. The increase is modest keeping the pandemic in mind.

HAS contribution can be made until tax filing da. The 2021 HSA contribution deadline is April 15, 2022. But, you can only make contributions for the months you were eligible to contribute.

9. Child Tax Credit– The CTC witnessed a very significant change. The CTC was increased from $2,000 to:

• $3,600 for children aged 6 and under at the end of 2021.
• $3,000 for children aged 6 to 17 at the end of 2021.

The IRS also started to send out half the credit as advance monthly payments of $300 per month for each child under 6, and $250 for each child aged 6-17.

The Advance CTC payments are not to be counted as income. But, if you receive more than you are eligible for, then you will owe the IRS the excess amount that you received. And if you did not receive the payments at all, you can claim them while filing.

10. Child and dependent care credit– It allow families to claim expenses related to the care of a child or a dependent who is physically or mentally unable to care for themselves. For 2021 taxes, families may now claim a refundable credit of up to 50% of qualifying expenses, meaning they could claim a maximum credit of:

• $4,000 for one qualifying child/dependent (based on $8,000 of expenses)
• $8,000 for two or more qualifying children/dependents (based on $16,000 of expenses)

11. Required minimum distributions– Once the taxpayer reaches the age of 72, the IRS requires you to start withdrawing money annually from traditional IRAs and 401(k)s. The withdrawals are made mandatory so that taxpayers do not use them to avoid paying taxes. These are called RMDs. The CARES Act put a temporary stop to the mandatory withdrawals in 2020, but they are now back in effect for 2021. If you fail to withdraw, you will be charged with a 50% tax on the amount you were supposed to withdraw.
12. Charitable contributions– Earlier, you could deduct charitable contributions only if you itemized your deductions. In 2021, even if you do not itemize, to encourage charitable contributions the government allows a $300 per person deduction. If you do itemize your deductions, the CARES Act now allows you to deduct up to 100% of your AGI in 2021 (only 60% earlier).
13. Tax-free student loan forgiveness– Earlier, student loan forgiveness was considered taxable income. Although you did not have to pay the loan back, the IRS did charge a hefty tax bill. However, in 2021, loan forgiveness is not considered taxable.
14. Foreign Earned Income Exclusion- It is intended to prevent double taxation by excluding income that is taxed in another country. For 2021, the maximum FEIE is the lesser of the foreign income earned or $108,700 per qualifying person.

Keeping all these changes in mind while filing your taxes is a herculean task. It is advised that you take the help of a CFO consulting service to help you navigate the filing process.