Let The Wealth Defender guide you through the complex new tax regulations.
The world has been topsy-turvy for more than a year — and the tax world isn't any different.
Due to a slew of income disruptions, government interventions, and law changes, 2021 will be a year like no other when it comes to taxes. This article will discuss many of those changes, provide some considerations for lowering your taxes, and then conclude with a rousing collection of important numbers for this year, including tax brackets, retirement account limitations, the standard deduction, and more. So read on, Fool!
Take Some Extra Time to File...Maybe
Good news, procrastinators! The IRS has announced that the deadline for filing a tax return and making any associated payments has been moved from the usual April 15 to May 17. While it was framed as a way to help Americans still struggling through the coronavirus crisis, the truth is that the IRS is overwhelmed.
Last year, the IRS was forced to close its processing centers and then reopen them with limited staff. As of the end of 2020, 13 million 2019 paper returns had still not been processed, according to the Government Accountability Office. On Jan. 15, the agency announced that the official start of tax season, which usually kicks off toward the end of January, would be pushed back to Feb. 12.
On top of the usual workload, the IRS has also been tasked with sending out stimulus checks, the third round of which were recently delivered thanks to the American Rescue Plan (more on that later). So, to make this tax season easier on all involved, the deadline has been moved to May.
The additional good news is that May 17 is also now the deadline for contributing to an IRA, Health Savings Account, or Coverdell Education Savings Account for 2020. The not-as-good-news is that if you pay estimated quarterly taxes, the due date for the first-quarter payment is still April 15.
Most states have also extended their filing deadlines, but check the website of your state's tax agency to get an update on the latest local developments. Note that earlier this year, the IRS announced that it had extended the federal filing deadline to June 15 for residents of Louisiana, Oklahoma, and Texas as relief for victims of the storms in February. That later deadline is still in place for those who live in those states.
The IRS is urging taxpayers to file electronic returns. If you're due a refund, you'll get it sooner. And you won't risk your return sitting in a warehouse for months (though if you owe money, I suppose that's a way to hopefully delay the time it takes for the IRS to cash your check).
As always, if you need more time, you can get an extension by filing Form 4868 through your accountant, tax-prep software, or the IRS free e-file service. Note that you still have to file the form and pay any estimated taxes that you owe by May 17, so it does take a bit of effort. But then you have until Oct. 15 to file your full return. What if you underestimated the amount you owed when you filed for the extension? You may then owe interest and penalties, so it's better to overestimate and get the difference back as a refund.
The decision of exactly when to file is a bit trickier this year, thanks to the $1.9 trillion bill signed into law on March 11, which is why you should...
Get to Know the American Rescue Plan Act of 2021
The final version of the bill was hundreds of pages long, so this article will only hit a few of the highlights. What's most important to know is that your eligibility for many of the tax breaks will be based on your 2021 taxes.
As an example, let's start with the so-called stimulus "checks" (most of which are actually electronically deposited). The amount a household could receive is $1,400 per each adult and dependent (not just children 16 and under, as was the case with the previous payments). However, the amount begins to be reduced, and eventually eliminated, according to phaseout ranges based on adjusted gross income (AGI) and filing status. Those phaseout ranges are:
Single filers and married filing separately: $75,000 to $80,000
Head of household: $112,500 to $120,000
Married filing jointly: $150,000 to $160,000
These payments are technically advanced credits on your 2021 tax return, which of course you won't file until sometime in 2022. But in order to get the money out sooner, the IRS will base the payments on your 2020 return if it has been filed; if not, your eligibility will be based on your 2019 return.
Thus, if you'd be eligible for the payment based on your 2019 return but not on your 2020 return, don't be in a hurry to file this year (ideally not until you've received a payment). On the other hand, if you wouldn't be eligible based on 2019 income but would be based on 2020 income — or your 2020 income would qualify you for a larger payment — file your taxes ASAP. To get your payment this year, you need to file by what the Act is calling the "additional payment determination date," which is the earlier of:
90 days after the 2020 calendar year filing deadline (currently Aug. 15, but it would change if the tax-filing deadline gets pushed back further); or
Sept. 1, 2021.
What if your 2021 taxes would have made you ineligible but you received a payment based on your 2019 or 2020 tax return? Don't worry about it; the IRS isn't going to ask for the money back.
Now, what if you're not eligible based on your 2019 and 2020 returns but your 2021 AGI ends up being below the phaseout thresholds? You'll get the payment as a credit on your return when you file in 2022. So if you didn't get a payment based on past income — or you received just a partial payment — but your 2021 income is close to the phaseouts, consider taking steps to lower your adjusted gross income, such as contributing to a traditional 401(k), a deductible traditional IRA, or a health savings account; selling underwater investments in non-retirement accounts for a tax loss (make sure you don't buy the investments back for at least 30 days); making qualified charitable contributions; deferring income to 2022; or, if retired, taking distributions from a Roth account instead of a traditional account.
The same principle applies to many of the other potential tax breaks in the American Rescue Plan. Here's a sampling.
An expanded child credit: The tax credit for children ages 6 to 17 (yes, 17-year-olds are now eligible, unlike in past years) has been increased to $3,000 per child, while the credit for kiddos 5 and younger will be boosted to $3,600. Both of those are increases over the existing $2,000 credit. For the purposes of the credit, the age of the child is her or his age as of Dec. 31, 2021.
However, these credits will phase out at a rate of $50 for every $1,000 of income above the following thresholds:
Single filers: $75,000
Head of household: $112,500
Joint filers: $150,000
Those phaseouts are just for the additional credit above the regularly scheduled $2,000, which begins to be phased out at an AGI of $200,000 for single filers and $400,000 for married folks filing jointly.
The American Rescue Plan makes child tax credit fully refundable, which means that if the credit wipes out a family's tax bill and then some, the extra will be sent to the family as an additional payment. For example, if a family's tax bill is $7,000, but their child tax credit is $9,000 thanks to having three kids between the ages of 6 and 17, Uncle Sam will send them the difference (i.e., $2,000).
Another notable provision is that the Act directs the IRS to create a method by July that will allow families to receive an advance of half of their credit as a series of payments. However, if a family receives an advanced credit that is larger than what they should have received based on their 2021 AGI, they will have to pay back the excess when they file in 2022 if their AGI is above yet another phaseout range ($40,000 to $80,000 for single filers, $60,000 to $120,000 for married joint filers).
An expanded dependent-care credit: Previously, the largest credit you could receive for paying for qualifying dependent-care expenses was $1,050 for one child and $2,100 for two or more. However, the American Rescue Plan increases those potential credits to $4,000 and $8,000, respectively.
This formula isn't as simple as "pay $1,000 in expenses, get a $1,000 credit." It's based on a somewhat complicated formula that you should investigate further if you think you may be eligible. That is, unless your AGI is above $440,000 (single or married); at that point, you'll be unable to claim the credit. Also, you can't claim the credit and use money in your flexible-spending account for the same expenses.
Partial unemployment compensation exemption: Up to $10,200 of unemployment income, per person, will be tax-free if the household's AGI is below $150,000 (single or married). There's no phaseout for this. If your AGI is $149,999, up to $10,200 won't be taxed; earn a dollar more, and that entire $10,200 becomes taxable. Also, this is one of the few provisions of the bill that applies to both 2020 and 2021. (The IRS is investigating ways to return excess payments to those who already filed their 2020 returns; they are strongly discouraging eligible taxpayers from filing amended returns at this time.)
And much more!
The aforementioned are just a few of the provisions of the American Rescue Plan. Dig deeper into the Act if you own a business, could be eligible for the earned income credit, have student debt that is forgiven, are receiving unemployment benefits, or have health insurance through COBRA or the Affordable Care Act. Consult a tax professional to determine whether you should take steps this year to lower your AGI or, if married, file separately.
For more information, check out these resources:
The American Rescue Plan Act Of 2021: Tax Credits, Stimulus Checks, And More That Advisors Need to Know! (Kitces.com)
Tax Tips: American Rescue Plan Act of 2021 individual tax changes summary by year (IRS Taxpayer Advocate Service)
Coronavirus Tax Relief (IRS)
Also, these tools will help track payments and estimate whether you're eligible for credits. You may be required to enter your adjusted gross income, which can be found on line 11 of the 2020 federal 1040 and on line 8b of the 2019 1040.
Get My Payment (IRS, for stimulus payments)
Refund Status (IRS, for tax refunds)
Stimulus Check Calculator (TurboTax)
Child Tax Credit Calculator (Kiplinger's)
Health Insurance Marketplace Calculator (Kaiser Family Foundation)
Consider Bulking Up Your Roth Assets
As you may know, Uncle Sam owes a lot of money. He was already deeply in hock before the pandemic panic, but it's just gotten worse since then. Add all that debt to the unfunded liabilities embedded in the Social Security, Medicare, and Medicaid systems, and you can understand why many experts believe future tax rates will have to be higher.
After all, we're currently paying taxes at rates that are historically on the low side.
In fact, the lower tax rates instituted by the Tax Cuts and Jobs Act of 2017 will expire at the end of 2025 unless Congress acts before then.
One way to hedge against these higher rates taking a bite of your retirement is by increasing the amount you have in Roth accounts — the distributions from which are tax-free as long as you follow the rules.
To Roth or not to Roth is a question of when you want a tax break. Contributing a Roth account means you're going to pay more taxes this year in exchange for lower taxes in retirement. The same if you choose to convert a traditional retirement account to a Roth, as the converted amount gets added to your taxable income (unless you're converting a non-deductible traditional account, as via a backdoor Roth conversion). This is especially important to remember in 2021, since — as we've already explained — a higher AGI could make you ineligible for the credits available in the American Rescue Plan.
But for many investors, paying higher taxes this year in exchange for tax-free withdrawals from Roth accounts in retirement is the right move.
The internet is full of tools that can help break the decision down to actual numbers .However, most of these tools make a very important — and perhaps unrealistic — assumption: The tax savings realized this year by contributing to a traditional account are invested for retirement. If you instead spend those savings, you may have been better off with the Roth, at least as far as which choice provides the most after-tax income in retirement.
Plus, Roth IRAs have an additional benefit: no required minimum distributions at age 72.
Finally, keep in mind that this isn't an either/or decision. You may be able to contribute to both types of accounts, as long as those contributions combined don't exceed the annual limits for 401(k)s or IRAs.
4. Practice Smart Asset "Location"
Let's say you've decided to add a new investment or two to your portfolio. But now you're confronted with another decision: In which account should you buy it? You might have a regular, taxable brokerage account, as well as both traditional and Roth retirement accounts.
Making smart decisions about where to put your investments — known as asset location — could increase your after-tax wealth by 15%, according to some studies. The key is to understand the tax advantages of different accounts, as well as the tax characteristics of different investments.
Generally, use your Roth accounts for investments with the highest growth potential, particularly if they also pay a dividend. Use your traditional accounts for tax-inefficient investments with medium growth potential, such as high-yielding blue chip stocks or actively managed mutual funds. Use your taxable brokerage accounts for stocks that pay little to no dividends and that you plan to hold for the very long term.
Once you retire, if you plan to invest in dividend-paying stocks for the income, it makes sense to hold them outside of a traditional retirement account to take advantage of the lower tax rate on qualified dividends.
Harvest Capital Gains
Are you single and will have less than $40,400 in taxable income — that is, gross income minus deductions — this year? Or married and will have less than $80,800? Then I have good news: You won't pay any taxes on long-term capital gains, at least up to a point. Just sell the investment and take the profits. You can even immediately buy back the investment; the 30-day wash-sale rule applies only to capital losses, not to gains. This will give you a tax-free stepped-up cost basis, which you'll appreciate if you're in a higher tax bracket or if capital-gains tax rates are higher when you sell in the future.
You see, taxpayers below the aforementioned income thresholds don't pay taxes on long-term capital gains or qualified dividends. (Short-term gains are still taxed as ordinary income.) Remember, we're talking about taxable income — in other words, gross income minus all the adjustments and deductions. So many taxpayers may be closer to 0% long-term capital gains taxes than they think.
Just know that the capital gains themselves will increase your taxable income, which could tip you into the next capital-gains tax bracket. But that's not as bad as it may sound. The long-term gains up to that point still enjoy the 0% tax rate; only the long-term gains that crept into the next tax bracket will be taxed at 15%.
Important Tax Numbers for 2021
Standard Deduction
Single: $12,550
Married filing jointly: $25,100
Head of household/married filing separately: $18,800
2021 Tax Brackets
Your tax bracket is determined by your taxable income, which is your gross income minus adjustments and deductions.
Marginal Tax Bracket | Single Filers | Married Filing Jointly | Head of Household
Married Filing Separately
10%
$0-$9,950
$0-$19,900
$0-$14,200
$0-$9,950
12%
$9,950-$40,525
$19,900-$81,050
$14,200-$54,200
$9,950-$40,525
22%
$40,525-$86,375
$81,050-$172,750
$54,200-$86,350
$40,525-$86,375
24%
$86,375-$164,925
$172,750-$329,850
$86,350-$164,900
$86,375-$164,925
32%
$164,925-$209,425
$329,850-$418,850
$164,900-$209,400
$164,925-$209,425
35%
$209,425-$523,600
$418,850-$628,300
$209,400-$523,600
$209,425-$314,150
37%
Greater than $523,600
Greater than $628,301
Greater than $523,600
Greater than $314,150
2021 Long-Term Capital Gains and Qualified Dividends Tax Brackets
Capital gains that result from selling an asset you owned for a year or less will be treated as a short-term gain and will be taxable according to the tax brackets listed earlier. But long-term gains that result from sales of assets held for over a year get a preferential tax treatment, as do qualified dividends. In 2021, those brackets are the following:
Long-Term Capital Gains/Qualified Dividends Tax Rate
Single Filers (Taxable Income)
Married Filing Jointly
Heads of Household
Married Filing Separately
0%
$0-$40,400
$0-$80,800
$0-$54,100
$0-$40,400
15%
$40,401-$445,850
$80,801-$501,600
$54,101-$473,750
$40,401-$250,800
20%
$445,851 or more
$501,601 or more
$473,751 or more
$250,801 or more
Note that the figures represent taxable income, not just capital gains and/or dividends.
IRA Income Phaseout Ranges
IRA contribution limits for traditional and Roth accounts in 2021 will be the same as 2020's. If you're under 50, you can put in up to $6,000 in 2021. If you're 50 or older, you get a $1,000 catch-up that raises this limit to $7,000.
That said, the income phaseout limits (based on modified adjusted gross income) for contributing to a Roth IRA have increased for 2021:
Single or head of household: $125,000 to $140,000
Married filing jointly: $198,000 to $208,000
Married filing separately: $0 to $10,000
While there are no income limits for contributing to a traditional IRA, there are income limits for tax-deductible contributions if you're covered by another workplace plan like a 401(k). In 2021, these limits are:
$76,000 for single filers and heads of household
$125,000 for married couples filing jointly
$10,000 for married couples filing separately
If you don't have a workplace retirement savings plan but your spouse does, these income limits will apply:
$206,000 for married couples filing jointly
$10,000 for married couples filing separately
Retirement Account Contribution Limits
Account Type
2021 Contribution Limit: Under 50
2021 Contribution Limit: 50 and Over
Traditional or Roth IRA
$6,000
$7,000
Traditional or Roth 401(k)
$19,500
$26,000
SIMPLE IRA
$13,500
$16,500
SEP IRA
$58,000
$58,000
Solo 401(k)
$58,000
$64,500