Changing tax laws can be confusing in the best of times. Add on the complications brought about by COVID-19? Suddenly everything is even more complicated.
But there’s no need to sift through endless information online to figure out which tax updates will be relevant to you — we’ve gathered the top seven 2021 tax changes that most taxpayers should know about before filing next year.
So, how did taxes change this year, and how might these new tax laws affect your 2021 tax refund? Let’s go through some of the main events to help you save as much money as possible.
1. The Child Tax Credit increase and advance monthly payments
If you’re a parent, don’t forget about the advance monthly Child Tax Credit (CTC) payments. Instead of receiving the credit in one lump sum, many families received part of their 2021 CTC in six monthly installments from July through December and will claim the remaining portion of their credit when filing their 2021 taxes.
In January 2022, the IRS will send you Letter 6419 to provide the total amount of advance Child Tax Credit payments that were disbursed to you during 2021. Make sure you keep this letter with your tax records! You may need to refer to it when you file your 2021 tax return.
This year’s CTC was also higher than normal years with the 2021 tax credit increasing to $3,000 per child (up from $2,000 previously) or as much as $3,600 for children ages 5 years old or younger. Credit amounts are based on income, so if your income is above the IRS thresholds, the extra credit amount you qualify for will begin to phase out. If you’re curious how much of the Child Tax Credit you will receive come tax time, check out our informative article providing several common scenarios.
2. Expansion of the $300 charitable contribution deduction for joint filers
Turns out being generous pays this year. In the past this tax break was typically only available for those who itemized their tax deductions. The CARES Act changed that in 2020, allowing those who took the standard deduction to write off their cash charitable contributions as well.
Like last year, single filers can still claim a maximum tax deduction of $300 for cash contributions made to qualified public charities. The biggest tax change comes for married couples filing jointly, who can now deduct up to $600 ($300 per person) on their 2021 tax return.
3. Unemployment benefits no longer tax-free in 2021
Many Americans who collected unemployment payments last year received a huge tax break after Congress passed the American Rescue Plan on March 11, 2021. Under this law, the unemployment exclusion was calculated on a per-person basis — married taxpayers could claim up to $10,200 each if they both received unemployed benefits and their modified adjusted gross income (MAGI) was under $150k.
If you’re wondering about tax changes for 2021 unemployment, just remember this was a temporary change for 2020. If you and/or your spouse continued to collect unemployment benefits in 2021 you should not expect to receive the same tax break this year.
4. Forgiven Paycheck Protection Program loans are tax-exempt
Part of the CARES Act, the Paycheck Protection Program (PPP) provided low-interest loans for small businesses and self-employed individuals. As long as you met the criteria and used the loan funds to pay for qualified expenses (such as payroll costs, interest on mortgages, rent, and utilities), your PPP loan would be fully forgiven.
But how will forgiven PPP loans affect your taxes? Normally, forgiven loans are considered taxable income, but the good news is the IRS provided an exemption for these in 2021. This means the amount of any forgiven PPP loans you have will not be included in your gross income. And here’s an added bonus: All expenses you paid with forgiven PPP loan funds are fully deductible in 2021 as well!
If you have any other questions about PPP loans, we put together a helpful FAQ page with some answers for you.
5. Threshold permanently lowered for Medical Expense Deduction
When it comes to 2021 tax deduction changes, itemizers with high medical costs will be pleased to know that the threshold for deducting medical expenses was permanently lowered to 7.5 percent of your 2021 adjusted gross income (AGI). The threshold used to be 10 percent before it was temporarily lowered, and then permanently lowered in December 2020 thanks to stimulus relief legislation.
So, what does this mean? As an example, let’s say you itemize your deductions and your AGI for 2021 is $50,000. The medical expense deduction allows you to deduct anything beyond the first 7.5 percent of your adjusted gross income — in this case, that would be $3,750. Meaning, if you had $9,000 worth of medical bills, you could claim a deduction of $5,250.
6. Tax inflation adjustments to standard deduction and more
The IRS automatically adjusts many tax numbers for inflation every year, and it’s always a good idea to stay up to date on new exclusion rates, maximum contribution amounts, and income thresholds. The pandemic has no doubt affected our economy, and several tax changes were introduced for 2021 to accommodate this inflation.
For example, the standard deduction increased by $300 to $25,100 for married couples who file jointly and by $150 to $12,550 and $18,800 for single and head-of-household filers, respectively. The standard deduction effectively reduces your income, meaning you will pay less in income taxes. Because of this, it’s essential that this number is connected with inflation.
More notable changes include:
- The tax year 2021 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 tax year 2020 (we’ll go into more EITC changes in a bit).
- The IRS adjusts the income thresholds for capital gains tax rates every year for inflation; you can compare the 2020 and 2021 tax rates for long-term capital gains
- The The Lifetime Learning Credit is worth up to $2,000 and there is no limit on the number of years the credit can be claimed.
- The Adoption Credit also increased. The maximum credit allowed for adoptions for 2021 is the amount of qualified adoption expenses up to $14,440, an increase from $14,300 for 2020.
For more information on all of the 2021 tax adjustments due to inflation, you can check out the IRS’s detailed article about it.
7. Expansion of the Earned Income Credit for 2021 and future years
As long as you meet the IRS income requirements, you may be able to claim the Earned Income Tax Credit (EITC) for 2021, even if you do not have any qualifying children. To qualify for the credit, you must meet the following conditions:
- You need to have lived in the United States for more than half of 2021
- You cannot be claimed as a dependent or qualifying child on someone else’s tax return
There is not a maximum age limit to claim this tax credit, but you must meet the following minimum age requirements depending on your situation:
- You must be at least 24 if you were a student for at least five months in 2021
- You must be at least 18 if you were in foster care any time after turning 14 or if you were ever homeless in any taxable year
- You must be at least 19 in all other circumstances
There are a few more EITC changes you should know about for 2021 and beyond. For instance, the IRS increased its limit for investment income — you can now claim the Earned Income Credit as long as your investment income does not exceed $10,000.
If you are married but separate, you do not have to file a joint return to qualify for the Earned Income Credit as long as you live with your qualifying child for more than half the year. You must also meet one of the following requirements:
- You did not live with your spouse for at least the last six months of 2021; or
- you are legally separated under your state’s laws with either a written separation agreement or a decree of separate maintenance and also weren’t living with your spouse at the end of 2021
What HASN’T changed for 2021?
Sometimes it’s also helpful to go over what tax laws have stayed the same compared to last year, so we’ve covered a few topics you might be wondering about.
- There is still no limit on itemized deductions you can claim for 2021.
- Marginal tax rates did not change (the IRS has a helpful list of marginal income tax rates for 2021 if you need a refresher on what the tax brackets for 2021 look like).
- The gift tax exclusion remains the same at $15,000 (spoiler alert — it will be increasing to $16,000 for tax year 2022).
- Student loan forbearance is still in effect through May 1, 2022.
- The monthly limit for qualified transportation fringe benefits is still $270.
Keep tax changes for the 2021 tax year in mind
Due to the pandemic, the 2020 tax year was an outlier in many ways. Several new tax benefits you may have received last year will no longer apply in 2021, while other benefits have been expanded and extended into the current tax season.
Nobody likes surprises when it comes to filing taxes, so remember to keep these federal tax law changes for 2021 in mind to ensure you’re adequately prepared.