As the 2022 filing season rapidly approaches, taxpayers should be aware of federal tax law changes and updates that will affect individual 2021 income tax returns. For the 2021 tax year, tax rates remained the same; however, the federal government made certain changes to the income tax brackets to account for inflation.
Standard Deductions in 2021
The IRS also released new standard deductions for 2021 to adjust for inflation.
Health Savings Accounts
The IRS also announced new contribution limits to Health Savings Accounts (HSA) for 2021. It increased amounts to adjust for inflation.
Child Tax Credit
The American Rescue Plan (ARP), which was enacted March 2021, provides a dramatic, one-year expansion of the child tax credit for the 2021 tax year. One of the biggest changes is to the amount of the credit. For 2021, it jumps from $2,000 to $3,000 per child and $3,600 for a child under age 6. The extra amount ($1,000 or $1,600) is reduced – potentially to zero – for families with higher incomes.
For taxpayers filing their income tax return as a single person, the extra amount phases-out if their adjusted gross income is above $75,000. The phase-out begins at $112,500 for head-of-household filers and $150,000 for married couples filing a joint income tax return. The credit amount is further reduced under the pre-existing $200,000/$400,000 phase-out rules.
Child and Dependent Care Tax Credit
The ARP also made significant improvements to the child and dependent care credit. But, again, the changes only apply to the 2021 tax year. For 2021, the child and dependent care credit is fully refundable. The maximum credit percentage also jumps from 35% to 50%. More child and dependent care expenses are available for the credit as well.
For 2021, the credit is allowed for up to $8,000 in expenses for one child/disabled person and $16,000 for more than one child/disabled person. When the 50% maximum credit percentage is applied, the top credit for the 2021 tax year is $4,000 families with just one child/disabled person and $8,000 for families with more than one child.
The Taxpayer Certainty and Disaster Tax Relief Act of 2020, enacted last December, provides several provisions to help individuals and businesses who give to charity. The new law extends, through the end of 2021, four temporary tax changes originally enacted by the Coronavirus Aid, Relief, and Economic Security (CARES) Act. Here is a rundown of these change
• A $300 charitable contribution deduction for single filing taxpayers and $600 for Married Filing Jointly taxpayers who take Standard Deduction.
• The 100% adjusted gross income limit on cash contributions by individuals was extended to 2021.
• For corporations, the taxable income limit increased from 10% to 25% on cash charitable contributions.
• The taxable income limit on contributions of food inventory increased from 15% to 25%.
Noncash property and contributions, carried forward from prior years, do not qualify for this deduction; rather, the existing 20%, 30%, and 50% limits apply.
The self-employed and owners of LLCs, S corporations, and other pass-through entities can continue to deduct 20% of their qualified business income, subject to limitations for individuals with taxable incomes in excess of $329,800 for joint filers and $164,900 for others ($326,600 and $163,300, respectively, for 2020).
The ARP also extended certain pandemic-related tax credits to those self-employed through September 30, 2021. Theses tax credits apply to eligible self-employed individuals who were unable to work due to COVID-19 related illness, quarantine measures suggested by a healthcare provider, or time off seeking medical diagnosis or assistance. Qualifying, self-employed taxpayers are eligible to receive $511 per day or 100% of the average, daily self-employment income.
In addition, the number of days self-employed individuals can claim the credit for family leave increased from 50 to 60 days, and the 10-day limit on the maximum number of days for which a self-employed individual can claim the sick leave credit was reset to begin again on January 1, 2021.
• The deduction for business meals increased from 50% to 100% for 2021 and 2022;
• Self-employment taxes cannot be deferred in 2021 as they were in 2020; and
• The excess business loss limitation, codified in Internal Revenue Code section 461(l), was originally created by the Tax Cuts and Jobs Act of 2017 (TCJA). Applying to taxpayers other than corporations, this provision limits the amount of trade or business deductions that can offset nonbusiness income, making 2018 through 2025 filings subject to the limitation. However, the CARES Act retroactively delayed the implementation of section 461(l) for tax years 2018 – 2020. For 2021, the excess business loss limitation is now in effect. The indexed limitation amount is $262,000 (or $524,000 for joint filers). Net business losses in excess of this amount will be disallowed on 2021 income tax return filings and carried forward.
State and Local Income Taxes (SALT)
Taxpayers may claim an itemized deduction of up to $10,000 ($5,000 for married taxpayers filing separately) for the aggregate of state and local income taxes and property taxes (the “SALT” limitation). The IRS has given its blessing for a limited workaround of the $10,000 SALT itemized deduction limitation created by the TCJA. IRS Notice 2020-75; IRC §164(b)(6) states that if specified state and local income taxes are imposed directly on a partnership or an S corporation,
• the income taxes are actually paid by the partnership or S corporation; then
• the entity can deduct the taxes in computing its non-separately stated income or loss for the tax year (reported on each owner’s Schedule K-1, line 1).
The significance of Notice 2020-75 is that these taxes are assessed to, and paid by, the pass-through entity and not the owner of the pass-through entity. Therefore, the income taxes are fully deductible by the entity and escape the $10,000 SALT cap on the owner’s individual federal income tax return. These taxes are deductible to the owner because the net income of the entity is reduced by those taxes.
The various states that have passed laws imposing income taxes directly on a partnership or an S corporation (or those contemplating such laws) also provide the partners/shareholders with either a deduction at the state level for state income taxes, an exclusion, a credit for taxes paid by the pass-through entity, and/or some combination thereof.
States with Legislation in Place
States are rapidly enacting tax laws that impose either a mandatory or elective entity-level income tax on partnerships and S corporations. With some variations among the states that have enacted such laws, the state then provides a corresponding or offsetting owner-level tax benefit, such as a full or partial credit, deduction, or exclusion.
Multistate Pass-through Entity Elective Tax Summary provides a chart over-viewing the various states.
As part of the 2021 Consolidated Appropriations Legislation, extender provisions that affect individuals were extended. Below are just a few of the higher impact-extender items:
• The Tuition and Fees Deduction was eliminated and replaced by an increase in the income limitation for the Lifetime Learning Credit. The income limitation increase from $58,000 to $80,000 was made permanent.
• Ability to treat mortgage insurance premiums as qualified mortgage interest on Schedule A
• Nonbusiness energy property credit that is claimed on Form 5695
• Credit for 2-wheeled plug-in electric vehicles
• Credit for newly qualified fuel cell motor vehicles
For more information on changes to tax laws, visit the IRS website and/or consult with a tax professional.
Author, Susie Ng
Tax Supervising Senior
Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.