Tax Law Updates 2021

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There are sure to be some surprises in Tax Year 2021, although certain adjustments are already in the works. In this blog, we will highlight some of the IRS's 2021 tax phase-outs, modifications, and inflation adjustments.

There are numerous advantages to budgeting your finances. Most of which is effective financial planning, which will help you identify changes that may be made to better prepare for the future. At least, It can surely provide you the freedom to respond in a timely manner. Many individuals will want to know the taxes that will change in 2021 and provisions that will be phased out or adjusted for inflation in the new year. Here's an overview of some of the tax changes in 2021.

Inflationary adjustments

Our incomes generally rise in lockstep with the pricing of the products and services we buy. Income taxes would typically rise faster than incomes if the income tax system fails to take into account this projected shift, producing unexpected financial stress. In 2021, income taxes will be assessed in the same way. The standard deduction, income tax rates, and eligibility for various tax deductions and credits will all be adjusted to account for inflation.

The standard deduction for most married couples filing jointly will increase to $25,100, rising $300 from the previous year. The standard deduction for most individual taxpayers and married persons filing separately rises to $12,550, approximately half that of married filers. The standard deduction for most filler filing as head of household will increase to $18,800.

The Consolidated Appropriations Act, 2021 (CAA)

The CAA became law at the end of 2020. Many expiring deductions, credits extensions, and expansion of tax relief provisions are included in this package in response to the pandemic.

The legislation has a number of provisions, including:

  1. A tax credit of $600 per taxpayer paid in advance ($1,200 for married filing jointly) in addition to $600 for each eligible child. Credit phaseout starting at $75,000 of modified AGI ($112,500 for heads of family and $150,000 for couples filing together).

  2. Broadening of the ability of companies to deduct all of their meal expenditures at 100%.

  3. An explanation that personal safety equipment is deductible as part of the $250 qualified educator tax deduction for qualified instructors.

  4. A clarification that an amount equal to the forgiven amount of a PPP loan will not be included in the gross income and that expenses settled up with forgiven PPP loans are completely tax-deductible.

Tax hikes scheduled for 2021

As stated above, income tax brackets, deductions and credits eligibility and regular deductions will all go up in 2021, due to inflation. The way the tax code measures inflation has changed since the Tax Cuts and Jobs Act was signed into law. Inflation is now measured using a "chained" CPI, instead of linking it to the conventional CPI.

Chained CPI measures inflation in a distinct way, taking into consideration the fact that customer's purchasing decisions vary in conjunction with the price changes, rather than just monitoring periodic variations in the price of a set list of items. For taxpayers, this implies they may be pushed into a higher marginal tax rate more readily than they were before tax reform due to the increase in a cost-of-living paycheck or yearly increments that outperform the chained CPI.

Credit Phase-out and Deduction Adjustments

Many tax deductions and credits will have their phase-outs altered to account for these changes, in accordance with inflation adjustments. The following are some phase-outs modifications to be aware of:

Earned Income Tax Credit: In 2021, the maximum credit for married couples filing jointly and having three or more eligible dependents is $6,660, with the credit phase-out commencing at $56,844 of adjusted gross income. The credit of $538 can be received by a single filler with no dependent, with phaseout at $15,820 of adjusted gross income.

AMT: In 2021, higher exemptions and income phaseouts will be implemented.

IRS Contributions: Contribution amounts will remain the same in 2021, however the phaseout thresholds for deducting these payments will increase as follows. For active participants, phaseout for making IRS contributions will be at adjusted gross income between $66,000 and $76,000 for single and head of household filers, $105,000, and $125,000 for joint returns. Contributions phase out in 2021 at AGIs of $125,000 to $140,000 for singles and $198,000 to $208,000 for couples. If neither of the married couple has an employment retirement plan, phaseouts do not apply.

Changes To AMT (Alternative Minimum Tax)

The AMT was introduced by Congress to prevent affluent taxpayers from taking advantage of too many tax credits, deductions, and other loopholes to avoid paying taxes. Unlike previously, The AMT exemption amount now adjusts automatically with inflation, enabling many middle-income taxpayers to avoid paying the tax.

The exemption amount in 2020 was $72,900, started phasing out at $518,400 ($113,400 for married  filing jointly, with the exemption phasing out at $1,036,800).

The exemption amount will increase to $73,600 in 2021, with a phase-out starting at $523,600 ($114,600 for couples filing jointly, with a phase-out starting at $1,047,200), respectively.

Retirement Plan Distributions Changes

Taxpayers affected by COVID-19 were able to withdraw up to $100,000 of their retirement savings without paying the usual 10% early withdrawal penalty under provisions in the CARES Act. In addition, the Act made it easier for retirees to withdraw required minimum distributions from their retirement funds.

For 2021, several important financial restrictions on retirement plans and IRAs stay unchanged. Unless Congress enacts new legislation, above mentioned penalty waiver and the eased RMD regulations will only apply through 2020.

You may take advantage of these tax changes by starting to prepare now since they are due to take effect in 2021. Don't close your eyes to increasing your retirement contributions or enrolling in a health savings account. These contributions will help you save money for future needs while also lowering your tax payment today, regardless of what taxes 2021 brings.