The Tax Cuts and Jobs Act (TCJA) significantly increased the standard deduction amount beginning in 2018. Fewer people claim itemized deductions as a result, and the timing of these deductions is now more important for some of those taxpayers who still do. Depending on your personal situation and the outcome of pending tax legislation, you may want to accelerate, or possibly even defer, deductible expenses in 2021.
YEAR-END MOVE: Evaluate whether to step up your charitable giving at the end of the year to reap the tax rewards on your 2021 return. This includes amounts charged to your credit card in 2021 that you do not actually pay until 2022.
Under the CARES Act, and then extended through 2021 by the CAA, the annual deduction limit for monetary donations is increased to 100% (up from 60%) of your adjusted gross income (AGI). Theoretically, you can eliminate your entire tax liability through charitable donations.
Conversely, if you donate appreciated property held longer than one year (i.e., long-term capital gain property), you can generally deduct an amount equal to the property’s fair market value (FMV). But the deduction for short-term capital gain property is limited to your initial cost. In addition, your annual deduction for property donations generally cannot exceed 30% of your AGI.
Tip: If you do not itemize deductions, you can still write off up to $300 of your monetary charitable donations. The maximum has increased to $600 for joint filers in 2021.
Previously, you could generally deduct mortgage interest on loans that qualified as either “acquisition debt” or “home equity debt”, within generous limits. But the TCJA revised the rules, beginning in 2018. Notably, it eliminated the current deduction for home equity debt.
YEAR-END MOVE: When appropriate and allowable, convert nondeductible home equity debt into deductible acquisition debt. This may be accomplished by using home equity loan proceeds to pay for home improvements.
For 2021, you can still deduct mortgage interest on the first $750,000 of new acquisition debt, defined as debt used to buy, build or substantially improve a qualified home. (The prior threshold of $1 million is “grandfathered” for certain older loans.) The deduction for home equity loans, up to the first $100,000 of debt, is suspended for 2018 through 2025.
Thus, if you take out a new home equity loan to make a substantial home improvement, it qualifies as acquisition debt. The interest is deductible within the usual tax law limits.
Tip: If you were planning to use personal funds for a home improvement and a home equity loan for another purpose—say, a child’s education—you might switch things around.
The tax law allows you to deduct qualified medical and dental expenses in excess of 7.5% of AGI. This threshold was recently lowered from 10% of AGI. What’s more, the latest change is permanent.
To qualify for a deduction, the expense must be for the diagnosis, cure, mitigation, treatment or prevention of disease or payments for treatments affecting any structure or function of the body. However, any costs that are incurred to improve your general health or well-being, or expenses for cosmetic purposes, are nondeductible.
YEAR-END MOVE: If you expect to itemize deductions and are near or above the AGI limit for 2021, accelerate non-emergency expenses into this year, when possible. For instance, you might move a physical exam or dental cleaning scheduled for January to December. The extra expenses are deductible on your 2021 return.
Note that you can include expenses you pay on behalf of a family member—such as a child or elderly parent—if you provide more than half of that person’s support.
The medical deduction is not available for expenses covered by health insurance or other reimbursements.
Child Tax Credit
ARPA provides several key enhancements to the Child Tax Credit (CTC) for the 2021 tax year.
Notably, ARPA includes the following changes that may benefit your family.
- The maximum credit increases from $2,000 to $3,000 for a qualifying child ($3,600 for qualifying children under age six).
- The definition of a qualifying child expands to include children under age 18 at the end of the year (up from age 17).
- The credit is fully refundable. Previously, only $1,400 was refundable.
- Although the credit begins to phase out at lower income levels ($150,000 Married Filing Jointly (MFJ); $112,500 Head of Household; $75,000 Single), taxpayers adversely affected by these new ranges can elect to claim the $2,000 credit under the prior rules ($400,000 MFJ; $200,000 all other).
Finally, the IRS began making advance payments of the CTC during the second half of the year (you may opt out of receiving advance payments, however, and instead claim the credit on your tax return).
Don’t forget that the advance payments will be reflected on your 2021 return. This may result in a smaller tax refund than you were expecting.
Alternative Minimum Tax
The alternative minimum tax (AMT) is a complex calculation made parallel to your regular tax calculation. It features several technical adjustments, inclusion of “tax preference items” and subtraction of an exemption amount (subject to a phase-out based on your income). After comparing AMT liability to regular tax liability, you effectively pay the higher of the two.
YEAR-END MOVE: Have your AMT status assessed. Depending on the results, you may want to shift certain income items to 2022 to reduce AMT liability for 2021. For instance, you might postpone the exercise of incentive stock options (ISOs) that count as tax preference items.
Fortunately, the AMT now affects fewer taxpayers, because the TCJA boosted the AMT exemption amounts (and the thresholds for the phase-out), unlike the minor annual “patches” authorized by Congress in prior years. The chart below shows the exemptions since 2017, including a significant boost in 2018.
|Married filing separately (MFS)||$42,250||$54,700||$55,850||$56,700||$57,300|
The two AMT rates for single and joint filers for 2021 are 26% on AMT income up to $199,900 ($99,950 for MFS ) and 28% on AMT income above this threshold. Note that the top AMT rate is still lower than the top ordinary income tax rate of 37%.
- Various tax proposals related to the BBB Act have included increases in the ordinary and capital gains rates in addition to a new income tax surcharge of 5% on modified AGI in excess of $10 million ($5 million for MFS; $200,000 for estates and trusts) and 8% on modified AGI in excess of $25 million ($12.5 million for MFS; $500,000 for estates and trusts). As of the date of this letter, negotiations are ongoing and it is unclear which provisions may be included in the final version of any legislation signed into law, so consult your tax advisor before making any decisions which may be impacted by a change in tax rates for 2022.
- A recent version of the BBB Act, if passed, would increase the deduction limitation for state and local taxes from $10,000 to $80,000 ($40,000 for MFS) effective for 2021 and future years. If this change is enacted before year end, it could impact the decision whether to itemize or claim the standard deduction amount in 2021.
- Take advantage of the enhanced dependent care credit. Under ARPA, the maximum credit for a taxpayer with an AGI of $125,000 or less is $4,000 for one child and $8,000 for two or more children.
- Pay a child’s college tuition for the upcoming semester. The amount paid in 2021 may qualify for one of two higher education credits, subject to phase-outs based on modified adjusted gross income (MAGI). Note: The alternative tuition-and-fees deduction expired after 2020.
- Avoid an estimated tax penalty by qualifying for a safe-harbor exception. Generally, a penalty will not be imposed if you pay 90% of your current tax liability or 100% of the prior year’s tax liability (110% if your AGI exceeded $150,000), and these payments are made ratably throughout the year.
- If you are in the market for a new car, consider the tax benefits of the electric vehicle credit. The maximum credit for a qualified vehicle is $7,500. Be aware, however, that credits are no longer available for vehicles produced by certain manufacturers. Note that a recent version of the BBB Act, if passed, would increase the credit amount to $12,500 for 2022 and would remove the production limitations, so you should monitor the status of this legislation before purchasing an electric vehicle before year end.
- Empty out your flexible spending accounts (FSAs) for healthcare or dependent care expenses if you will have to forfeit unused funds under the “use-it-or-lose it” rule. However, due to recent changes, your employer’s plan may provide a carryover to next year of up to $550 of funds or a 2½-month grace period.
- If you own property damaged in a federal disaster area in 2021, you may qualify for quick casualty loss relief by filing an amended 2020 return. The TCJA suspended the deduction for casualty losses for 2018 through 2025 but retained a current deduction for disaster-area losses. Note: the Texas winter storms that took place in February 2021 qualify as a federally declared disaster. If you were affected by the Texas winter storms and incurred property losses that were not covered by insurance or other reimbursement, you may be able to claim these losses on your 2021 tax return or by filing an amended 2020 tax return. The losses must overcome two limitations in order to be deductible. First, $100 of each casualty loss is not deductible. Second, the total losses must be in excess of 10% of AGI for the year the loss is claimed. It is possible but uncertain if Congress will provide relief from these limitations.
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At Maxwell Locke & Ritter, our team members have extensive experience helping individuals with their tax planning needs. Please contact us if you have questions about these updates and how they may affect your situation.