How the New Stimulus Package May Impact Your Personal Income Taxes
Included in the second stimulus package, (referred to as the Consolidated Appropriations Act of 2021), were changes to the Internal Revenue Code that will likely impact your personal income tax return in some manner, this year and in future years. As usual, I'll try to keep this high level. (Keep in mind, this is not meant to be comprehensive, but simply serve as an overview of some of the modest changes).
Let's begin with some changes to tax deductions…
Above-the-Line Qualified Charitable Deduction: The CARES Act (passed in March 2020) introduced a new above-the-line deduction (meaning you can take the deduction even if you don't itemize), for 2020 only, for donations made to qualifying charities, up to a maximum of $300. The new Act extended this provision to 2021 and allows joint filers to deduct a maximum of $600 (while single filers are still capped at $300). While a small deduction, it does encourage taxpayers to support qualifying charities, even if those taxpayers aren't able to itemize their deductions (hence the "above-the-line" deduction).
Itemized Qualified Charitable Deduction: The CARES Act also included a provision allowing for the deduction of qualified charitable contributions for up to 100% of Adjusted Gross Income ("AGI"), for those who itemize deductions. This maximum was previously set at 60%, but was increased to 100% for 2020. The new Act extended this provision through 2021, meaning, a taxpayer could deduct up to 100% of their AGI for charitable contributions made in 2020 and 2021. Note: Donor-Advised Funds do NOT qualify for this provision.
Medical Expense Deduction: The hurdle rate for deductible medical expenses has been permanently set at 7.5%. Meaning, you can deduct qualifying medical expenses for amounts over 7.5% of AGI. This rate has changed between 10% and 7.5% for many years, and was temporarily set at 7.5% with the Tax Cuts and Jobs Act in 2018, with Congress extending it on an annual basis. With the new Act, 7.5% is the permanent hurdle rate (until Congress changes it again).
Meal Expenses (for Business Owners): Previously, business owners and sole proprietors were able to deduct 50% of business-related meal expenses. In order to encourage spending at restaurants, the new Act increased the amount deductible from 50% to 100% for tax years 2021 and 2022 (but not 2020). The idea here is that this deduction incentives business owners to spend money in an industry that has been financially decimated by the pandemic.
Tuition and Related Expenses Deduction: Historically, taxpayers could deduct (above-the-line) up to $4,000 annually in Tuition expenses. The new Act made 2020 the last year this deduction could be taken. However, to make up for this, the Act increased the income limit on the Lifetime Learning Credit from $69,000 for single filers ($138,000 for joint filers) to $90,000 for single filers ($180,000 for joint filers). Based on these higher income limit, overall this should be a net benefit to taxpayers with tuition expenses.
Above-the-Line Qualified Charitable Deduction: The CARES Act (passed in March 2020) introduced a new above-the-line deduction (meaning you can take the deduction even if you don't itemize), for 2020 only, for donations made to qualifying charities, up to a maximum of $300. The new Act extended this provision to 2021 and allows joint filers to deduct a maximum of $600 (while single filers are still capped at $300). While a small deduction, it does encourage taxpayers to support qualifying charities, even if those taxpayers aren't able to itemize their deductions (hence the "above-the-line" deduction).
Itemized Qualified Charitable Deduction: The CARES Act also included a provision allowing for the deduction of qualified charitable contributions for up to 100% of Adjusted Gross Income ("AGI"), for those who itemize deductions. This maximum was previously set at 60%, but was increased to 100% for 2020. The new Act extended this provision through 2021, meaning, a taxpayer could deduct up to 100% of their AGI for charitable contributions made in 2020 and 2021. Note: Donor-Advised Funds do NOT qualify for this provision.
Medical Expense Deduction: The hurdle rate for deductible medical expenses has been permanently set at 7.5%. Meaning, you can deduct qualifying medical expenses for amounts over 7.5% of AGI. This rate has changed between 10% and 7.5% for many years, and was temporarily set at 7.5% with the Tax Cuts and Jobs Act in 2018, with Congress extending it on an annual basis. With the new Act, 7.5% is the permanent hurdle rate (until Congress changes it again).
Meal Expenses (for Business Owners): Previously, business owners and sole proprietors were able to deduct 50% of business-related meal expenses. In order to encourage spending at restaurants, the new Act increased the amount deductible from 50% to 100% for tax years 2021 and 2022 (but not 2020). The idea here is that this deduction incentives business owners to spend money in an industry that has been financially decimated by the pandemic.
Tuition and Related Expenses Deduction: Historically, taxpayers could deduct (above-the-line) up to $4,000 annually in Tuition expenses. The new Act made 2020 the last year this deduction could be taken. However, to make up for this, the Act increased the income limit on the Lifetime Learning Credit from $69,000 for single filers ($138,000 for joint filers) to $90,000 for single filers ($180,000 for joint filers). Based on these higher income limit, overall this should be a net benefit to taxpayers with tuition expenses.
Speaking of education, a few more modifications that impact students…
Employer-Paid Student Loans: The CARES Act introduced a provision that allowed employers to pay up to $5,250 towards an employees student-loans (principal and interest), tax-free! Meaning, the student, would NOT have to count that education assistance as taxable income. While this was originally intended for 2020 only, the new Act extended this provision to 2025!
No 2021 Student Loan Relief: Those with federal student loans remember the CARES Act suspension of minimum payments and interest on those loans in 2020. Originally set to resume on September 30, 2020, it eventually got extended to January 31, 2021. Unfortunately, this was NOT extended further. Meaning, borrowers with federal student loans will have to begin making payments again in February 2021. (This one surprised me).
Employer-Paid Student Loans: The CARES Act introduced a provision that allowed employers to pay up to $5,250 towards an employees student-loans (principal and interest), tax-free! Meaning, the student, would NOT have to count that education assistance as taxable income. While this was originally intended for 2020 only, the new Act extended this provision to 2025!
No 2021 Student Loan Relief: Those with federal student loans remember the CARES Act suspension of minimum payments and interest on those loans in 2020. Originally set to resume on September 30, 2020, it eventually got extended to January 31, 2021. Unfortunately, this was NOT extended further. Meaning, borrowers with federal student loans will have to begin making payments again in February 2021. (This one surprised me).
A few other things worth mentioning that didn't really fall into the above categories…
Deferred Payroll Taxes: In August 2020, the President signed an Executive Order allowing employees to defer Social Security taxes, thereby providing more cash flow during the fourth quarter of 2020. Shortly afterwards, the IRS indicated the employers may have the option to suspend payroll taxes for employees, but were not required to. The guidance also indicated that these deferred taxes would need to be repaid between January 1, 2021 and April 30, 2021. The new Act revised those repayments date to extend through December 31, 2021.
Carryforward of Flexible Spending Accounts ("FSA") Funds: A Dependent Care Flexible Spending account or a Health Flexible Spending account allows employees to set aside funds to be used tax-free for qualifying expenses later in the year. Employee set an amount to be withheld from each paycheck, that money is held in an FSA, and it must be spent before the end of the year, otherwise the money is forfeited (with some minor exceptions). Since many medical procedures were cancelled/delayed in 2020, the new Act is allowing FSA funds to be carried over to 2021, and for unused 2021 funds to be rolled over to 2022. Additionally, it allows employees to change their contributions at any point throughout the year (which is typically prohibited).
No Waiver of Required Minimum Distributions (RMDs): The CARES Act allowed those taxpayers with Required Minimum Distributions from their retirement accounts to waive the requirement for 2020. Meaning, individuals didn't HAVE to take their RMD in 2020 if they didn't need to. This prevented people from having to pull money out of their retirement account when the market was volatile (little did we know that market would recover so quickly). This waiver was NOT extended through 2021.
Deferred Payroll Taxes: In August 2020, the President signed an Executive Order allowing employees to defer Social Security taxes, thereby providing more cash flow during the fourth quarter of 2020. Shortly afterwards, the IRS indicated the employers may have the option to suspend payroll taxes for employees, but were not required to. The guidance also indicated that these deferred taxes would need to be repaid between January 1, 2021 and April 30, 2021. The new Act revised those repayments date to extend through December 31, 2021.
Carryforward of Flexible Spending Accounts ("FSA") Funds: A Dependent Care Flexible Spending account or a Health Flexible Spending account allows employees to set aside funds to be used tax-free for qualifying expenses later in the year. Employee set an amount to be withheld from each paycheck, that money is held in an FSA, and it must be spent before the end of the year, otherwise the money is forfeited (with some minor exceptions). Since many medical procedures were cancelled/delayed in 2020, the new Act is allowing FSA funds to be carried over to 2021, and for unused 2021 funds to be rolled over to 2022. Additionally, it allows employees to change their contributions at any point throughout the year (which is typically prohibited).
No Waiver of Required Minimum Distributions (RMDs): The CARES Act allowed those taxpayers with Required Minimum Distributions from their retirement accounts to waive the requirement for 2020. Meaning, individuals didn't HAVE to take their RMD in 2020 if they didn't need to. This prevented people from having to pull money out of their retirement account when the market was volatile (little did we know that market would recover so quickly). This waiver was NOT extended through 2021.
Like I said, this was not meant to be comprehensive but simply provide an overview of some of the big changes that will likely affect a large group of taxpayers. Hope this was helpful!