By Josh Morris, CPA/PFS, CFP®
Less than 100 days into President Biden’s administration and the first piece of major tax legislation has been enacted. The main talking point of this legislation is the third round of direct payments to individuals designed to stimulate the economy and help those that may be struggling most. This round of stimulus payments is up to $1,400 per individual (not just dependent children under 17), but the phaseouts are much tighter, which may require extra tax planning for some to benefit.
In addition to the stimulus payments, there were some sweeping changes to various tax credits that affect families with young children, those purchasing health insurance from the state exchanges, and the new law sets the tone that student loan forgiveness may be coming in the future since the forgiven student loan debt won’t be included in income. We have summarized some of the key points from this legislation that might affect you along with action items you can take now to make the most of these benefits.
The American Rescue Plan Act of 2021
The entire law can be found here, but a summary of key areas that may affect you are listed below.
1. Unemployment benefits are extended. Previously, the expanded unemployment benefits under the CARES Act were going to end on March 14, 2021, but they have now been extended through September 6, 2021.
2. Up to $10,200 of 2020 unemployment compensation could be tax-free. For 2020 only, if your adjusted gross income (AGI) is less than $150,000, then the unemployment compensation up to $10,200 shall not be included in income. The main reason this was added was because of the number of people who filed for unemployment and didn’t have any taxes withheld. As a result, many who were used to getting a refund likely are looking at owing tax when filing their 2020 tax returns.
The $150,000 AGI limit applies to all taxpayers, regardless of filing status, and appears to be a true cliff in that exclusion of income is available if AGI is up to $149,999 but unemployment income is completely taxable if $1 more is earned. In addition, the total amount of unemployment received must be included when calculating AGI for purposes of this income exclusion. Finally, it is unclear whether states that collect income taxes will follow suit or continue to tax unemployment income.
3. Student loan forgiveness will be tax-free through 2025. The act doesn’t provide any student loan forgiveness, but it does allude to possible forgiveness through Executive Orders or further legislation.
4. Provides up to $1,400 stimulus payments per individual, including other dependents and not just children under 17. However, the stimulus payments are phased out based on a lower adjusted gross income (AGI) threshold than the first and second rounds.
- $75,000 - $80,000 Single filers
- $150,000 - $160,000 Joint or Surviving Spouse
- $112,500 - $120,000 Head of Household
The initial stimulus payment will be based on your 2019 tax return (or 2020, if already filed). Then, the amount will be recalculated using your 2020 tax return data on or before September 1, and an additional payment will be made to true-up any shortfall from the initial payment. Finally, when you prepare your 2021 tax return, you will be eligible to claim a credit based on your 2021 information if either your income was lower this year or you had additional dependents compared to 2020.
5. Temporarily expands the child tax credit (for 2021 only). Previously, 17-year-olds were not eligible for the child tax credit of $2,000 and were instead limited to the dependent tax credit of $500. For 2021 only, the child tax credit includes children 17 and under.
In addition, the maximum child tax credit is temporarily increased for 2021 only from $2,000 to $3,000 ($3,600 for children under 6 at the end of the year). However, not all taxpayers will qualify for the maximum credit since they are subject to lower phaseout ranges than the standard child tax credit.
- $75,000 Single filers
- $150,000 Joint or Surviving Spouse
- $112,500 Head of Household
For every $1,000 over your applicable threshold, the expanded maximum credit will be reduced by $50. The “regular” child tax credit of $2,000 per child is still available and is not reduced unless your AGI exceeds $200,000 ($400,000 for Joint filers).
Finally, a portion of the child tax credit will be paid in advance in equal installments during the latter half of the year. An online portal will be established where you can elect not to receive advance payments or adjust the number of qualifying children to avoid any potential clawbacks of amounts advanced but not eligible for the credit due to income or otherwise.
6. Increases dependent care assistance for children (for 2021 only). The maximum you can contribute to a dependent care flexible spending account (DCFSA) for childcare expenses is increased from $5,000 to $10,500. If you are in a higher tax bracket (24% or more), this often makes more sense than the dependent care tax credit if your employer provides it. Now that this law has been enacted, it will be up to your employer to allow modifications to your elected annual contribution amounts.
In addition, you might see a much larger dependent care tax credit if you don’t have access to a workplace DCFSA, your expenses exceed the annual DCFSA limit, or if you are in a lower tax bracket. Before this law, expenses for purposes of the credit were limited to $3,000 per child under 13 and $6,000 in total. Now the amounts have been increased for 2021 only to $8,000 and $16,000, respectively. These qualified expenses are multiplied by your applicable percentage based on income, which for most households was 20% in previous years.
The law changes the applicable percentage maximum to be 50% up to an adjusted gross income (AGI) of $125,000 regardless of filing status, and the percentage reduces 1% for each $2,000 above the threshold. Therefore, if your AGI is over $185,000, you will likely see the same 20% applicable percentage until a second phaseout begins at $400,000, which further reduces the applicable percentage by 1% for every $2,000 above the threshold. If your AGI exceeds $440,000, you will no longer receive any dependent care tax credit in 2021 even though you may have received it in prior years.
7. Provides premium assistance for health insurance coverage. If you were terminated from employment (not a voluntary resignation), the law allows you to maintain COBRA coverage from April through September and not pay any premiums (the premiums will instead be paid by the previous employer).
Also, for 2021 and 2022, the law temporarily expands premium assistance if you purchased insurance on the open exchange (Obamacare policies). Essentially, they have removed the income limit to receive a subsidy, as the premiums are now capped at no more than 8.5% of income. If you haven’t received a subsidy in the past, there is a good chance you will qualify now. Finally, if you receive or are approved to receive unemployment at any time during 2021, you are deemed to have income below 133% of the poverty line. As a result, you would receive a full subsidy of the second least expensive Silver plan on the exchange.
Action Items to Take
Based on the changes laid out in the new law, below are the key action items that you should take as soon as possible to ensure you receive the most benefit from this legislation.
1. Possibly amend your 2020 tax return. If you have already filed your 2020 taxes and reported any unemployment income, you would want to see if it is worth amending your tax return. If your AGI was below $150,000, you should be able to exclude up to $10,200 of unemployment benefits received once the tax software is updated, which would likely result in a refund or a smaller amount owed.
2. File your 2020 taxes ASAP. If your 2020 income is projected to be less than the thresholds for the stimulus payments, you may wish to file your taxes as soon as possible assuming either your 2020 income is less or you had a child during 2020. This will ensure you get a larger stimulus now rather than waiting for the additional determination date.
3. Look for opportunities to defer income in 2021. Making adjustments now can help in reducing your taxable income for 2021, which may allow you to claim a larger credit for the third stimulus if you aren’t able to receive the full amount due to 2019 or 2020 income. This is even more important if you have young children and can qualify for the increased child tax credit and dependent care credits.
Some ways to reduce your adjusted gross income (AGI) with your employer would be the following:
- Switching from Roth contributions to Traditional within your 401(k), 403(b), or IRA
- Increasing your contributions to your health savings account (HSA) or flexible spending account (FSA)
- Contributing to a 457 or deferred compensation plan
- If you pay for childcare, ensure that you are utilizing the dependent care FSA, if available with your employer.
Also try to reduce any capital gains, dividends, and interest during the year to the extent possible and limit Roth conversions or other types of income that can be triggered in a subsequent year. If you own a business, try to defer income and accelerate expenses, set up a retirement plan, and work with your advisors to make sure you aren’t leaving anything on the table.
4. Adjust your withholding. Depending on your situation, you might be entitled to more credits during 2021 than in prior years, especially if you make less than $150,000 jointly and you have young children. Work with your financial planner or accountant to see if you might be having too much withheld from each paycheck and update your W-4 accordingly so that you don’t give Uncle Sam an interest-free loan.
5. Make adjustments for COBRA premiums from April through September. If you are receiving COBRA from your previous employer due to being terminated, you shouldn’t have to pay any premiums until October. If you are the employer, you will want to contact your payroll provider to ensure you are receiving the correct tax credits for making these COBRA payments over the next 6 months.
6. Contact your health insurance agent. If you purchased your health insurance via the exchange, you may be eligible for a subsidy, and we would recommend connecting with your agent to see if anything is needed.
Hopefully, the information above has helped you think about how the new legislation affects you and what can be done in order to benefit from the changes. If you need help in putting these strategies in place, Strategic Financial Planning can help you navigate these decisions along with other aspects of your own financial life. To get started or review your progress, call (972) 403-1234 or contact us online to schedule a meeting, and let us help you navigate your life journey and prepare for the future.
Josh Morris serves as a financial planner with Strategic Financial Planning. With over 11 years of industry experience, Josh is passionate about developing relationships with clients, learning about their dreams, and helping them reach their goals.
Josh graduated summa cum laude from Oklahoma Christian University with a Bachelor of Business Administration in Accounting and started his career at Ernst & Young LLP, where he focused his efforts on high-net-worth individuals and their closely-held businesses before transitioning to wealth management.
Josh is a CERTIFIED FINANCIAL PLANNER™ Professional, a Texas CPA, and holds the Personal Financial Specialist (PFS) designation from the AICPA. Josh is a long-term member of both the AICPA and the Texas Society of CPAs, has been recognized as a Five Star Wealth Manager, and in 2020 was recognized as a recipient of the AICPA Standing Ovation Award.
To learn more about Josh, connect with him on LinkedIn.