The past few years have seen many changes to the tax codes that could impact not just your tax filing, but your long-term financial plan. Some tax changes have been extended from 2020, while other changes have been enhanced for 2021 and others have been eliminated. Find out what has changed and what hasn’t, and what you need to do to strategize your 2021 tax filing.

Child tax credit

One of the biggest tax changes in 2021 was to the Child Tax Credit. In prior years, you would claim the Child Tax Credit when you file your taxes; however, the additional Child Tax Credit is a refundable credit and applied only for 2021. With the American Rescue Plan Act (ARPA), the IRS sent one half of the anticipated child tax credit as a monthly payment from July 2021 through December 2021. These payments were sent via direct deposit into a bank account the IRS has on file or in the form of a check. The remaining half of the credit will be processed as a credit on your 2021 federal income tax return.

Economic impact payments

These payments are an advance on the recovery premium credit (like the 2020 Pandemic Tax Relief). Therefore, taxpayers who did not qualify for the advanced payment can claim the credit on their 2021 federal income tax return. Like last year, these advance payments are not taxable even if your income in 2021 is too high for the credit.

As a reminder, the IRS used your most recent tax return to calculate how much you receive as an advanced payment. The payments were reduced once income reached $150,000 for joint filers and $75,000 for single. The income thresholds were phased out once income reached $160,000 for joint filers and $80,000 for single filers.

Student loan forbearance extended

Just before Christmas, President Biden announced the fourth extension on student loan forbearance – or a freeze on payments and interest rate accruals for federally held student loans (these are loans held by the U.S. Department of Education). Payments will resume on May 1, 2022. It’s important to note that this relief only applies to federal student loans. If you have private student loans, you should contact your loan provider to discuss options. While the relief is automatically applied, some details, such as accounts paid by automatic debit, have not yet been confirmed and may vary by loan servicer.

Another provision of the ARPA impacts student loans. Borrowers will not be responsible for paying federal taxes on their forgiven student loan debt from 2021 to 2025. Typically, debt forgiven is considered taxable income, but this has been eliminated until 2025, so borrowers will be able to reap the full benefits until then.

Employers can also support their workers when it comes to student loans. Until 2025, employers can pay up to $5,250 in student loan payments for an employee tax free—meaning this amount won’t count as income for the employee. Note that this $5,250 limit can be used either for education expenses or student debt. On the flip side, the tuition and fees deduction were repealed in 2021. This deduction allowed up to $4,000 of tuition and fees to be deducted before calculating your adjusted gross income (“above the line”).

Inflation adjustments

Each year, there are changes due to inflationary increases. Here are few of interest:

• Ordinary and capital gains rates. For 2021, ordinary tax rates range from 10% to 37%, depending on your income and filing status.
• Higher standard deductions. The standard deduction has increased to $12,550 for single filers and married couples filing separately (up $150 from 2020) and $25,100 for married couples filing jointly (up $300 from 2020).
• The estate tax exemption and gifting exclusion is $11.7 million for 2021, however it did go up in 2022 to $12.06 million for single filers ($24.12 million for joint filers). In addition, the annual exclusion for gifting will increase to $16,000 in 2022 after staying constant at $15,000 for the past four years.
• Wages subject to Social Security was $142,800 in 2021 and will increase to $147,000 for 2022.

Changes to required minimum distribution (RMD) calculations

Starting in 2022, the RMD formula is changing, making RMD amounts smaller and allowing your money to grow tax-deferred even longer. The new RMD life expectancy tables issued by the IRS took effect January 1, 2022, and apply to all IRA, 401(k) and other retirement accounts. The new rules acknowledge that retired workers need to conserve their retirement assets in the event they live longer than anticipated.

Here’s an example of how the new formula will lower required distributions, assuming you have an IRA worth $300,000:

• In 2021, your RMD at age 72 was $11,718.75 ($300,000 divided by the life expectancy factor of 25.6).
• In 2022, your RMD will drop to $10,948.91 ($300,000 divided by the new life expectancy factor of 27.4). That’s a reduction of 6.6%, allowing your retirement funds to continue growing for a longer time.

Unemployment distributions

If you collected unemployment payments in 2021, don’t forget that they count as taxable income and must be accounted for when withholding taxes.

Other tax provisions

Here are some other tax provisions that are being extended into 2022:

• If you’re paying private mortgage insurance, this monthly expense is deductible, but you must itemize your federal taxes (if you take the standard deduction, this wouldn’t apply).
• The energy-efficient home improvement credit is still available for homeowners (for example, if you purchased items like windows, exterior doors, insulation, water heaters, roofs, heating, and air conditioning). Note that this credit is limited to $500 for all tax years combined, with lower limits for certain items.
• The residential energy credit for items such as solar and geothermal remains 26% of the total cost instead of dropping to 22%. The 26% rate will continue for 2022 and expire in 2023.
• If you have mortgage debt that’s been forgiven (from a foreclosure, loan modification, short sale, or deed in lieu of foreclosure) you may be able to exclude the cancelled amount from your federal income tax. Mortgage debt forgiveness was extended through 2025 and you can exclude up to $750,000 max.
• The itemized deduction for medical expenses will remain at 7.5% instead of increasing to 10% of the adjusted gross income. The IRS allows you to deduct unreimbursed expenses for preventative care, surgeries, transportation (such as mileage, bus fare, and parking fees), and other treatments, essential to medical care. On a related note, if you have a Flexible Spending Account (FSA) and didn’t use up your plan funds, you may be able to carry forward unused benefits. These changes are optional, so not all FSA plans may implement this change. Ask your employer if your FSA plan includes these more flexible rules.
• If charitable giving is part of your financial plans or values, your cash donations to eligible charities are fully deductible (instead of being limited to 50% or 60% of your adjusted gross income). The 100% cash donation limit was extended from 2020 to 2021 only. This may help offset any income you might recognize from other taxable events (like from Roth IRA conversions).
• Also, the additional deduction of $300 for donation to charity has been renewed for 2021; however, that amount will increase to $300 per person. Therefore, married filers can claim $600 in addition to their standard deduction. Note that this year, the deduction is after adjusted gross income (AGI) and will not affect calculations using AGI, such as Medicare premiums, net investment income tax, and taxability of Social Security benefits, to name a few.

While this list of changes is not exhaustive and all-inclusive, you can see that there were many significant tax changes. We cannot stress enough how important it is to have a holistic approach to financial planning that includes income tax planning. Given the changes we’ve seen with the pandemic, now may be a good time to talk with your advisor and tax professional regarding your 2021 and 2022 tax planning.