Plan your 2021 taxes now—or else.
Or else what? Or else risk missing out on a large stimulus payment, or face a surprise bill at tax-filing time, or forgo a charitable deduction.
Year-end tax planning always matters, but new or temporary tax-code changes make it different this year.
"There are so many new variables, and they bring opportunities for saving—if you plan," says Jeffrey Porter, a CPA who practices in Huntington, W.Va.
Here’s a dramatic but not far-fetched example of how strategizing could save a young family at least $7,600 this year.
Say that a married couple has a new baby plus two children ages six and eight. They think their 2021 adjusted gross income will be $162,000, which is below their 2020 income because one spouse temporarily left the workforce this year.
This couple didn’t qualify for $7,000 in third-round stimulus payments based on their 2020 income. And their 2021 income will be just above the $160,000 limit for payments to married joint filers.
But see what happens if this couple rearranges their 2021 income so it’s below $150,000. They become eligible for $7,000 of stimulus payments, and they’ll get $600 in new child tax credits for 2021 that they would have lost due to a separate phaseout.
How could this couple reduce their reported income to qualify for these benefits? By making pretax contributions to 401(k) retirement plans, SEP IRAs, health-savings accounts or flexible spending accounts for 2021, among other things. Business owners could defer income or accelerate deductions, if possible.
What won’t help is deductions for charitable contributions, mortgage interest, state taxes and other items on Schedule A. Those don’t reduce adjusted gross income.
Such 2021 strategies aren’t just for families with children. A retired couple might qualify for $2,800 in stimulus payments by deferring income or timing investment gains and losses. There are also special breaks for charitable giving this year.
Here are tax wrinkles to be aware of for 2021.
The third round of stimulus payments enacted by Congress in March was the most generous—up to $1,400 for each member of a household.
This benefit phases out quickly, beginning at $150,000 and ending at $160,000 of adjusted gross income for most couples filing jointly. The range is $75,000 to $80,000 for most singles and $112,500 to $120,000 for most heads of households.
Many filers have already received payments; the Internal Revenue Service has sent more than 171 million of them totaling more than $400 billion based on 2019 or 2020 income. Some were "top-up" payments for people who received a payment based on 2019 income and then qualified for more based on 2020 income, say because of job loss or the birth of a child.
However, people who didn’t receive third-round stimulus payments or else got partial ones can be eligible for more money based on their 2021 income. For some filers, relatively small reductions in income could bring big benefits.
Stimulus payments due will be claimed on 2021 tax returns. They aren’t taxable income.
Child tax credit amounts
Just for 2021—unless Congress extends the law—there’s a new child tax credit of up to $1,600 per child under 6 and $1,000 per child under 18 at year-end. That’s in addition to the existing child credit of up to $2,000 per child, which this year applies to dependents under 18 at year-end, versus under 17 in other years.
The two credits have different phase-outs. Recipients lose $50 of the new credit per $1,000 of income, starting at $150,000 of adjusted gross income for joint filers, $75,000 for singles and $112,500 for heads of households. For the existing credit, the phaseout begins at $400,000 for joint filers and $200,000 for single and head-of-household filers.
The upshot: child tax credits don’t phase out as quickly as stimulus payments, but lower income can bring higher benefits this year.
Child tax credits and withholding
When Congress expanded the child tax credit in March, it told the IRS to make monthly advance payments to taxpayers of up to half their total credit, based on existing tax records.
These payments will lower expected refunds or raise taxes due for many filers on their 2021 returns. So those who are getting monthly checks should be aware of this issue and either adjust their expectations or raise paycheck withholding.
This year taxpayers who don’t itemize deductions on Schedule A can deduct charitable donations of cash up to $600 for joint filers and $300 for single filers.
Unlike last year’s $300 deduction for non-itemizers, this one is "below the line," so it reduces taxable income but not adjusted gross income. As usual, the donor must have a notice from the charity before filing a return that records the donation amount and whether anything of value was received.
What about givers who don’t itemize, but donate IRA assets through so-called qualified charitable distributions? They can still take the $300 or $600 deduction for cash donations.
There’s also a benefit for people who give large amounts relative to their income this year. Usually taxpayers can deduct cash donations only up to 60% of their income, although they can use up the excess over five years. For 2021, donors can deduct cash gifts up to 100% of income.