Pandemic relief, unemployment, and student loans are among the areas where changes have taken place.
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Preparing your federal taxes can be a daunting task. And every year, some things change, making it even more onerous for the average taxpayer. Everything from changes in the standard deduction and tax brackets to pandemic-related tax provisions can affect your return for the 2021 tax year.
"The bad news is the tax returns are more complicated this year," says Mark Steber, chief tax information officer at Jackson Hewitt Tax Services. "On the positive side, most of those changes are positive changes for the taxpayer. If you can navigate through the complicated rules, it will have a very positive taxpayer impact. With the greater complexity, there comes a greater benefit."
Here are some of the key tax changes to keep in mind when preparing your 2021 federal tax return.
When you prepare your taxes, you have the option of taking the standard deduction or itemizing deductions. Both reduce the amount of your income that is taxed. Itemizing can be more complicated than taking the standard deduction and is only worth doing if the total amount exceeds the standard deduction. Standard deductions increased in 2021. For those whose filing status is single, married filing separately, and head of household, the amount increased by $150 from 2020. For joint filers qualifying widows or widowers, it increased by $300.
Standard deduction amounts for 2020 and 2021
Filing status | 2020 | 2021 |
Single and married filing separately | $12,400 | $12,550 |
Head of household | $18,650 | $18,800 |
Married filing jointly and qualifying widow/er | $24,800 | $25,100 |
Source: IRS
The 2021 federal income tax brackets also increased to account for inflation. However, the number of brackets didn't change, remaining at seven, with the lowest at 10% and the highest at 37%. These tax brackets are marginal, which means different portions of your taxable income will be taxed at different rates. These are the rates that apply to 2021 tax year which is normally filed in 2022. While the changes were relatively small, it's possible that your tax burden could be lower this year if they resulted in you being bumped down to a lower bracket.
2021 federal income tax brackets
Rate | Single | Married filing jointly | Married filing separately | Head of household |
10% | $0 to $9,950 | $0 to $19,900 | $0 to $9,950 | $0 to $14,200 |
12% | $9,951 to $40,525 | $19,901 to $81,050 | $9,951 to $40,525 | $14,201 to $54,200 |
22% | $40,526 to $86,375 | $81,051 to $172,750 | $40,526 to $86,375 | $54,201 to $86,350 |
24% | $86,376 to $164,925 | $172,751 to $329,850 | $86,376 to $164,925 | $86,351 to $164,900 |
32% | $164,926 to $209,425 | $329,851 to $418,850 | $164,926 to $209,425 | $164,901 to $209,400 |
35% | $209,426 to $523,600 | $418,851 to $628,300 | $209,426 to $314,150 | $209,401 to $523,600 |
37% | $523,601 and over | $628,301 and over | $314,151 and over | $523,601 and over |
Source: IRS
The American Rescue Plan Act (ARPA) of 2021 increased the amount families can claim for child tax credits. The 2021 amounts are $3,600 per child under age 6, and $3,000 per child for ages 6 to 17. This compares with $2,000 for per child under age 17 previously. This provides major tax relief to working families.
Taxpayers whose adjusted gross income (AGI) is within these thresholds qualify for the maximum credits:
Taxpayers who received advance payments in the second half of 2021 will receive the remainder after they file their tax returns. Those who didn't receive advance payments will receive the full credit.
Those who received advance payments can use information in Letter 6419 from the IRS to claim the balance. It's possible, however, that some taxpayers may have received more than the eligible credit and can find themselves in a position where they need to repay it.
"The challenge is the forms are not matching up exactly with what people have received," says Jamie Hopkins, managing partner of wealth solutions at Carson Group, a financial services firm with over $20 billion of assets under management. "I have been advising people to make sure what you actually received agrees with the IRS Letter 6419. It's going to be a challenge for people filing their taxes."
The earned income tax credit (EITC) is a refundable tax credit that assists low and moderate income families.
ARPA temporarily helps workers without children to claim the credit. It roughly triples the maximum credit for childless workers from $538 to $1,502.
Based on IRS reports and statistics on EITC, 25 million eligible workers and families received about $62 billion of EITC as of December 2020. The average amount received was $2,461.
Taxpayers can reduce taxes owed and increase their tax refund with this credit.
Earned income tax credit for 2021
Dependents | Maximum AGI (single or head of household) | Maximum AGI (married filing jointly) | Maximum EITC |
0 | $21,430 | $27,380 | $1,502 |
1 | $42,158 | $48,108 | $3,618 |
2 | $47,915 | $53,865 | $5,980 |
3 or more | $51,464 | $57,414 | $6,728 |
In order to expand relief to Americans, certain student loan forgiveness is tax free for 2021. The IRS says that lenders should not issue Forms 1099-C, Cancellation of Debt, for loans discharged from 2021 through 2025. Prior to ARPA, loans that are forgiven are included in the gross income, and are reported in Forms 1099-C.
Normally, taxpayers who select the standard deduction cannot claim a deduction for charitable contributions. A temporary tax change enacted in the CARES Act allows taxpayers who select standard deduction, to claim a deduction of up to $300 for cash contributions made to qualifying charities in 2021. It increases to $600 for those filing married and filing jointly.
In addition, for taxpayers who itemize their deductions, they can deduct 100% of the adjusted gross income (AGI) in qualified charitable contributions. Previously, taxpayers could only deduct a range of 20% to 60% of AGI, depending on the type of contribution and type of charitable organization.
Many Americans were unemployed (some temporarily) due to the pandemic and sought help from unemployment insurance. The American Rescue Plan allowed taxpayers to waive up to $10,200 of paid unemployment compensation for the 2020 tax year, if the adjusted gross income was less than $150,000. This was not extended in 2021, therefore, you will pay taxes on unemployment compensation if you did not withhold taxes from your benefits in the 2021 tax year.
Taxpayers who did not receive the full amount of the payments from the third round of direct stimulus payments may be eligible to receive it through a recovery rebate credit. The amount of the credit is generally $1,400 per person. For example, for a family of four, the credit could be a total of $5,600. This credit will reduce taxes owed or will be included in a tax refund for 2021. However, taxpayers will need to file a 2021 tax return to claim this credit, even if you don't have to file a tax return.
You should receive Letter 6475 from the IRS by the end of March if you qualify for this credit. According to the IRS, most people have already received the full amount.
The Biden administration's budget presented last year included new reporting requirements for cryptocurrency, and the administration's plan to strengthen tax compliance includes a requirement to report to the IRS transfers of at least $10,000 of cryptocurrency. So if you sold or traded Bitcoin or any other cryptocurrency in 2021, the IRS wants to know about it.
"The rules around cryptocurrency have not changed," says Hopkins. "The amount of data the IRS has and the urgency of which they are going to enforce the taxation of cryptocurrency has changed. The IRS will start enforcing tracking and start hunting down lost tax revenue due to crypto transactions."
Form 1040 for tax year 2021 asks the following question: "At any time during 2021, did you receive, sell, exchange or otherwise dispose of any financial interest in any virtual currency?" If the answer is yes, you must report it on Form 8949, Sales and Other Dispositions of Capital Assets, and then summarize it on Form 1040, Schedule D, Capital Gains and Losses.
"Any time you exchange crypto one to another it's a taxable transaction," Hopkins says. "If you buy something with crypto it's a taxable transaction. If you sell crypto and exchange bitcoins to US dollars, it's a taxable transaction. If you exchange crypto for anything, it's a taxable transaction."
The IRS received almost 36 million returns as of Feb. 18, 2022, about a million more than it had at that time a year earlier. Almost 22 million of them are receiving refunds averaging $3,590, up roughly 23% from last year. This shows that most of the 2021 tax changes are positive or favorable for the taxpayer.
One piece of advice Jackson Hewitt's Steber has for taxpayers this year is to file sooner rather than later.
"Three out of four taxpayers get a tax refund, so file early to get money early," Steber says. "File early and your information is locked with the IRS so if someone steals your data, your data is locked [with the IRS] and you have already received your refund. The third reason is, given the complexities and enormity of dollars involved, it's just smart to file early," says Steber.
