Understanding 2021 Tax Updates

(before you file your taxes)

This meme pops up in my social media feed from time to time: It’s clever and a bit funny, but the sad truth is that it would be pointless to teach the specifics of taxes in school. Unlike parallelogram rules, tax rules change every year. Things we learned in high school that might be helpful during tax season would likely be superseded before we finished our first semester in college. In this age of activism and immediate results, our Congress just can’t help themselves. They must legislate! This year was no different. There are numerous changes to the tax laws for 2021. Some you likely know about, others you might not. Here I will cover the handful likely to impact a significant portion of military and veteran families.

Child Tax Credit

Congress made several changes to this popular tax credit. They expanded it, changed the age range, made some of it payable in advance, and made it fully refundable without restrictions. Here are the details

1. The maximum credit was expanded from $2,000 to $3,000 ($3,600 for children under 6.) There is an AGI limitation on this expanded amount. The expanded amount begins to phase out above AGI of $150,000 for married couples filing jointly, $112,500 for taxpayers filing as head of household, and $75,000 for all other filers. (The unexpanded (regular amount – $2,000 begins to phase out at $400,000 AGI for married couples filing jointly.)
2. Qualifying children under the age of 18 are eligible for the credit. (In prior years it was qualifying children under the age of 17.)
3. Part of the 2021 Child Tax Credit was eligible to be paid as an advance. The default was for the IRS to pay 1/12th of the estimated 2021 credit each month to taxpayers from July to December of 2021. You may have received checks or direct deposits to your bank account. Or you may have elected out of some (or all) of the advanced payments. Either way, you will need to rectify the amount of Child Tax Credit for which you are eligible with the amount of Advanced Child Tax Credit already received to determine how much more Child Tax Credit you will receive at the time you file your 2021 federal tax return. The IRS should send you a letter 6419 telling you how much Advanced Child Tax Credit you have received. Verify this letter against your records to ensure they match. Then keep the letter for tax prep time!
4. The 2021 Child Tax Credit is fully refundable for all taxpayers. In prior years the refundable portion was limited and subject to earned income restrictions. This year it is fully refundable.

The enhancements to the Child Tax Credit were made as part of emergency / pandemic legislation, and are therefore temporary. These enhancements all expire at the end of 2021. Many lawmakers have expressed an interest in extending these enhancements into 2022, but as of this posting, this has not yet happened.

Child and Dependent Care Credit (Child Care Credit)

In past years this credit has likely drawn more sighs and eye-rolls than any other. The government has long admitted child care (or care for a disabled dependent) was necessary for taxpayers to work. Then they offered a ridiculously small credit in comparison to the actual costs actually of such care. Only $3,000 of expenses from one, or $6,000 for multiple dependents were qualifying expenses. A mere fraction of the real-world costs. Then, anyone who earned enough to actually pay those expenses could only claim 20% of the qualifying expenses as the credit. Essentially you got $600 for one child, $1,200 for 2 or more children. In 2021 this credit got significantly beefier. Eligible expenses grew to $8,000 for one dependent, $16,000 for two or more. The income ranges on the percentages grew even more dramatically for most families, with a new top rate of 50%. If you have 2 or more dependents, your child care credit might have grown from $1,200 to $8,000 in 2021! Additionally, in 2021 this credit is refundable for the first time. These Child and Dependent Care Credit enhancements were a big win for working families. They are also only temporary but may be extended or made permanent by subsequent legislation.

Student Loan Debt Cancellation

Money that is borrowed, but not repaid, is treated as income, and subject to income taxes under our tax laws. There are a few exceptions to that general rule, and starting in 2021 you can add student loan debt to that list. If you have student loan debt forgiven, charged off, or otherwise canceled in 2021, it may be excluded from income on your 2021 tax return. This applies to nearly all legitimate student loan debt, whether it was government-backed or private. This law applies to student loan debts canceled between 2021 and 2025.

Assorted Others

Two rules that were in effect for last year, but are hanging around for this year are worth reviewing. The first is the Recovery Rebate Credit. This is the credit you receive if you did not receive your Economic Impact Payment (“stimulus check”), or did not receive the correct amount of Economic Impact Payment. All taxpayers need to know the amount of Economic Impact Payments received in 2021 (round 3 of the stimulus, issued in late March/early April) because this amount is used to calculate your Recovery Rebate Credit. If you don’t remember, the IRS will send you letter 1444 to remind you, or you can log into the IRS website (after you prove your identity) and check it yourself. Spouses filing jointly will both need to check their tax accounts to get the entire amount the IRS sent. The other is the expanded charitable deduction. In 2020 taxpayers could deduct $300 of charitable contributions (cash only, not donated items) in addition to the standard deduction. This is in effect again for 2021, but with a couple of modifications. First (and best!) is that married couples filing jointly can now deduct up to $600 of charitable contributions in addition to the standard deduction. In 2020 they were limited to just $300 per return. Secondly, the deduction is a deduction this year and not an adjustment. In 2020 the deduction was an adjustment to income, which would reduce adjusted gross income (AGI). (Often called an above-the-line deduction.) In 2021 the expanded charitable deduction comes after AGI is calculated. Since it no longer reduces AGI, this deduction no longer helps make you eligible for other AGI-based tax credits and benefits.  In trying to do the right thing for America, Congress often injects a tremendous amount of complexity into the tax code. This year was no different. They heaped tax breaks on us, but they also heaped a mountain of paperwork on the administration of those tax breaks. Military and veteran families enjoy targeted tax benefits, but they should also make sure they are taking advantage of the tax benefits available to all Americans. If you are unsure of your eligibility for a tax benefit, or how to take advantage of it, please consult with a tax professional familiar with military and veteran tax issues.