Key Tax Changes Could Affect Your Tax Situation in 2021

August 16, 2021

Key tax provisions in the American Rescue Plan Act of 2021 could affect your tax situation. Here’s what you need to know:

Child and Dependent Care Credit Increased for 2021 Only
The new tax law affected taxpayers in several ways. First, it increased the dollar amount of the credit and the amount of eligible expenses for child and dependent care. It also modified the phase-out amount for the credit to allow higher earners to take advantage of the credit. Finally, the new law made the child and dependent care credit fully refundable.

For 2021, the top credit percentage of qualifying expenses increased from 35% to 50%. In addition, eligible families can claim qualifying child and dependent care expenses of up to $8,000 for one qualifying individual (up from $3,000 in prior years) or $16,000 for two or more qualifying individuals (up from $6,000 before 2021). This means that the maximum credit in 2021 of 50% for one dependent’s qualifying expenses is $4,000, or $8,000 for two or more dependents.

When figuring the credit, employer-provided dependent care benefits, such as those provided through a flexible spending account (FSA), must be subtracted from total eligible expenses.

As before, the more a taxpayer earns, the lower the credit percentage. Under the new law, however, more people will qualify for the new maximum 50% credit rate because the adjusted gross income (AGI) level at which the credit percentage is reduced is raised substantially from $15,000 to $125,000.

For adjusted gross incomes above $125,000, the 50% credit percentage is reduced as income rises and plateaus at a 20 percent rate for taxpayers with an AGI above $183,000. The credit percentage level remains at 20 percent until reaching $400,000 and is then phased out above that level. It is completely unavailable for any taxpayer with AGI exceeding $438,000.

Also of significance is that in 2021, for the first time, the credit is fully refundable. As such, an eligible family can get it, even if they owe no federal income tax.

Workers Can Set Aside More in a Dependent Care FSA
For 2021, the maximum amount of tax-free employer-provided dependent care benefits increased from $5,000 to $10,500. An employee can set aside $10,500 in a dependent care FSA if their employer has one instead of the normal $5,000. Workers can only do that if their employer adopts this change. Interested employees should contact their employer for details.

Childless EITC Expanded for 2021
For 2021 only, more childless workers and couples can qualify for the Earned Income Tax Credit (EITC), a fully refundable tax benefit that helps many low- and moderate-income workers and working families. That’s because the maximum credit is nearly tripled for these taxpayers and is, for the first time, made available to both younger workers and senior citizens.

In 2021, the maximum EITC for those with no dependents is $1,502, up from $538 in 2020. Available to filers with an AGI below $27,380 in 2021, it can be claimed by eligible workers who are at least 19 years of age. Full-time students under age 24 don’t qualify. In the past, the EITC for those with no dependents was only available to people ages 25 to 64.

Another change is available to both childless workers and families with dependents. For 2021, it allows them to choose to figure the EITC using their 2019 income, as long as it was higher than their 2021 income. In some instances, this option will give them a larger credit.

Changes Expanding EITC for 2021 and Future Years
Changes expanding the EITC for 2021 and future years include:

  • Singles and Couples – who have Social Security numbers can claim the credit, even if their children don’t have SSNs. In this instance, they would get the smaller credit available to childless workers. In the past, these filers didn’t qualify for the credit.
  • Workers and Working Families – who also have investment income can get the credit. The limit on investment income is increased to $10,000 starting in 2021. After 2021, the $10,000 limit is indexed for inflation. The current limit is $3,650.
  • Married but Separated Spouses – can choose to be treated as not married for EITC purposes. To qualify, the spouse claiming the credit cannot file jointly with the other spouse, cannot have the same principal residence as the other spouse for at least six months out of the year, and must have a qualifying child living with them for more than half the year.

Expanded Child Tax Credit for 2021 Only
The new law increases the amount of the Child Tax Credit, makes it available for 17-year-old dependents, makes it fully refundable, and makes it possible for families to receive up to half of it, in advance, during the last half of 2021. Moreover, families can get the credit, even if they have little or no income from a job, business, or another source.

Prior to the taxable year 2021, the credit is worth up to $2,000 per eligible child. The new law increases it to as much as $3,000 per child for dependents ages 6 through 17 and $3,600 for dependents ages five and under. The maximum credit is available to taxpayers with a modified AGI of:

  • $75,000 or less for singles,
  • $112,500 or less for heads of household and
  • $150,000 or less for married couples filing a joint return and qualified widows and widowers.

Above these income thresholds, the extra amount above the original $2,000 credit — either $1,000 or $1,600 per child — is reduced by $50 for every $1,000 in modified AGI. Furthermore, the credit is fully refundable for 2021. Before this year, the refundable portion was limited to $1,400 per child.

Advance Child Tax Credit Payments
From July through December 2021, up to half the credit will be advanced to eligible families by the Department of Treasury and the IRS. These advance payments will be estimated from their 2020 return, or if not available, their 2019 return.

For that reason, the IRS urges families to file their 2020 returns as soon as possible – including many low-and moderate-income families who don’t normally file returns. Often, those families will qualify for an Economic Impact Payment or tax benefits, such as the EITC. This year, taxpayers have until May 17, 2021, to file a return.

To speed delivery of any refund, be sure to file electronically and choose direct deposit. Doing so will also ensure quick delivery of the Advance Child Tax Credit payments to eligible taxpayers later this year.

In the next few weeks, eligible families can choose to decline to receive the advance payments (more information about this, below). Likewise, families will also be able to notify Treasury and IRS of changes in their income, filing status, or the number of qualifying children using the IRS Child Tax Credit Update Portal.

Help is Just a Phone Call Away
For the most up-to-date information on these and other changes affecting your tax situation in 2021, don’t hesitate to contact the office below. With taxes becoming more complicated every year, it’s never too early to consult a tax and accounting professional for assistance.