Updated: Jan 26, 2021
Though 2021 will inevitably bring surprises, what do we know about taxes right now?
With the start of the new year, it’s about time for all of us to be thinking about organizing W-2s, 1099s, and all the other documents needed for filing 2020 taxes. There may be some opportunity for a few of you to influence your 2020 taxes, but, at this point, the only thing left for the majority is to report last year’s events appropriately (and hope that all those payments you made throughout the year were sufficient). For most of you, it’s time to look ahead in your planning for 2021 #taxes.
While it seems that there is a lot up in the air at the moment – politics and pandemic, for starters – the IRS has stuck to their schedule of releasing important adjustments for 2021 taxes. These numbers have actually been public for some time (since October 26), so be sure to process this information soon if you haven't already.
Just as a reminder, we are currently under a tax code governed by the Tax Cuts and Jobs Act of 2017 (“TCJA”). The TCJA reformed much of the tax code, including – but not limited to – tax brackets, income thresholds, estate taxes, and business deductions. While it’s scheduled to sunset at the end of 2025, it’s certainly possible that congress reforms the tax code sooner. For the time being, though, we still operate under this Act.
Let’s start with something that isn’t changing – the tax rates. For 2021, the tax rates remain constant, meaning that rates will be calculated as 10% > 12% > 22% > 24% > 32% > 35% > 37%
(37% being the top rate which applies to any income over $628,300 for couples married filing jointly; $523,600 for single taxpayers and heads of households; $314,150 for couples Married Filing Separately). Just so we don’t overlook the fundamentals, remember that these are progressive tax rates. This means that even though your income puts you in the 37% bracket, that percentage only applies to income earned above $523,600 – not to the entire income. That first $19,900 earned (for couples MFJ) is only taxed at 10%.
What has changed, however, is the income thresholds in these tax brackets. The IRS has adjusted each of these brackets up to account for cost-of-living adjustments. Below is a chart which sums up the 2021 brackets:
2021 Tax Brackets
The IRS decided, once again, to increase the #StandardDeduction. It's increased to $25,100 for married couples filing joint returns (an increase of $300 from 2020) and $12,550 for single taxpayers and couples filing separate returns (an increase of $150). Heads of households also got a slight $150 increase, up to $18,800.
There are a few nuances to the standard deduction, including provisions for individuals who are blind or aged, as well as for those who can be claimed as a dependent on another’s tax returns. From a planning perspective, what’s interesting about this Standard Deduction (which was dramatically increased as part of the TCJA) is its effect on itemized deductions.
Individuals who have historically claimed #ItemizedDeductions due to the interest paid on their mortgage and/or charitable contributions now find it difficult to claim additional tax benefits from those expenses given that the Standard Deduction is so high. While we’ve been aware of this headwind from the date the TCJA was released, we at Cairn have noticed that not a lot of people have done much about it. There are some ways to be creative with your charitable-gift planning which might allow you to recognize those itemized deductions less frequently while relying on the standard deduction every other year. In specific terms, donating twice as much to a charity every other year (either directly or through some type of Donor Advised Fund) might tip the Itemized-Deduction scales over the Standard Deduction threshold on those years, then allowing you to rely on the standard deduction on those non-gifting years. And, of course, for those over age 70 and a half who are subject to RMDs, don’t overlook the importance of Qualified Charitable Distributions (QCDs) which allows you to fulfill your RMD requirement and claim the tax deduction for the full distribution.
Long Term Capital Gains tax rates are designed to be lower than a taxpayer’s ordinary income tax rate. On top of that, Long Term Capital Gains have three brackets, different from the seven that ordinary income has.
Long-Term Capital Gains & Qualified Dividend Rates
Unfortunately, the IRS decided that most retirement plan contribution limits were not in need of adjusting this year. That means that deferral limits for your 401(k), 403(b), and 457 plans (as well as the government's Thrift Savings Plan, or “TSP”) will remain at $19,500. The catch-up provision extended to employees age 50 or older will also remain at $6,500, allowing those employees to contribute up to $26,000 in 2021. It should be noted that the same limits apply if your employer offers an after-tax “Roth” version of these accounts.
SIMPLE retirement plans’ limitations will also remain at $13,500, but there is one bit of good news applicable to those with Simplified Employee Pension IRA (“SEP”) plans. Those SEP IRA limits increased by $1,000 in 2021 to a maximum of $58,000.
For the truly individual retirement accounts – Traditional IRAs and Roth IRAs – the maximum contribution also remains steady at $6,000/person with catch-up provisions of an additional $1,000 for individuals over age 50. What has changed for IRA planning, though, is that the income phase-out levels have adjusted upwards (slightly).
For those ineligible to make Roth IRA contributions in 2021, the “back door Roth IRA” remains an effective strategy of getting money into a Roth IRA through a conversion instead of a contribution.
The last thing to note about retirement plans going into 2021 is that the special tax provisions enacted as part of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act applied ONLY in 2020 (barring further legislation). Specifically, the waiver for required minimum distributions (“RMDs”) from plans will not be effective in 2021, nor will other liberalized rules on certain distributions and loans from retirement plans.
Estate Tax Allowance will increase to $11,700,000 (from $11,580,000) in 2021 even though the Gift Tax Exclusion remains constant at $15,000. For those wishing to gift more than $15,000 (per grantor per recipient), be sure to file a gift tax return, including IRS Form 709 to disclose this gift. Note that this annual exclusion is applied per recipient (rather than the sum total of gifts).
Fortunately, not much has actually changed (yet) for taxes in 2021! That means unless/until we are handed an update to the Internal Revenue Code, you can continue to refine your tax-planning as you have been doing the last few years under the TCJA. Many people anticipate that the TCJA may be amended before the scheduled sunset date (at the end of 2025). However, at this point, the anticipation is purely speculation.
Seek proper guidance. Act on what you know. Don’t let the noise distract you from your plan.