Taxes are an unavoidable obligation that must be fulfilled each year. Preparing for it ahead of time makes it easy to file while procrastinating makes the process a lot more complicated. So, we would suggest start preparing now or at least stay up-to-date with tax regulations!
It’s important to note that the tax code is subject to changes every year. The amendments are reflected on Form 1040 of the tax return. Due to the COVID-19 pandemic, however, the legislative sessions were cut short in 2020. As a result, very few tax changes were implemented last year. Many of the tax changes that will be in effect from 2021 are a result of laws that were adopted in 2020 but weren’t put into effect.
In addition to the changes in Federal taxes discussed in this post, notable adjustments in state taxes have also been introduced in 26 states and the District of Columbia.
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If you want to know how your taxes will be different in 2021, keep reading.
1. Payroll Tax Deferral
If you’re self-employed or had household employees who are reported on Schedule SE and Schedule E, you’ll need to pay more attention to this calculation. Up till now, the calculation was simple. All you had to do was deduct any credits and payments from the taxes owed. This year, however, the COVID-19 relief bill gives employees the leverage to defer the payment and deposit the employer’s portion of the Social Security taxes. Hence, any payroll taxes that may have been deferred from March 27 to December 31, 2020, can be paid in half by December 31, 2021. The remaining balance can be paid by December 31, 2022. This applies to you if you’re a Schedule C filer.
2. Higher Standard Deductions in 2020
When you file your income tax return, you have the option to opt for standard deduction or itemize your deductions. Itemizing involves calculating your deductions one by one, which is more hectic. If your itemized deductions exceed the standard deduction amount, it’s worth going for the itemized deduction approach.
To adjust for inflation, the standard deduction increased slightly for the tax year 2020. Let’s examine the standard deduction situation for different filing statuses:
o Singles: Increased from $12,200 in 2019 to $12,400 in 2020
o Married Filing Jointly: Increased from $24,400 in 2019 to $24,800 in 2020
o Married Filing Separately: Increased from 12,200 in 2019 to $12,400 in 2020
o Head of Household: Increased from $18,350 in 2019 to $18,650 in 2020
Whether you should itemize or take the standard deduction approach depends on your individual case. To figure out what’s the best approach for you, consult an eCommerce tax service, such as Fully Accountable.
3. Tax Credits to Consider for 2021
If you have children, you can claim up to $2,000 per child with a child tax credit. Given that child tax credit is a refundable credit, you can get up to $1,400 per qualified child as a refund. Note that the income limits for this credit are $400,000 for married couples and $200,000 for single parents.
Similarly, the Earned Income Tax Credit (EITC) is another refundable credit available to low- and middle-income workers. The credit can save you hundreds of thousands of dollars, depending on your filing status and the number of children you have. Yet, around 1-in-5 eligible taxpayers don’t file their tax returns at all or don’t claim the credit on their taxes. Make sure you’re not one of them.
You might be eligible for earned income tax credit in the tax year 2020 if you earn up to $56,844.
4. Adjustment to Income through Charity
Thanks to the COVID-19 relief bill, taxpayers might be eligible to deduct their income by up to $300 for charitable contributions. This initiative was implemented to encourage US citizens to contribute more to charity during the COVID-19 outbreak. However, these contributions must be in the form of credit card payments, check, or cash. Also, you need to possess proper documentation for this.
On their federal tax returns, taxpayers normally have the right to write off tax-deductible charitable donations if they itemize deductions, not if they go for the standard deduction. The above-stated change allows you to deduct charitable contributions for the standard deduction, too. Plus, you’re subject to the $300 limit if you itemize deductions on your 2020 tax return. Furthermore, the proportion of cash contributions you can deduct has been increased from 60% to 100% of your adjusted gross income (AGI).
This reduction of income is beneficial because it lowers your adjusted gross income, also referred to as AGI, which affects various other aspects of your financial health. For example, the state-level programs and premiums of your Medicare Parts B and D are tethered to the AGI. Thus, with a lower adjusted gross income, you might be eligible for more state programs or reduced premiums.
Be sure to prepare your substantiating documents properly, especially receipts for charitable contributions. Also, you’ll need a letter of acknowledgment for contributions of $250 or more.
5. Retirement Plan Distributions Flexibility
For taxpayers impacted by the COVID-19 pandemic, distributions from their retirement account, including the IRA, are subject to flexibility. Contraction of the disease is not important. If your economic life has been disrupted, you’re considered to be impacted by the pandemic.
For instance, if you couldn’t find childcare due to the current situation, had to reduce your work hours or have been unable to work because you had to take care of your young children, you should qualify for the Retirement Plan Provision. The same can be said if you were laid-off, quarantined, or furloughed because of the pandemic.
The tax implications are enormous when the taxpayer self-certifies to these facts. The distribution you take will be spread over 3 years, i.e., you can repay the amount over 3 years while avoiding taxation. Plus, if you’re under the age of 59, you won’t have to pay a 10% penalty.
However, make sure you maintain proper documentation. As you’re going to self-certify that you’ve been impacted, you’ll need notes describing your situation, notices from employers, and any medical records.
6. An Emphasis on Cryptocurrencies
The Department of Treasury is largely focused on cryptocurrencies this year. It has issued guidance on how they are to be treated and issued a warning to taxpayers that may not be reporting their transactions correctly. The government does have an infrastructure in place to trace your virtual currency transactions.
Hence, one of the most significant questions you’ll come across will be whether you received, sold, sent, exchanged, or acquired any financial interest in a virtual currency at any time during 2020. When answering this question, keep in mind that you’re signing the tax return under penalties of perjury. If you’re found guilty, you may be sentenced to up to 5 years in prison.
7. Higher Income Brackets
Another aspect of how your taxes will be different in 2021 includes income brackets. Because of inflation, tax brackets change every year. While the tax rates haven’t been changed for the 2020 tax return, the amounts in tax brackets have been adjusted to factor in inflation. According to the IRS, the income brackets for single filing status in 2020 include:
| Tax Rate | Taxable Income on Which Tax is Applicable |
| 10% | $9,875 or less |
| 12% | Between $9,875 and $40,125 |
| 22% | Between $40,125 and $85,525 |
| 24% | Between $85,525 and $163,300 |
| 32% | Between $163,300 and $207,350 |
| 35% | Between $207,350 and $518,400 |
| 37% | More than $518,400 |
The 2020 income tax rates for married couples filing together include:
| Tax Rate | Taxable Income on Which Tax is Applicable |
| 10% | $622,050 or less |
| 12% | Between $414,700 and $622,050 |
| 22% | Between $326,600 and $414,700 |
| 24% | Between $171,050 and $326,600 |
| 32% | Between $163,300 and $207,350 |
| 35% | Between $207,350 and $518,400 |
| 37% | More than $518,400 |
8. Unemployment Insurance Benefits
In response to the unprecedented increase in unemployment, to a peak rate of 14.8% in April 2020, lawmakers significantly raised payments of unemployment insurance benefits. These include an additional compensation of $600/week between March 28th and July 30thas part of the Federal Pandemic Unemployment Compensation (FPUC) and a benefit of $300/week granted through executive action.
The US Department of Labor reports that unemployment benefits increased from $6.4 billion in the 4th quarter of 2019 to $64.2 billion in the 2nd quarter of 2020 and $48.7 billion in the 3rd quarter of 2020. These unemployment benefits, along with others, supported American incomes during the year and are regarded as taxable income.
Taxpayers should have correctly withheld taxes from their unemployment benefits so as to avoid an unexpected tax bill when filing their returns. While a taxpayer filing their federal income tax return can opt into a 10% withholding rate, it’s not required. Also, taxpayers can remit taxes on a quarterly basis over the year.
A large number of taxpayers have not saved or withheld tax owed on unemployment benefits. When they file for the 2020 tax year, they might see an expectedly high tax liability as a result.
9. Tax Refund Changes
Many return filers want to learn about the tax refunds heading into tax season. The combination of tax and economic policy circumstances can impact refunds for all taxpayers.
In an economic recession, taxpayers have lower incomes and tax policy stimulus that go into refund amounts, so refunds will most likely be affected. Let’s take a look at the past. At the time of the Great Recession, refunds saw a drastic increase from $250 billion to $335 billion between 2007 and 2009 and then stayed flat for the next few years. The average tax refund also surged from $2,200 to $2,600 between 2007 and 2009 before coming down to $2,200 in 2016. For returns filed in those years, the share of returns with a tax refund remained stable around 75% to 80%.
Coming back to 2020, refund levels were considerably high as compared to recent tax seasons. By September 2020, around 9 million individuals eligible for an economic impact payment hadn’t received one. Plus, many individuals did not receive a second-round stimulus payment. To receive this, they must indicate this on their return.
These payments will greatly increase the refunds. Many people who don’t normally file their tax returns are expected to file this year to claim these payments.
The tax credit adjustments can also help sustain refund levels for taxpayers with low incomes. The cost of this adjustment is around $4 billion, which is close to 1% of the tax refunds processed in 2019.
What’s expected to act as a downward force on tax refunds is the increase in unemployment insurance claims. This is because filers who have not properly withheld tax over the year may have additional tax owed. During the Great Recession, however, the same problem was not big enough to offset the opposing trend pushing refunds up.
10. Social Security Payroll Taxes
As a piece of bad news for some filers, there’s now a higher cap on Social Security payroll taxes. The maximum amount of an employee’s income that’s subject to SS payroll taxes rose from $132,900 in 2019 to $137,700 in 2020.
Closing Thoughts
In summary, given the challenges presented by the COVID-19 pandemic, the 2021 tax year will be quite different. After going through this article, you should have a clear idea of how your taxes will be different in 2021.
To file your tax returns correctly in 2021, you should have proper sets of accounts, summarizing your financials. To seek assistance in taxation and/or accounting, talk to an expert from Fully Accountable. If you wish to learn more about how your taxes will be different in 2021, feel free to schedule a 30-minute strategy call.
Chris Giorgio is the President of Fully Accountable. Fully Accountable is an outsourced accounting firm specializing in eCommerce and digital businesses. Chris has served as a CPA, CFO and has over 14 years of experience in the accounting and finance industry. Chris has dedicated his career towards helping entrepreneurs and high-level business owners achieve greater profitability through specialized outsource accounting functions.
