5 New Tax Opportunities for 2021

The Consolidated Appropriations Act, 2021, made changes late in 2020 that mainly affect 2021 and later years. Some changes may impact your 2020 return; others apply for 2021 and later years. Taken as a whole, tax implications for 2021 may be significant.

1.     Savings opportunity on your 2020 return

If you are eligible for the earned income tax credit and/or the child tax credit, you may choose to use your 2019 income in figuring your 2020 credits. This election may be beneficial if your income from 2019 creates a larger credit amount.

2.     Take advantage of employee benefit offerings

In 2021, employers can continue to offer student debt loan repayment through education assistance plans. The dollar limit continues to be capped at $5,250. This is a tax-free fringe benefit that continues to be available through 2025.

If you can participate in an employer-sponsored medical and/or dependent care flexible spending arrangement (FSA), you’ll have more flexibility in 2021. You’ll be able to make mid-year changes (e.g., electing in, opting out, or changing your salary reduction contribution going forward). In addition, you’ll have more access to unused funds (essentially ending the use-it-or-lose it feature for FSAs).

• If the plan has a grace period, it’s going to run through the end of the year (not merely to March 15).
• If the plan allows a dollar amount carryover, instead of being capped at a set amount (which would have been $550), you can carry over all unused amounts.
• If you leave the job, you can continue to receive reimbursements through the end of the year.

3.     Disaster relief assistance

Taxwise, you may enjoy some tax breaks if you are a resident in a disaster area. This applies to federally-declared disasters from January 1, 2020, through February 25, 2021. This means savings on your 2020 or 2021 return, depending on the date of the disaster. This tax relief includes:

• Claiming a net disaster loss for personal-use property not fully or partially covered by insurance. This applies even if you claim the standard deduction.
• Receiving a disaster loss distribution from a qualified retirement plan or IRA. You can spread the distribution ratably over three years to minimize the tax cost, and there’s no 10% early distribution penalty. What’s more, you can repay the distribution within three years and recoup the taxes that were previously paid on the distribution.

4.     Deducting medical expenses

If you itemize your out-of-pocket medical expenses, the costs must exceed a set percentage of adjusted gross income (AGI). For 2020, it’s 7.5% of AGI. The percentage had been scheduled to rise to 10% of AGI in 2021, but the new law has made the 7.5% of AGI threshold permanent. This applies regardless of age.

5.     Help for homeowners

If you buy a home in 2021 and use mortgage insurance to swing the deal, you can deduct the premiums as home mortgage interest as long as your income is below set limits. This tax deduction had been set to expire at the end of 2020, but has been extended for one year.

If you make certain improvements to your home, you may claim a tax credit. The nonbusiness property tax credit for adding insulation to your principal residence or making certain other energy improvements has been extended for one year, through 2021. However, there is a lifetime cap on the credit of $500, so if you’ve previously used it, you’re now out of luck.

If you cannot pay your mortgage and the lender forgives it in 2021, you aren’t taxed on this cancellation of debt. Again, this break was supposed to expire at the end of 2020, but it has been extended for five years. However, previously the exclusion from gross income applied to up to $2 million of debt; now it’s capped at $750,000.

Conclusion

The 2021 tax season for filing 2020 federal income tax returns is imminent. Pay attention to new opportunities that may reduce your 2020 tax bill or lower your tax obligation for 2021, including reduced estimated tax payments.