New Stimulus Law Grants Eight Tax Breaks for 1040 Filers
The new, massive stimulus bill enacted into law on December 27, 2020, contains eight new tax breaks designed to help the non-business taxpayer. None of these tax breaks are earthshaking by themselves, but together they add up to a nice tax present for COVID-weary Americans.
1. Enlarged Universal Charitable Contribution Tax Deduction
Ordinarily, charitable contributions are deductible only if you itemize your personal deductions on IRS Schedule A instead of taking the standard deduction. In the past, about 30 percent of taxpayers itemized. Today, only about 10 percent itemize because the Tax Cuts and Jobs Act roughly doubled the standard deduction. Thus, today the vast majority of individual taxpayers don’t get any tax benefit from charitable contributions.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act attempted to ameliorate this state of affairs and thereby help struggling charities that rely on donations. It added a new $300, universal, above-the-line charitable deduction for cash contributions by non-itemizers to tax-qualified charities during 2020. Unfortunately, this deduction came with a marriage penalty: it was the same for single and joint filers. The Taxpayer Certainty and Disaster Tax Relief Act of 2020 extends this deduction to 2021 and eliminates the marriage penalty: the deduction is $600 for married non-itemizers who file jointly, but for 2021 only. Interestingly, the new law also adds a special 50 percent penalty for taxpayers who cheat by taking this deduction without actually making the cash contributions they claim on their return.
2. Extension of CARES Act Elimination of AGI Limit on Charitable Contributions
Under regular tax rules, the amount of charitable cash contributions taxpayers can deduct on Schedule A as an itemized deduction is limited to 60 percent of the taxpayer’s adjusted gross income (AGI). The CARES Act increased this deduction to 100 percent of AGI for cash deductions to qualified charities (not including donor advised funds). But this increase was for 2020 only. The Taxpayer Certainty and Disaster Tax Relief Act of 2020 extends this 100 percent of AGI charitable deduction to 2021.
Planning point. It’s rarely a good tax planning strategy to donate an amount equal to 100 percent of your AGI.
3. Lengthened Payroll Tax Deferral Repayment Period
Back in August, President Trump signed an executive order allowing employers to defer withholding the employee portion of the Social Security tax due for September through December 2020. The deferred amount would then be withheld from the employees’ pay during January through April 2021.
The idea was to increase employee take-home pay during these months (the employee Social Security payroll tax is 6.2 percent of up to $137,700 in wages during 2020). Compliance with the order was purely voluntary, and few private employers took advantage of the deferral. But the tax deferral was made mandatory for most federal and military employees. The COVID-related Tax Relief Act of 2020 allows employees who had their Social Security taxes deferred to pay them back by December 31, 2021, instead of by April 30. Payments are to be made ratably during these months.
This will give these employees a bit more take-home pay during January through April, but a bit less for the remainder of the year.
4. 7.5 Percent AGI Floor for Medical Expense Deduction Made Permanent
Medical expenses are deductible as a personal itemized deduction only if, and to the extent, they exceed a percentage of the taxpayer’s AGI. For several years, this AGI floor has fluctuated between 10 percent and 7.5 percent of AGI. The rate is 7.5 percent
of AGI for 2020, and before the new law, it was scheduled to go up to 10 percent for 2021 and later. The Taxpayer Certainty and Disaster Tax Relief Act of 2020 makes the 7.5 percent of AGI floor permanent. This makes it a bit easier for taxpayers who itemize to deduct their medical expenses.
5. Flexible Spending Account Carryovers
Under regular tax rules, employees who have health flexible spending accounts (FSAs) may carry over a maximum of $550 of unused funds in the account to use the following year. The Taxpayer Certainty and Disaster Tax Relief Act of 2020 allows employees to carry over any unused 2020 balances in their health FSAs to 2021. Moreover, any remaining balance at the end of 2021 may be carried over to 2022.
Planning point. Employers are not required to allow such carryovers in their FSA plan; it’s purely voluntary for the employer.
6. Earned Income Tax Credit and Child Tax Credit
Two of the most important federal programs that benefit the working poor are the earned income tax credit (EITC) and the child tax credit (CTC). The EITC and the CTC are based on a taxpayer’s family size and earned income. The more earned income, the larger the credits, subject to maximum limits. But due to the COVID-19 pandemic, the earned income of many low-income taxpayers declined dramatically during 2020. This would ordinarily result in a reduction in their EITC and CTC credits—up to an 80 percent decrease for some taxpayers.
For purposes of the EITC and the CTC only, the Taxpayer Certainty and Disaster Tax Relief Act of 2020 permits taxpayers to substitute their earned income for 2019 if it is greater than their earned income for 2020. This will result in larger tax credits for these low-income taxpayers.
7. Educator Expense Deduction Includes PPE
Teachers of kindergarten through grade 12 may take an above-the-line deduction of up to $250 for books, supplies, and other equipment they purchase with their own money for use in the classroom.
The COVID-related Tax Relief Act adds to this deduction expenses for personal protective equipment (PPE), disinfectant, and other supplies used to prevent the spread of COVID-19. Only PPE and supplies purchased after March 12, 2020, qualify. The deduction remains a maximum of $250.
Note that the educator expense deduction is not available for homeschoolers, including parents who are teaching their children at home during the pandemic. It’s only for professional educators who work at least 900 hours during the school year.
8. Goodbye, Tuition and Fees Deduction—Hello, Expanded Lifetime Learning
The tax code contains a bewildering array of deductions and credits for higher education, including the American opportunity tax credit, the lifetime learning credit, and the tuition and fees deduction. The tuition and fees deduction16 is being allowed to expire at the end of 2020. In its place, the Taxpayer Certainty and Disaster Tax Relief Act of 2020 is making the lifetime learning credit available to more taxpayers by increasing the phaseout range for the credit.
The 2020 lifetime learning credit phaseout range is $59,000 to $69,000 for single filers, and $118,000 to $138,000 for joint filers. Beginning in 2021, the lifetime learning credit phaseout range will be $80,000 to $90,000 for single filers, and $160,000 to $180,000 for joint filers. This is the same as the American opportunity tax credit phaseout range.
The main purpose here seems to be to simplify the tax code by reducing the number of education-related tax benefits taxpayers have to deal with. Also, the lifetime learning credit is better than the tuition and fees deduction because it’s a tax credit, not a deduction. Unlike a deduction, which reduces only your taxable income, a credit is a dollar-for-dollar reduction in
tax. The lifetime learning credit offers a credit of 20 percent of up to $10,000 in education expenses, for a maximum credit of $2,000.
The tuition and fees deduction allows you to deduct a maximum of $4,000 above the line ($2,000 if your AGI is over $65,000 if single, or over $130,000 for joint filers). Even if you were in the top bracket (37 percent), a $4,000 deduction would save only $1,480 in tax (but you can’t qualify for this deduction at all if your income is high enough to be in the 37 percent bracket).
The new stimulus law contains eight new tax breaks that enable you as an individual taxpayer to do the following:
Deduct cash contributions to charity if you don’t itemize.
Deduct up to 100 percent of your AGI as a charitable deduction.
Lengthen to one year the time you have to repay your employee 2020 Social Security taxes if you had them deferred.
Deduct medical expenses that exceed 7.5 percent of your AGI in 2021.
Carry over unused flexible savings account funds to next year.
Use your 2019 income to qualify for the EITC and/or CTC if you’re a lower-income taxpayer.
Deduct out-of-pocket expenses for PPE if you’re a teacher.
Take advantage of the lifetime learning credit if you’re a higher-income taxpayer in 2021.