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As everyone is undoubtedly hearing in the news, on March 11th, President Biden signed the American Rescue Plan (ARP) into law. There are a lot of components of the ARP, but I wanted to give our clients and contacts an update on the ARP. This will cover some of the individual-related aspects of the ARP while you can click here for the business side update. Obviously, there are a lot of details we are still learning about, and even more items in the ARP are not covered here, but we hope this provides you some insight at a high level.
Stimulus Payments, Round 3
This is the one that gets all the play in the news, so hopefully, you have heard about it. In fact, there is speculation that the processing of these payments will begin by the weekend of March 13th– possibly when you are reading this article. The third round of stimulus payments (technically, economic impact payments) will be $1,400 per qualified individual. This is on top of the prior two stimulus payments, which were up to $1,200 and $600 each. However, there are some important differences to be aware of here with Round 3:
- Qualifications: If income is below $75,000 for individuals, $150,000 for those Married Filing Jointly (MFJ), and $112,500 for Head of Household (HOH), you will receive the entire $1,400 stimulus payments.
- Dependents: Unlike the prior stimulus payments, all dependents appear to qualify for the $1,400 stimulus, even older children who may be in college, for example.
- Phaseout: The income phaseout is very short as follows:
- $75,000 to $80,000: Individuals (Single/Married Filing Separate)
- $150,000 to $160,000: Married Filing Jointly
- $112,500 to $120,000: Head of Household
- Base Year: The base year is essentially the most recent tax return on file with the IRS. If you have already filed 2020, that will likely be the base year they use. If you have not filed 2020, then the 2019 filing will be utilized.
The $1,400 stimulus payments are supposed to be paid out in two phases this time around. The first phase will be quick, so for many, it will be based on their 2019 tax filing (or 2020 if you have filed previously). However, if you do not qualify based on your 2019 filing, the IRS will do the second phase of advance payments, which is the earlier of September 1st or 90-days after the tax deadline. This means if you do not get your round 3 stimulus payment on phase 1, we do not have to scramble to get your filing in…your stimulus payment will still come during 2021, hopefully.
A few other items that usually come up are:
- No, the stimulus payments are not taxable,
- Yes, this third round is an advance payment of a 2021 credit,
- No, you do not have to pay it back even if when you file your 2021 tax return, you do not meet the income thresholds, excluding cases of fraud obviously, and
- Yes, if you do not receive an advance payment of the stimulus during 2021, you can claim it on your 2021 tax filing.
This brings about multiple planning opportunities that we need to be aware of, including:
- Timing: We may want to delay filing your 2020 tax return if your income went up in 2020 compared to 2019. Or we may want to hurry up and file your 2020 taxes if your income dropped and now you are eligible.
- Dependent Planning: Depending on the age and situation with your dependents, we may want to consider the timing of when 2020 tax filings are completed.
- IRA Contributions: Depending on income levels, contributing to a deductible IRA or SEP IRA may be even more advantageous for those who qualify.
- Filing Status: It may be worth the time to re-look at filing status opportunities to see if possible Married Filing Separate (MFS) creates some benefits.
Taxation of Unemployment Benefits
A lot of folks have been supported by unemployment payments during the pandemic. Too many do not realize that unemployment is taxable by the IRS. By the way, California does not tax unemployment, but most other states actually do. I have been advocating since the beginning that the IRS should not tax at least the federally funded pandemic portion of unemployment benefits as it is being paid by the federal government and then the same federal government is essentially asking for a portion of it right back. Well, they actually listened, or at least partially….
For 2020 only, up to $10,200 of unemployment is tax-free for those with income below $150,000. This income cut-off is a “cliff,” meaning that $149,999 applies while $150,001 does not. Yes, that is an expensive $2, which is why most of us in the tax world do not like cliffs but rather phaseouts. Regardless, that is what Congress approved. This is a per tax filing $150,000 income threshold, so the same applies to single, married filing jointly (MFJ), married filing separately (MFS), and head of household (HOH). Further, the $10,200 exemption is per person and not per tax return, so if you are married, each spouse can have $10,200 of exemption.
This brings up some very interesting planning opportunities, including:
- Filing Status: A further dive into consideration of MFS status to take advantage of the $150,000 income threshold per filing.
- Community Property: For those in a community property state like California, shoring up on our rules for community income, especially as it relates to filing status comparisons.
- IRA Contributions: Looking at utilizing a deductible IRA to possibly get below the $150,000 cliff.
- SEP IRA contributions: Looking further at utilizing a SEP IRA contribution for those who may have self-employment income.
- Business Planning: Further exploring business income reduction strategies.
This obviously creates some logistical challenges since this is a retroactive change to 2020 during the middle of the filing season. We may need to amend previously filed 2020 tax filings. Additionally, we will need to wait to file some others in order to have updated forms to properly exclude the unemployment income. There are still some questions out there on this, so we will likely be taking the slow route on finalizing up filings that may be impacted.
Pandemic Unemployment Extension
The expanded pandemic unemployment benefits set to expire on March 14th have been extended through September 6th at a level of $300 per week, which is a reduction of the prior $400 per week. As a reminder, your 2021 unemployment compensation is taxable. The above $10,200 tax-free unemployment provision is a 2020 provision only. Additional legislation would be required to change the taxation of these benefits in 2021.
Premium Assistance Tax Credits (2020)
For those who received advance premium assistance tax credits, which are essentially subsidies to assist in paying for health insurance on the state exchange, they will not be required to pay back any excess advances received. In cases when an advance subsidy is received, and income is above what was previously used to calculate the advance, the excess generally is paid back on that year’s tax filing. This can catch a lot of folks by surprise. ARP though, removes the clawback of the overpayment for the 2020 tax year. Yes, this means some may need to amend their tax filings or delay filing them in order to allow forms and software to catch up to the changes.
Child Tax Credit (2021)
ARP expands our current Child Tax Credit (CTC) from the existing $2,000 per child under the age of 17 up to $3,600 for children under 6 years of age and up to $3,000 for children aged 6 to 17. Age determinations are made as of December 31, 2021. There is a slight age change here for 2021 also due to ARP. The existing CTC was for children under age 17 (i.e. 16 or under), while for 2021, ARP changes the qualification to include children who are 17 years of age on December 31, 2021. Another aspect that will help some families is the CTC is now fully refundable for 2021.
It is important to note that additional CTC only applies to 2021 and does not impact 2020 or future years. Obviously, Congress can choose to expand this in the future also.
Further, just like a lot of tax benefits, there are income limits for the expanded portion of the CTC. The phaseout is set to start at $75,000 for single/HOH/MFS filers and $150,000 for MFJ filers at the rate of reducing the CTC by $50 for each $1,000 above the phaseout range.
Additionally, in an apparent effort to get money into parents’ hands earlier, they will payout 50% of the CTC from July through December of 2021.
WARNING: Unlike the stimulus payments, though, the advance payment of the 2021 CTC will be reconciled on the 2021 tax return. This means if you receive the CTC advance but do not qualify for it based on your 2021 tax filings, you will pay it back. This means if you get these payments, but your income is increasing, your filing status is changing, or your dependents may be changing due to life circumstances, please be aware that you may be paying the advance back come tax time next year. There are some guardrails based on prior filings to help lessen the impact of this, but it is something to be aware of.
Dependent Care Credit
ARP is also expanding the benefits for those who pay for child care by expanding the Child and Dependent Care Credit (CDCC) for those that qualify. Without going into too much detail here, the maximum CDCC appears to be moving from $1,050 for those with one qualifying child up to $4,000 while moving from $2,100 up to $8,000 for those with 2 or more qualifying children. This is a huge jump, as you can see, almost a four-fold increase.
Those who will reap the majority of the increased CDCC will be those whose income is below $125,000, with the benefits decreasing as income increases. Those who have income above $440,000 will no longer receive the CDCC.
Another important change to note is that the CDCC will now also be refundable, which means it can reduce your tax to zero and generate a refund…on top of the stimulus payments and the CTC, as discussed above.
Student Loan Forgiveness
In general, if you have a debt forgiven, that is taxable income. ARP specifically allows for student loan debt forgiven from December 30, 2020, and January 1, 2026, to be exempt from federal income tax. This may not have a huge impact today but is likely just setting the stage for more targeted discussions about possible student debt forgiveness at the federal level.
Disclaimer: This is all new to us also, so please be patient as interpretations of ARP will inevitably evolve as we get a better understanding of the details.
We’re Here to Help
If you have questions about how the ARP might apply to your individual tax situation, feel free to reach out to me at firstname.lastname@example.org or click here.