COVID Stimulus #2 and Personal Tax Planning Strategies

Jan 11, 2021

Curious to know how the second round of Coronavirus stimulus can provide you some personal income tax relief? It's not all stimulus checks and PPP2. Did you know that you can carry forward unused Flexible Spending Account balances? Or, that the Lifetime Learning Credit was improved and you can deduct up to 100% of your AGI for qualified charitable donations? You can do all that and more.

The Consolidated Appropriations Act, 2021, was signed into law on December 27, 2020. The $2.3 trillion bill combined COVID stimulus relief ($900 billion) with the fiscal year 2021 federal omnibus spending bill ($1.4 trillion). Along with the allocation of spending dollars, the following explains a few of the benefits for taxpayers that were also included.

Flexible Spending Account (FSA) Balance Carryforward

Flexible Spending Accounts (FSA), offered by many employers, are a valuable tax-saving tool that allows you to put pre-tax money aside for medical expenses and dependent care. Individuals can contribute $2,750 to a Health FSA and $5,000 (individuals or married filing joint) to a Dependent Care FSA. The catch is, the Flexible Spending Account is a "use it or lose it" tax strategy. Dollars remaining in the account could be subject to forfeiture at the end of the year.

What happens if you didn't need childcare in 2020 and you put $5,000 in your Dependent Care FSA? If allowed by your employer, you can rollover (or carryforward) any 2020 dollars in your Health or Dependent Care FSA to 2021. It even extends the rollover of 2021 FSA money to 2022.

Improved Lifetime Learning Credit Replaces Tuition and Related Expense Deduction

The Lifetime Learning Credit is available annually for an unlimited number of years and can be used for undergraduate, graduate, or professional degree tuition expenses. The credit amount is equal to 20 percent of the taxpayer's first $10,000 of qualified out-of-pocket tuition and related expenses and maxes out at $2,000 per year. If the taxpayer is claiming an American Opportunity Credit for a student, none of that student's expenses for that year can be applied toward the Lifetime Learning Credit.

The phase-out of the Lifetime Learning Credit now mirrors the American Opportunity Credit. The credit amount is phased out between $160,000 to $180,000 of modified adjusted gross income (MAGI) for married filing jointly taxpayers, or $80,000 to $90,000 for individuals.

CARES Act Charitable Contribution Changes and Extensions

The CARES Act, passed in March 2020, allowed taxpayers using the standard deduction to take an above the line deduction for up to $300 in cash donations to qualified charities. This $300 cap applies to both individual and married filing joint taxpayers. The above-the-line deduction is extended to 2021; however, married filing joint taxpayers can claim a deduction up to $600 (2021 only).

Also extended into 2021 is the ability to deduct up to 100% of AGI for cash gifts to qualified charity(ies). The donation must be made in cash and sent directly to the public or private charity (donor-advised funds do not qualify).

Medical Expense Deduction of 7.5% of AGI Restored

Taxpayers are allowed to deduct qualified, unreimbursed medical expenses that exceed a percentage of AGI on Schedule A. Over the past several years, the percentage amount has changed from 7.5% to 10% and sometimes included age limits. The new act restored the deductibility of all qualified, unreimbursed medical expenses exceeding 7.5% of AGI for year 2021 and all future years – until the law changes again.

Earned Income Credit and Additional Child Tax Credit

An earned income threshold must be met to qualify for the Earned Income Credit and the Additional Child Tax Credit. However, for many working taxpayers, income has dropped due to the pandemic, and they no longer have sufficient income to qualify for these credits. In some cases, even though their income is reduced, their tax liability could be higher! The Consolidations Appropriations Act of 2021 allows you to use your 2019 earned income to qualify for these tax credits on your 2020 federal tax return.

What About Required Minimum Distributions?

There was no mention of suspending required minimum distributions for 2021, so be prepared to resume RMDs in 2021.

Summary

After months of debate, Congress finally passed round two of economic relief. Ensure that you review your tax situation and take advantage of any options available to you in The Consolidated Appropriations Act of 2021.

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