On March 11th, President Joe Biden signed into law the American Rescue Plan Act. The $1.9 trillion legislation includes a number of provisions aimed at stimulating the U.S. economy and the bill represents the largest aid package passed since the start of the coronavirus pandemic in March 2020. As a result of the legislation, there are a number of financial planning opportunities for individuals and families to consider in 2021. Before we dive into these opportunities, let’s take a closer look at some key provisions in the new legislation:
The American Rescue Plan Act is the first COVID relief bill to come from the Biden Administration, and the relief package includes $1,400 checks for individuals making less than $75,000 annually and $2,800 for married couples or joint filers making less than $150,000. The legislation also provides a stimulus check if you have dependents. The stimulus payments will include an additional $1,400 payment for each dependent. Each stimulus check will be sent by either direct deposit or by mail. In terms of income limit, the stimulus checks will begin to phase-out for individuals and families making more than the income thresholds specified above and will be completely phased out for individuals making more than $80,000 and for married couples earning more $160,000. Income limits are based on the most recent tax filing with the IRS. For example, if a taxpayer has already filed a 2020 return, the stimulus check will be based on their 2020 filing. If the taxpayer has not filed a 2020 return, the stimulus check will be based on their 2019 filing. For taxpayers who are ineligible based on 2019 or 2020 income; but, experience a drop in income in 2021, the taxpayer can claim a credit on their 2021 tax return.
The recently passed COVID-19 relief bill also makes meaningful changes to tax credits for children in 2021. Namely, the bill raises the $2,000 Child Tax Credit to $3,000 for children ages 7 -17 and $3,600 for children under age 6. The increased tax credit is available based on similar income thresholds as the stimulus checks. That is, the increased credit is fully available for married couples making less than $150,000, head of household taxpayers making less than $112,500, and single filers making less than $75,000.
In addition to the child tax credit, the American Rescue Plan significantly increases the child and dependent care tax credit for 2021. The legislation increases the eligible expenses from $3,000 to $8,000 for one child and from $6,000 to $16,000 for two or more children. Additionally, while prior year credits were capped at 20% of eligible expenses for most taxpayers, in 2021, taxpayers earning under $125,000 are able to claim a credit for 50% of eligible expenses. Taxpayers earning more than $125,000 will see their credit value phase out to 20% of eligible expenses. A change to the legislation in 2021 for taxpayers earning greater than $400,000 is that there will be a new phase-out of eligible expenses such that taxpayers with greater than $440,000 of income are unable to claim the credit at all. If you are wondering, “which tax bracket am I in?” read our blog to learn more.
Nearly 7% (Approximately $123B) of the funding allocated in the new legislation will be spent on COVID-19 related policies. These policies include items such as testing and contact tracing, COVID-19 vaccine distribution, and medical supplies.
Nearly 19% (Approximately $360B) of the funding allocated in the new legislation will provide aid to local and state governments.
The final bill extends the $300 enhanced Federal unemployment benefits that were set to expire on March 14th, 2021 through September 6th, 2021. Additionally, for households making less than $150,000 the first $10,200 of unemployment benefits are non-taxable.
While there are a number of planning opportunities that arise from the new legislation, we will focus on a few key opportunities. As indicated above, many of the taxpayer benefits provided by the new legislation are tied to income thresholds. For example, both the stimulus checks and the enhanced childcare tax credits are tied to an income threshold of $150,000 for married couples. Income above $150,000 results in phase-outs for both of these benefits. Accordingly, taxpayers with income levels near the thresholds described above may benefit from tax planning strategies to ensure that they are eligible for the enhanced provisions set in the American Rescue Plan Act.
For example, a family of four making $165,000 annually with two children ages 8 and 13 would be completely phased out of a stimulus check/recovery credit and would have their enhanced child tax credit reduced by $750 due to phase-outs. In 2021, if the same family decided to contribute $15,000 pre-tax to an employee sponsored retirement plan (such as a 401(k) or 403(b)), the family’s reportable income drops to $150,000 ($165,000 – $15,000 = $150,000), unlocking $5,600 in recovery credits and increasing the child tax credit by $750. The $15,000 contribution unlocks a $6,350 benefit before considering the additional tax savings from shielding the $15,000 retirement contribution from taxes. Importantly, for employer sponsored retirement plans, contributions can’t be made now for 2020. However, if a tax payer is self-employed and has a SEP IRA/Individual 401(k) or if the taxpayer is not covered by an employer sponsored plan and has an IRA, 2020 contributions can be made up until the tax filing deadline. These contributions made before the tax filing deadline may reduce 2020 income to the point of qualifying for the enhanced benefits outlined in the American Rescue Plan Act.
The above is one example of how reducing gross income may be beneficial for certain taxpayers. Please seek tax advice from a licensed tax professional for information specific to your financial situation. Now let’s explore other ways to reduce gross income reported to the IRS.
Adjusted gross income (AGI) is a taxpayer’s gross income minus certain adjustments and is the primary income basis for the income thresholds in the American Rescue Plan Act. Accordingly, for taxpayers wanting to maximize the benefits enacted in the new legislation, looking for opportunities to reduce AGI may be beneficial. Below are strategies to reduce AGI:
The American Rescue Plan Act creates a few unique opportunities for taxpayers. In order to maximize the benefits outlined in the stimulus bill, individuals may consider the tax planning strategies outlined above. If you are seeking help in understanding how you may be impacted by the recent legislation, and would like to learn more about wealth management, D&Y can help. Contact us today.