En español | You've checked and rechecked your 2020 tax return, sent it to the IRS, and then spent some time sobbing in the basement. Now you're all set to plan for your 2021 tax return.
No? Think of it this way: A bit of planning now can keep you from wailing and gnashing your teeth next year, when you fill out your 1040 for this year.
Bear in mind that the White House has proposed major tax changes, most of which affect high-income taxpayers — those earning more than $400,000 a year — and those with taxable investments. Will those tax changes take effect for 2021? Probably not, although you never know.
"With the infrastructure plan and corporate tax hikes coming first on the Hill, [Congress] may not introduce a measure into committee until later this summer or early fall,” says Garrett Watson, senior policy analyst at the Tax Foundation, a tax research nonprofit. “That makes me think it's less likely they'll try to enact retroactive tax hikes on the individual side, but it can't completely be ruled out."
Nevertheless, a few things appear certain about the 2022 tax filing season, and some of them are good. Let's take a look.
1. Charitable deductions
Start with the $300 charitable deduction for filers who don't itemize. This provision allows you to claim up to $300 in cash donations, which reduces your adjusted gross income and your taxable income — as well as your tax bill. You can take the deduction only if you take the standard deduction rather than itemizing your deductions.
When you filed your 2020 tax return this year, the $300 charitable deduction was for each taxable unit — meaning you got a $300 deduction whether you filed as a single taxpayer or a married couple filing jointly. When you file your 2021 taxes next year, however, married people filing jointly can each take a $300 charitable deduction for cash donations, for a total of $600.
If you do itemize your deductions, and if you're in the enviable position that you don't need your income to make ends meet, you can deduct cash donations to charity equal to 100 percent of your income. This tax break was instituted for the 2020 tax year by the CARES Act, but Congress extended it for the 2021 tax year. Prior to that the cutoff was 60 percent of income. “Very few people benefit from that,” says Eric Bronnenkant, head of tax at Betterment, an online financial services company. “I know people who donate far less than 60 percent of their income, and they are super-generous people."
2. Lifetime Learning Credit
Another enticing tax break: the Lifetime Learning Credit. It's for qualified tuition and related expenses paid for undergraduate, graduate and professional degree courses — including courses to acquire or improve job skills — for yourself, your spouse or dependents.
Unlike deductions, which reduce your taxable income, tax credits decrease your tax bill dollar-for-dollar. If, for example, you had a $4,000 tax credit and your tax bill was $5,000, you'd owe $1,000. If you owed $3,000 in taxes and had a $4,000 credit, your bill would drop to zero. (Sorry, in this case the government won't mail you a check for the extra $1,000.)
Congress raised the 2021 income limits for the Lifetime Learning Credit, which can be worth as much as $2,000. Instead of phasing out at income levels starting at $59,000 for single filers and $118,000 for joint filers, as it did for the 2020 tax year, the phaseout will begin at $80,000 for single filers and $160,000 for joint filers this year.
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3. Medical expense deduction
If you're able to itemize your deductions and you have high medical expenses, don't miss out on this tax break that's now permanent. Before the 2017 tax reform law temporarily lowered the threshold for deducting medical expenses to 7.5 percent, the figure was 10 percent. This meant you could only deduct medical expenses that exceeded 10 percent of your income. So if you made $70,000 in a year and had $8,000 worth of medical expenses, you could deduct only $1,000 of those expenses since the expenses equal to the first 10 percent of your income ($7,000) didn't qualify.
Thanks to stimulus relief legislation passed in December 2020, the floor has been lowered permanently to 7.5 percent. In the example above, $5,250 of your medical expenses (7.5 percent of $70,000) wouldn't be deductible, but you'd be able to deduct $2,750. Again, you'd have to have more total deductions than the standard deduction to make deducting your medical expenses worthwhile.
4. Standard deduction
Even if you don't itemize your deductions, you still get a break from Uncle Sam in 2021. Congress nearly doubled the standard deduction in the 2018 tax year and mandated that it be increased each year for inflation. The standard deduction for the 2021 tax year is $12,550 for single taxpayers, up $150 from 2020, and $25,100 for married couples, up $300 from 2020.
The standard deduction is even higher if you're 65 or older. Married and filing jointly? Add an extra $1,350 for each spouse 65-plus. That's up from $1,300 for the 2020 tax year. Singles and heads of households 65 or older get an extra $1,700 tacked on to the 2021 standard deduction, up $50 from 2020.
The standard deduction reduces your income, which, in turn, reduces your income taxes. It also greatly limits the number of filers who can itemize their deductions — it makes no sense to itemize if you don't have enough deductions to exceed the standard deduction. The number of people who itemized their taxes fell from 46.5 million in 2017 to just over 18 million in 2018, when the tax reform law took effect, according to the Tax Foundation.
Adjust your tax withholdings now
If you're reeling from a big tax bill from 2020, don't set yourself up for a big disappointment on your 2021 return. The IRS offers an online tool that helps estimate the right amount of tax to withhold from your paychecks. Try it now, before you rack up another big bill. Once the tool estimates the correct tax withholding amount, you'll need to file a new Form W-4 with your employer to put it into effect.
John Waggoner covers all things financial for AARP, from budgeting and taxes to retirement planning and Social Security. Previously he was a reporter for Kiplinger's Personal Finance and USA Today and has written books on investing and the 2008 financial crisis. Waggoner's USA Today investing column ran in dozens of newspapers for 25 years.