10 Questions Retirees Often Get Wrong About Taxes in Retirement

You worked hard for your retirement nest egg, so the idea of paying taxes on those savings isn’t exactly appealing. If you know what you’re doing, you can avoid overpaying Uncle Sam as you start collecting Social Security and making withdrawals (including RMDs) from IRAs and 401(k)s. Unfortunately, though, retirees don’t always know all the tax code ins and outs and, as a result, end up paying more in taxes than is necessary. For example, here are 10 questions retirees often get wrong about taxes in retirement. Take a look and see how much you really understand about your own tax situation.

(And check out our State-by-State Guide to Taxes on Retirees to learn more about how you will be taxed by your state during retirement.)

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Tax Rates in Retirement

picture of tax rate arrow chart showing upward trendpicture of tax rate arrow chart showing upward trend

Question: When you retire, is your tax rate going to be higher or lower than it was when you were working?

Answer: It depends. Many people make their retirement plans with the assumption that they’ll fall into a lower tax bracket once they retire. But that’s often not the case, for the following three reasons.

1. Retirees typically no longer have all the tax deductions they once did. Their homes are paid off or close to it, so there’s no mortgage interest deduction. There are also no kids to claim as dependents, or annual tax-deferred 401(k) contributions to reduce income. So, almost all your income will be taxable during retirement.

2. Retirees want to have fun—which costs money. If you’re like many newly retired folks, you might want to travel and engage in the hobbies you didn’t have time for before, and that doesn’t come cheap. So, the income you set aside for yourself in retirement may not be much lower than what you were making in your job.

3. Future tax rates may be higher than they are today. Let’s face it…tax rates now are low when viewed in a historical context. The top tax rate of 37% in 2021 is a bargain compared with the 94% of the 1940s and even the 70% range as recently as the 1970s. And considering today’s political climate and growing national debt, future tax rates could end up much higher than they are today.

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Taxation of Social Security Benefits

picture of a Social Security card surrounded by stacks of coinspicture of a Social Security card surrounded by stacks of coins

Question: Are Social Security benefits taxable?

Answer: Yes. Depending on your “provisional income,” up to 85% of your Social Security benefits are subject to federal income taxes. To determine your provisional income, take your modified adjusted gross income, add half of your Social Security benefits and add all of your tax-exempt interest.

If you’re married and file taxes jointly, here’s what you’ll be looking at:

  • If your provisional income is less than $32,000 ($25,000 for singles), there’s no tax on your Social Security benefits.
  • If your income is between $32,000 and $44,000 ($25,000 to $34,000 for singles), then up to 50% of your Social Security benefits can be taxed.
  • If your income is more than $44,000 ($34,000 for singles), then up to 85% of your Social Security benefits are taxable.

The IRS has a handy calculator that can help you determine whether your benefits are taxable. You should also check out Calculating Taxes on Social Security Benefits.

And don’t forget state taxes. In most states (but not all!), Social Security benefits are tax-free.

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Withdrawals from Roth IRAs

picture of a jar labeled "Roth IRA" with money in itpicture of a jar labeled "Roth IRA" with money in it

Question: Are withdrawals from Roth IRAs tax-free once you retire?

Answer: Yes. Roth IRAs come with a big long-term tax advantage: Unlike their 401(k) and traditional IRA cousins—which are funded with pretax dollars—you pay the taxes on your contributions to Roths up front, so your withdrawals are tax-free once you retire. One important caveat is that you must have held your account for at least five years before you can take tax-free withdrawals. And while you can withdraw the amount you contributed at any time tax-free, you must be at least age 59½ to be able to withdraw the gains without facing a 10% early-withdrawal penalty.

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Taxation of Annuity Income

picture of an elderly couple discussing finances with an advisorpicture of an elderly couple discussing finances with an advisor

Question: Is the income you receive from an annuity you own taxable?

Answer: Probably (at least for some of it). If you purchased an annuity that provides income in retirement, the portion of the payment that represents your principal is tax-free; the rest is taxable. The insurance company that sold you the annuity is required to tell you what is taxable. Different rules apply if you bought the annuity with pretax funds (such as from a traditional IRA). In that case, 100% of your payment will be taxed as ordinary income. In addition, be aware that you’ll have to pay any taxes that you owe on the annuity at your ordinary income-tax rate, not the preferable capital gains rate.

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Age for Starting RMDs

picture of elderly man blowing out candles on a birthday cakepicture of elderly man blowing out candles on a birthday cake

Question: At what age must holders of traditional IRAs and 401(k)s start taking required minimum distributions (RMDs)?

Answer: Age 72. The SECURE Act raised the age for RMDs to 72, starting on January 1, 2020. It used to be 70½. (Note that, although the CARES Act waived RMDs for 2020, they’re back for 2021 and beyond.)

As for the amount that you are forced to withdraw: You’ll start out at about 3.65%, and that percentage goes up every year. At age 80, it’s 5.35%. At 90, it’s 8.77%. Figuring out the percentages might not be as hard as you think if you try our RMD calculator. (Note that, beginning in 2022, RMD calculations will be adjusted so that distributions are spread out over a longer period of time.)

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RMDs From Multiple IRAs and 401(k)s

picture of a spiral notebook with "Required Minimum Distributions" written on the front coverpicture of a spiral notebook with "Required Minimum Distributions" written on the front cover

Question: Are RMDs calculated the same way for distributions from multiple IRAs and multiple 401(k) plans?

Answer: No. There’s one important difference if you have multiple retirement accounts. If you have several traditional IRAs, the RMDs are calculated separately for each IRA but can be withdrawn from any of your accounts. On the other hand, if you have multiple 401(k) accounts, the amount must be calculated for each 401(k) and withdrawn separately from each account. For this reason, some 401(k) administrators calculate your required distribution and send it to you automatically if you haven’t withdrawn the money by a certain date, but IRA administrators may not automatically distribute the money from your IRAs.

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Due Date for Your First RMD

picture of a piggy bank with "RMD" written on the sidepicture of a piggy bank with "RMD" written on the side

Question: Do you have to take your first RMD by December 31 of the year you turn 72?

Answer: No. Normally, you have to take RMDs for each year after you turn age 72 by the end of the year. However, you don’t have to take your first RMD until April 1 of the year after you turn 72. But be careful—if you delay the first withdrawal, you’ll also have to take your second RMD by December 31 of the same year. Because you’ll have to pay taxes on both RMDs (minus any portion from nondeductible contributions), taking two RMDs in one year could bump you into a higher tax bracket.

It could also have other ripple effects, such as making you subject to the Medicare high-income surcharge if your adjusted gross income (plus tax-exempt interest income) rises above $88,000 if you’re single or $176,000 if married filing jointly. (Note: Those are the income thresholds for determining 2021 surcharges.)

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Taxation of Life Insurance Proceeds

picture of a life insurance contract with money laying on itpicture of a life insurance contract with money laying on it

Question: If your spouse dies and you get a big life insurance payout, will you have to pay tax on the money?

Answer: No. You have enough to deal with during such a difficult time, so it’s good to know that life insurance proceeds paid because of the insured person’s death are not taxable.

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Estate Tax Threshold

picture of the words "Estate Tax" next to a judge's gavel and moneypicture of the words "Estate Tax" next to a judge's gavel and money

Question: How valuable must an individual’s estate be at death to be hit by federal estate taxes in 2021?

Answer: $11.7 million ($23.4 million or more for a married couple). If the value of an estate is less than the threshold amount, then no federal estate tax is due. As a result, federal estate taxes aren’t a factor for very many people. However, that will change in the future. The 2017 tax reform law more than doubled the federal estate tax exemption threshold—but only temporarily. It’s schedule to drop back down to $5 million (plus adjustments for inflation) in 2026. Plus, during his 2020 campaign, President Biden called for a reduction of the exemption threshold sooner.

If your estate isn’t subject to federal taxes, it still might owe state taxes. Twelve states and the District of Columbia charge a state estate tax, and their exclusion limits can be much lower than the federal limit. In addition, six states impose inheritance taxes, which are paid by your heirs. (See 18 States With Scary Death Taxes for more details.)

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Standard Deduction Amounts

picture of a 1040 tax form with a pen laying on it next to the standard deduction linepicture of a 1040 tax form with a pen laying on it next to the standard deduction line

Question: If you’re over 65, can you take a higher standard deduction than other folks are allowed?

Answer: Yes. For 2021, to the standard deduction for most people is $12,550 if you’re single and $25,100 for married couples filing a joint tax return ($12,400 and $24,800, respectively, for 2020). However, those 65 and older get an extra $1,700 in 2021 if they’re filing as single or head of household ($1,650 for 2020). Married filing jointly? If one spouse is 65 or older and the other isn’t, the standard deduction increases by $1,350 ($1,300 for 2020). If both spouses are 65 or older, the increase for 2021 is $2,700 ($2,600 for 2020).

Source: kiplinger.com

COVID-19 Relief Law Includes Help for Mortgage Borrowers

Among the provisions in the $1.9 trillion fiscal relief plan signed by President Biden is $10 billion for states and cities to support homeowners who are in foreclosure or behind on their mortgage payments. So reports USA Today.

That money applies to an estimated 3.3 million people, according to the newspaper.

The American Rescue Plan also directs another $21.5 billion toward emergency rental assistance.

Read the full article from USA Today. 

Source: themortgageleader.com

Increase Your Third Stimulus Check By Filing Your Tax Return NOW

There are plenty of good reasons to file your tax return as soon as possible. You’ll get your refund faster, it cuts down on tax identity theft, and there’s one less thing to worry about until April 15. Plus, for some people, it could also mean a bigger third stimulus check! But before you rush out to find a CPA or buy tax prep software, there’s another side to this story. For other people, filing now could result in a lower stimulus check – and you don’t want that.

So, should you file now or wait to file until later? Which camp you’re in generally depends on whether there were any significant changes to your family or financial situation last year. That’s because your next stimulus check will be based on either your 2019 tax return or your 2020 return – whichever one was most recently filed and processed when the IRS starts processing your third stimulus payment.

When the IRS is ready to calculate the amount of your third stimulus check – which could be as soon as this weekend – they’ll need to know your tax filing status, how many dependents you have, and your adjusted gross income (AGI). If you file before the IRS is ready to send your payment, they’ll get that information from your 2020 tax return. If you file later, that information will be pulled from your 2019 return. Depending on your situation, that may give you an opportunity to alter the amount of your third stimulus check by timing the filing of this year’s tax return. But you need to act quickly if you want the IRS to base your stimulus payment on your 2020 return, because the tax agency could start processing your payment at any time.

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When Can You File Your Taxes and When Will Stimulus Checks Arrive

Before getting into the nuts and bolts of how you might be able to impact the amount of your third stimulus check, it’s important to understand when tax return filing season begins and ends, and when stimulus checks are expected to arrive.

The IRS began accepting federal income tax returns for the 2020 tax year on February 12. That’s a few weeks later than normal, because the tax agency had to do some unexpected computer programming after the December tax law changes that authorized the second round of stimulus checks and other benefits. You have until April 15 to file your tax return, unless you request an extension. (Last year, the deadline was pushed back to July 15, but there’s no plan to change the due date at this point.)

Now that President Biden has signed the American Rescue Plan Act, the IRS can start sending third-round stimulus checks as soon as they’re ready – which the White House said could be as soon as the March 13-14 weekend. However, although first-wave payments could go out within just a few days, it will still take weeks (if not months) to send out all the payments. So, while you could get your third stimulus check before you have a chance to file your 2020 return, it still might be a while before the IRS gets around to processing your payment.

Finally, since stimulus checks won’t start arriving in mailboxes until weeks after the tax return filing season began, there will be a mix of people who have filed their 2020 return and people who have not when the IRS starts processing stimulus payments. That’s why the IRS needs to be able to pull information from either your 2019 or 2020 tax return to calculate your stimulus check amount. And, as predicted, the American Rescue Plan allows just that.

Under the law, if your 2020 tax return isn’t filed and processed by the time the IRS starts processing your third stimulus check, the tax agency will use your 2019 tax return to get the information it needs to calculate your payment. If your 2020 return is already filed and processed, then your stimulus check will be based on your 2020 return. If your 2020 return is filed and/or processed after the IRS sends you a stimulus check, but before July 15, 2021 (or September 1 if the April 15 filing deadline is pushed back), the IRS will send you a second payment for the difference between what your payment should have been if based on your 2020 return and any payment actually sent based on your 2019 return.

[NOTE: Use Kiplinger’s Third Stimulus Check Calculator to see how much your next stimulus check will be under the American Rescue Plan. The law authorizes $1,400 payments to each eligible American ($2,800 for married couples filing a joint tax return), plus an additional $1,400 for each dependent in the family (regardless of the dependent’s age). However, payments will be gradually phased-out for people with income above a certain level. For more information, see Your Third Stimulus Check: How Much? When? And Other FAQs.]

Who Should File Taxes Now to Get a Larger Stimulus Check?

If you expect your third stimulus check to be higher if it’s based on your 2020 tax return (instead of your 2109 return), then you want to file your 2020 return electronically right away. (Use our calculator to run the numbers.) That way, you have the best chance of having it processed before the IRS starts sending out stimulus payments. Some of the things that could make your stimulus check higher if it’s based on your 2020 return include:

  • Your income was lower in 2020;
  • You had a child in 2020;
  • You got married in 2020 (especially if there’s a wide gap between each spouse’s income); or
  • You could be claimed as a dependent on someone’s 2019 tax return, but not on anyone’s 2020 return.

Here are a few examples:

Lower Income in 2020 – Nicholas was furloughed for several months in 2020. As a result, his AGI dropped from $95,000 in 2019 to $70,000 in 2020. Since Nicholas is single and doesn’t have any dependents, he would get a $1,400 third stimulus check if it’s based on his 2020 tax return. That’s because his payment wouldn’t be reduced at all, since his 2020 AGI is below the phase-out threshold ($75,000). On the other hand, since his 2019 AGI was above the phase-out threshold, Nicholas would only get a $280 stimulus check if it’s based on his 2019 return. Therefore, Nicholas’s stimulus check will be $1,120 higher if he files his 2020 return before the IRS starts processing his stimulus payment.

Child Born in 2020 – Andrew and Becky had their first child in 2020. They file a joint return each year, and their AGI was $80,000 in 2019 and $90,000 in 2020, which are both well below the phase-out threshold for joint filers ($150,000). However, if the IRS uses their 2020 tax return to calculate their third stimulus check, Andrew and Becky’s new bundle of joy will be counted as a dependent. That won’t happen if the IRS uses their 2019 return. So, by filing their 2020 return now, Andrew and Becky can boost their stimulus check by $1,400 – the additional amount allowed for one dependent.

Married in 2020 – Josh and Samantha were married in 2020. They had a combined AGI of $160,000 in 2020, which is the same total AGI they had for 2019 as separate single filers. Since they have no kids and will be filing a joint return this year, they would get a $2,240 stimulus check based on their 2020 return. Using their separate 2019 returns, when Josh had an AGI of $100,000 and Samantha had an AGI of $60,000, Samantha would get a $1,400 check, but Josh wouldn’t get anything at all because his 2019 AGI was too high. So, if they file their joint 2020 return quickly enough, their stimulus check will be $840 higher.

No Longer a Dependent in 2020 – Charlie turned 24 and graduated from college in 2020. He filed his own tax return in 2019 and will file one in 2020, too. His AGI was $15,000 in 2019 and $18,000 in 2020, and he has no dependents. Because Charlie was a student age 23 or younger in 2019, his parents claimed him as a dependent on their 2019 tax return. They can’t claim him as a dependent on their 2020 return, though. If the IRS uses Charlie’s 2019 tax return to determine his eligibility for a stimulus check, he will not get a payment. That’s because anyone who can be claimed as a dependent on another person’s tax return is not eligible. However, if Charlie files his 2020 tax return early enough, he’ll get a $1,400 stimulus check.

[NOTE: As mentioned above, if you file your 2020 return after the IRS sends your third stimulus check, you still could get a second payment for the difference between what your payment should have been if based on your 2020 return and any payment actually sent based on your 2019 return. But we don’t know when the IRS will send those second payments. So, if you want your full payment quickly, file your return now to give yourself the best chance of making that happen.]

Who Should Wait to File Taxes to Increase Their Stimulus Check?

If you flip the script on some of the examples above, you can see how some people could benefit by waiting to file their 2020 tax return. Depending on the exact timing, this could force the IRS to use your 2019 tax return to process your third stimulus check. So, for example, you might want to delay filing your tax return this year if:

  • Your income was higher in 2020;
  • You had a death in the family in 2020;
  • You got divorced in 2020; or
  • You can’t claim your child as a dependent anymore starting in 2020.

Again, here are some examples:

Higher Income in 2020 – Cheri got a promotion and a big raise last year. As a result, her AGI jumped from $80,000 in 2019 to $95,000 in 2020. She is single with no children. Using her 2019 return, Cheri would get a $1,120 third stimulus check. However, if the IRS used her 2020 return, she would only get $280. By waiting to file her 2020 return, Cheri could increase her stimulus check by $840.

Death of a Dependent in 2020 – Harold’s elderly and disabled mother, Maude, lived with him since 2015 since she couldn’t care for herself. Unfortunately, Maude died late in 2019, but Harold was still able to claim her as a dependent on his 2019 tax return. However, Harold can’t claim Maude as a dependent on his 2020 return. Harold’s AGI for both 2019 and 2020 was $50,000. He is single and has no other dependents. If the IRS uses his 2019 tax return to process his third stimulus check, Harold will get a $2,800 stimulus payment. Since he won’t get the extra amount for a dependent, his payment will drop to $1,400 if his 2020 return is used. So, by filing his 2020 tax return later, Harold could boost his stimulus check by $1,400.

Divorced in 2020 – Randy and Beth got a divorce in 2020. For 2019, they reported an AGI of $170,000 on their joint tax return. For 2020, they will each file their own return as a single taxpayer with no dependents. Randy has a 2020 AGI of $100,000, while Beth’s is $70,000. If Randy and Beth both file their 2020 tax return early, Randy won’t get a stimulus check because his 2020 AGI is too high. Beth would receive a $1,400 payment. However, if they wait to file their tax returns this year and the IRS uses their 2019 return to calculate their stimulus payment, they will get a combined total of $1,680 – an increase of $280 over the combined amount of their payments if their 2020 returns are used.

Empty Nesters in 2020 – George and Suzanne’s only child, Ron, turned 19 and moved out of the house in 2020. They claimed Ron as a dependent on their 2019 joint tax return, but they can’t on their 2020 joint return. For both 2019 and 2020, George and Suzanne had an AGI of $160,000. If the IRS bases their stimulus check on their 2020 return, George and Suzanne will get a $2,240 third stimulus check. However, if they delay filing until after their check is sent, they’ll get a $3,360 payment. The extra $1,120 George and Suzanne would get by waiting represents the reduced additional payment for one dependent (reduced because their AGI was within the phase-out range for joint filers).

Of course, there’s a potential drawback to delaying your 2020 return — you also delay any refund due. Last year, the average refund was $2,549. So, if you’re expecting a 2020 refund, you have to decide if the extra money you’d get in your stimulus check by waiting to file is worth the delay in getting your refund.

Source: kiplinger.com

Forgiven Student Loan Debt Will Be Tax-Free

A small but significant provision in the stimulus package signed by President Biden will temporarily exclude forgiven student loans from taxes, a move that could make it easier for Biden to forgive some student debts.

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Student Loan Forgiveness Won’t Increase Your Tax Bill

President Biden campaigned on a pledge to forgive $10,000 in student loan debt, but it was unclear whether the forgiven loans would be taxable. Ordinarily, with some exceptions, if a student loan is canceled, forgiven, or discharged for less than the amount you owe, the amount of the canceled debt is treated as taxable income in the year the cancellation occurs.

Federal student loan borrowers in income-driven repayment plans are eligible to have the balance of their loans forgiven after making payments for 20 to 25 years.

Tax Relief for Cancelled Student Loan Debt Also Includes Private Student Loans

The tax relief isn’t limited to federal student loans. If your private lender forgives some or all your student loan debt, you won’t have to pay taxes on those forgiven loans, either.

The Tax Relief on Cancelled Student Loan Debt is Temporary

Unless Congress extends it, the tax relief on student loan debt cancellation expires at the end of 2025.

Source: kiplinger.com

6 Biden Stimulus Benefits That Pack the Biggest Punch

The American Rescue Plan Act – the massive, $1.9 trillion economic stimulus package that President Biden signed on March 11 – sends a lot of money in many different directions. Almost every American will be impacted in one way or another. But when it comes to providing significant financial relief directly to Americans suffering the most through the COVID-19 pandemic, a lot of the American Rescue Plan’s provisions really don’t provide a lot of bang for the buck. In other words, they won’t necessarily make an immediate and meaningful impact on the financial health of Americans who need help the most.

However, there are a handful of provisions in the new stimulus law that go above and beyond when it comes to putting (or keeping) substantial amounts of money in the pockets of millions of Americans who are struggling financially right now. These six American Rescue Plan provisions will provide the most financial relief for the greatest number of people. As outlined below, most of them involve some sort of tax break, a couple of them provide direct payments, but all of them provide (or could provide) financial assistance that is both deep and wide.

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$1,400 Stimulus Checks

The American Rescue Plan authorizes a third round of $1,400 stimulus checks for each eligible person ($2,800 for couples), plus an additional $1,400 for each dependent (regardless of the dependent’s age). However, as with the first- and second-round payments, the third-round stimulus checks will be reduced – or eliminated – for people with an income above a certain amount.

If you filed your most recent tax return as a single filer, your third stimulus check will start to be “phased-out” (i.e., reduced) if your adjusted gross income (AGI) is $75,000 or more. That threshold jumps to $112,500 for head-of-household filers, and to $150,000 for married couples filing a joint return. Third-round stimulus checks will be completely phased out for single filers with an AGI above $80,000, head-of-household filers with an AGI over $120,000, and joint filers with an AGI exceeding $160,000. Use our Third Stimulus Check Calculator to estimate the amount of your stimulus payment.

Nonresident aliens and anyone who can be claimed as a dependent on someone else’s tax return do not qualify for a stimulus check.

Eligible Americans who don’t receive a third stimulus check, or don’t receive the full amount, can claim the difference as a Recovery Rebate credit when they file their 2021 tax return next year.

For more information, see Your Third Stimulus Check: How Much? When? And Other FAQs.

Unemployment Benefits

Last March, the CARES Act was a life saver for people who lost their job because of the pandemic. Unemployment benefits were provided to self-employed people, independent contractors, and others out of work because of the coronavirus pandemic who don’t otherwise qualify for benefits. Weekly unemployment checks were also increased by $600 through July 2020. Benefits were made available for a longer period of time, too.

In December, the COVID-Related Tax Relief Act extended benefits for people who usually don’t qualify for unemployment. An extra payment was also authorized, but at $300 per week instead of $600 per week. The number of weeks of benefits someone may claim was increased from 39 to 50, too. However, these benefits were set to expire on March 14.

Under the American Rescue Plan, the enhanced unemployment benefits are extended to September 6, 2021. That includes the $300-per-week of additional payments beyond the normal unemployment compensation allowed. (Progressives wanted a minimum of $400 in extra weekly benefits, but the amount was pushed back down to $300 during negotiations in the Senate.)

There’s also a new tax break for the unemployed. Thanks to the American Rescue Plan, the first $10,200 of unemployment benefits received in 2020 are exempt from tax for households with an adjusted gross income of $150,000 or less (although state taxes may still apply).

For more information on these new developments, see American Workers Get Enhanced Unemployment Benefits as Biden Signs Stimulus Package.

Child and Dependent Care Tax Credit

Finding and affording childcare is one of the more difficult challenges workers are facing during the pandemic. To help address the childcare affordability crisis, the American Rescue Plan significantly expands the child and dependent care tax credit for one year.

For the 2020 tax year, if your children were younger than 13, you were eligible for a 20% to 35% non-refundable credit for up to $3,000 in child-care expenses for one child or $6,000 for two or more. The percentage decreased as income exceeded $15,000.

The American Rescue Plan makes a number of enhancements to the credit for the 2021 tax year. First of all, the new stimulus law makes the credit refundable for this year. That helps lower-income people the most, since they are more likely to lose all or some of the credit’s worth when it’s non-refundable. It also bumps the maximum credit percentage up from 35% to 50% for 2021.

More of your childcare expenses are subject to the credit, too. Instead of up to $3,000 in childcare expenses for one child and $6,000 for two or more, the American Rescue Plan allows the credit for up to $8,000 in expenses for one child and $16,000 for multiple children in 2021. When combined with the 50% maximum credit percentage, that puts the top credit for this tax year at $4,000 if you have just one child and $8,000 for more kids.

In addition, the full credit will be allowed for families making less than $125,000 a year (instead of $15,000 per year). After that, the credit starts to phase-out. However, all families making between $125,000 and $500,000 will receive at least a partial credit.

Child Tax Credit

Another way to help families with children is to increase the child tax credit. For 2020 tax returns that you’re filing this year, the credit is worth $2,000 per child age 16 or younger. It also begins to disappear as income rises above $400,000 on joint returns and above $200,000 on single and head-of-household returns. For some lower-income taxpayers, the credit is partially “refundable” (up to $1,400 per qualifying child) if they have earned income of at least $2,500. That means the IRS will issue you a refund check for the refundable amount if the credit is worth more than your income tax liability.

The American Rescue Plan provides a dramatic, one-year expansion of the child tax credit for the 2021 tax year. One of the biggest changes is to the amount of the credit. For 2021, it jumps from $2,000 to $3,000 for most children – but to $3,600 for children 5 years old and younger. The extra amount ($1,000 or $1,600) is reduced – potentially to zero – for families with higher incomes, though. For people filing their tax return as a single person, the extra amount starts to phase-out if their adjusted gross income is above $75,000. The phase-out begins at $112,500 for head-of-household filers and $150,000 for married couples filing a joint return. The credit amount is further reduced under the pre-existing $200,000/$400,000 phase-out rules.

Another important change is that the 2021 credit is fully refundable. That means refund checks triggered by this year’s credit can be greater than $1,400. The $2,500-of-earned-income required is dropped for 2021, too.

Children age 17 also qualify for the 2021 credit. That will make a huge difference for parents with kids turning 17 this year – that’s an additional $3,000 they weren’t expecting.

Last but not least, half of the 2021 credit amount will be paid in advance through periodic payments issued between July and December of this year. We expect the periodic payments to be monthly, but that will be up to the IRS (they might make payments on a different schedule). You’ll claim the other half of the credit on your 2021 tax return, which you’ll file next year. Kiplinger’s 2021 Child Tax Credit Calculator lets you know how much your credit will be for 2021 (including how much your advance payments will be if paid monthly).

For more information about the 2021 child tax credit, see Families Get a $3,000 Child Tax Credit for 2021.

Earned Income Tax Credit

The earned income tax credit (EITC) provides an incentive for people to work. And, for 2021, many more workers without qualifying children will be able to claim this valuable credit, including both younger and older Americans. The “childless EITC” amounts will be higher, too. Plus, there are other changes that will help the bottom line for lower-income Americans as well.

For the 2020 tax returns that people are filing now, the maximum EITC ranges from $538 to $6,660 depending on your income and how many children you have. But there are income limits for the credit. For example, if you have no children, your 2020 earned income and adjusted gross income (AGI) must each be less than $15,820 for singles and $21,710 for joint filers. If you have three or more children and are married, though, your 2020 earned income and AGI can be as high as $56,844. (Note: People can use their earned income from 2019 to determine the EITC for the 2020 tax year if it results in a higher credit amount.) If you don’t have a qualifying child, you must be between 25 and 64 years old at the end of the tax year to claim the EITC.

The American Rescue Plan expands the 2021 EITC for childless workers in a few ways. First, the new law generally lowers the minimum age from 25 to 19 (except for certain full-time students). It also eliminates the maximum age limit (65), so older people without qualifying children can claim the 2021 credit, too. The maximum credit available for childless workers is also increased from $543 to $1,502 for the 2021 tax year. Expanded eligibility rules for former foster youth and homeless youth apply as well.

As with the 2020 EITC, you can use your 2019 earned income instead of your 2021 income if that will boost your credit amount. That will help many people who were laid off, furloughed, or otherwise suffer an income loss this year.

There are also a few permanent EITC changes in the American Rescue Plan. For instance, workers who otherwise wouldn’t be able to claim the credit because their children can’t satisfy the identification requirements can now claim the childless EITC. Certain married but separated couples can now claim the EITC on separate tax returns, too. The limit on a worker’s investment income is also increased from $3,650 (for 2020) to $10,000 (adjusted for inflation after 2021).

Student Loan Debt

Our final power punching piece of the American Rescue Plan won’t affect very many people right now. But it will save millions of Americans big bucks if it’s eventually paired with another financial benefit on President Biden’s wish list – student loan forgiveness.

Normally, the amount of any debt that is canceled, forgiven, or discharged for less than the full amount you owe is taxable and must be reported on your tax return. For example, if you have a $20,000 loan that is forgiven for some reason, you must report $20,000 of additional income on your tax return. There are several exceptions to this general rule, but in most cases forgiven student loans currently result in a higher tax bill.

The American Rescue Plan adds a temporary exception to the general rule for student loans. From 2021 to 2025, forgiven student loan debt is not subject to federal income tax. (To be clear, the American Rescue Plan doesn’t forgive any student loan debt. At this time, the tax exemption only applies to debt cancelled under current student loan forgiveness programs.)

Right now, relatively few people have their student loans wiped away. But President Biden promised to forgive up to $10,000 of student loan debt per person when he was running for office. If he keeps that promise, the tax exemption could save millions of people thousands of dollars. If, for example, you’re in the 22% tax bracket, having $10,000 of forgiven student loan debt taken off your tax return will save you $2,200. So, as you can see, the tax exemption for forgiven student loan debt has a lot of potential.

For more on this development, see Forgiven Student Loan Debt Will Be Tax-Free.

Source: kiplinger.com

6 Ways To Spend Your Third Stimulus Check

After a year of COVID shutdowns and restrictions leading to a general economic slowdown and unemployment for many Americans, the government is making an effort to jumpstart the economy by distributing a third stimulus check to American families, this time even larger than before. The goal? Help people get back on their financial feet and, ideally, spending a little as coronavirus restrictions wind down and vaccines become widely distributed.

Many Americans will receive a $1,400 check soon, once President Biden signs the third stimulus package. A bit of thought needs to go into how you spend that money so there are no regrets. We have some ideas for you below.

In this article

How do people say they will spend their third stimulus check?

For many families, this stimulus money is a powerful financial boon. What do Americans plan to do with this money?

According to a survey at Bloomberg, the most common responses to the question of how people intend to use this stimulus money are savings and basic needs like food and housing. In fact, those were the top three responses: savings, food, and housing.

This provides some insight into the financial reality of the last year for many Americans. Many families were faced with losing a loved one and, in many cases, that loved one was an important income earner. Many more families faced job loss due to economic uncertainty, extended illnesses and other financial troubles.

Priorities for your stimulus check

Given that picture, what are some priorities for spending your stimulus check? Building on advice from the first two stimulus checks, here are six things you should consider.

Emergency fund

An emergency fund is simply a pool of money set aside for unexpected events, such as a job loss, an unexpected passing, a major car repair, an emergency appliance replacement and so on. Starting an emergency fund is easy, particularly if you have money to start with.

For many Americans, 2020 was a stark lesson in the value of having an emergency fund, as many families were hit with unexpected job losses and deaths, putting them in a tough financial situation. Using some of or even all of your stimulus check to provide an emergency fund is a wise financial move.

Pros: An emergency fund gets you ready for the next emergency, and it gives you flexibility to change your mind later
Cons: It doesn’t offer a great return on your money

2020 tax bill

Many Americans are discovering that the challenges of 2020 may have brought unexpected tax implications. For some, this comes in the form of unemployment. If you received unemployment but didn’t elect to have taxes withheld from it, you may be facing a nasty tax bill. For others, this may come as a result of unexpected freelance work or gig economy work, where they received a 1099 for their efforts and learned that their employer did not withhold taxes for them. In both cases, a tax bill may be sitting there waiting for you, and the stimulus check may just help you pay it off.

Pros: It keeps the IRS off your back; unpaid taxes can have legal complications and can damage your credit
Cons: It can feel like the government is giving you money just to take it away again

High interest debt repayment

According to CNBC, 51 million Americans increased their credit card debt because of COVID. That’s a lot of people out there facing additional credit card debt. With credit card interest rates commonly as high as 30% annually, that credit card debt snowballs quickly into an overwhelming amount. Using your stimulus money to get that credit card debt under control using a simple debt repayment plan can put you in a much better financial place.

Pros: Probably the most beneficial to your net worth; eliminates monthly bills
Cons: You’re not gaining assets, merely losing debts

Investments

If you have an emergency fund and don’t have any high interest debts, another option for your stimulus check is to invest it. For example, if you want to save for retirement, you may want to put that check into a Roth IRA, and if you don’t have one, starting a Roth IRA is simple. If you’re saving for a child’s college education, consider putting money into a 529 college savings plan for them, another move that’s simple to get started. Even if you’re saving for something like a house down payment or a car, putting money somewhere secure for the next year or two is a simple way to invest.

Pros: Great way to build wealth; moves you toward big life goals
Cons: Puts money at risk; should be secondary after paying off high interest debts

Home refurbishment and appliance cycling

Another good option for stimulus money is to put it toward home improvements. Many households (ours included) have put their appliances and other aspects of their home to heavy use over the past year by staying at home much more often than before. This might mean that some of your appliances and other aspects of your home are simply worn out and due for replacement.

Pros: Replacing an ailing or broken appliance can be a major quality of life improvement
Cons: It’s not particularly exciting

Travel and fun

A final option is to just have fun with the money. Use it for a trip, or to buy something you’ve been wanting for a while. While this might not be the best financial choice for the money, if you’ve been financially lean for a long while, this might be a great opportunity to splurge a little. You might consider splitting the money as well, using some of it for investing and another portion for a family trip, for example.

Pros: It’s fun; it can feel like a reward after a long period of belt-tightening
Cons: It won’t improve your financial situation

We welcome your feedback on this article. Contact us at inquiries@thesimpledollar.com with comments or questions.

Source: thesimpledollar.com

2021 Child Tax Credit Calculator

Although it’s still subject to change, President Biden’s $1.9 trillion stimulus package includes a provision that would temporarily increase the child tax credit from $2,000 to $3,000 per child ($3,600 for children 5 years old and younger) for the 2021 tax year. It would also authorize periodic “child allowance” payments to families from July to December. Half the total credit amount would be paid in advance with the periodic payments, while the other half would be claimed on the tax return that you’ll file next year.

However, not everyone would get the additional amount under the president’s plan. And some families would not get any credit (or periodic payment) at all. That’s because the credit would be reduced – or even eliminated – for people with an income above a certain amount. In fact, there would be two “phase-out” rules in play – one just for the extra $1,000 (or $1,600) amount and one for the remaining credit. That makes calculating the total credit and periodic payments very tricky.

The massive stimulus package was already passed by the House once. However, since the Senate later passed the bill with amendments, it has to go back to the House for an additional vote before it can be sent to the president for his signature. But if you don’t want to wait until final passage to see how much money you would get, answer the four questions in the calculator below and we’ll give you a customized estimate of the amount you would receive in advance from July to December (assuming monthly payments) and how much you would be able to claim as a child tax credit on your 2021 tax return. Again, the child tax credit proposal could change before final passage, which could then affect how much you get. But, for now, you can use the tool to see where you stand under the current plan.

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Current Child Tax Credit Amount

The current child tax credit is $2,000 per qualifying child. It’s gradually phased-out (but not below zero) for joint filers with an adjusted gross income (AGI) of $400,000 or more and for other taxpayers with an AGI of $200,000 or more.

Proposed Phase-Out Scheme

Under the bill passed by the Senate, the 2021 increase (i.e., the extra $1,000 or $1,600) would be gradually phased-out for joint filers with an AGI of $150,000 or more, head-of-household filers with an AGI of $112,500 or more, and all other taxpayers with an AGI of $75,000 or more. However, the increase can’t be reduced below zero (other limitations to this reduction would apply as well).

After any reduction of the increased credit amount is calculated, the current phase-out would then be applied to the remaining credit amount. So, for joint filers with an AGI of $400,000 or more and other taxpayers with an AGI of $200,000 or more, the credit would be subject to an additional reduction – possibly to $0.

Proposed Periodic Payments

Once the credit amount is determined, 50% of it would be paid in advance with periodic payments under the current bill before Congress. But those periodic payments would only run from July to December 2021. (We’re expecting monthly payments, but the advance payments could be based on a different schedule.) The remaining 50% would be claimed as a credit on the taxpayer’s 2021 tax return.

The IRS would also be required to create an online portal so that people could update their income, marital status, and the number of qualifying children. You could also use the portal to opt out of the periodic payments if you want to take the full child credit on your 2021 return instead.

For more information on the proposed child tax credit plan, see Senate Passes $3,000 Child Tax Credit for 2021.

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Source: kiplinger.com