IRS Releases 2021 Inflation-Adjusted Tax Rates, Other Changes for Individual Taxpayers by Tony Gutierrez, CPA
The following changes to federal tax laws apply to U.S. individual taxpayers, trusts and estates for tax year 2021 and the tax returns they will file the following year.
Marginal Income Tax Rates
For tax years beginning on Jan. 1, 2021, there continues to be seven individual tax brackets with marginal rates topping out at 37 percent.
37 percent for individual taxpayers with income greater than $523,600 ($628,300 for married couples filing jointly)
- 35 percent for single individuals with income greater than $209,425 ($418,850 for married couples filing jointly)
- 32 percent for individual income exceeding $164,925 ($329,850 for married couples filing jointly)
- 24 percent for single taxpayers with income of more than $86,375 ($172,750 for married couples filing jointly)
- 22 percent for income exceeding $40,525 ($81,050 for married couples filing jointly)
- 12 percent for incomes over $9,950 ($19,900 for married couples filing jointly)
- 10 percent for individual taxpayers with income of $9,950 or less ($19,900 for married couples filing jointly)
For trusts and estates, the income tax rates break down as follows:
- 37 percent for income greater than $13,050
- 35 percent for income between $8,551 and $13,050
- 24 percent for income between $2,651 and $9,550
- 10 percent income amounts of $2,650 or less
Standard Deduction vs. Itemized Deductions
The standard deduction increases to $12,550 for individual taxpayers, or $25,100 for married couples filing joint tax returns. This is the amount all taxpayers may use to automatically reduce their adjusted gross income (AGI) for purposes of determining their tax brackets.
Taxpayers’ whose allowable expenses exceed the standard deduction may instead itemize their deductions and further reduce their taxable income and tax bills for the year. Examples of deductible, itemized expenses include student loan interest, mortgage interest, charitable donations and certain qualifying medical and dental expenses. It is critical taxpayers recognize the limits to these deductions, including a $10,000 cap on payments of state and local taxes, which may also be impacted by the state and local tax laws where they live and work.
Alternative Minimum Tax (AMT)
The AMT exemption for individual taxpayers in 2021 is $73,600 and begins to phase out at $523,600. For married couples filing jointly, the AMT exemption is $114,600, and it begins to phase out at $1,047,200.
Minor children under the age of 19 and college students younger than 24 with income of $2,200 or more from sources other than wages and salary are subject to income tax at the same rate as trusts and estates. Parents may elect to include on their tax returns an eligible child’s unearned income (i.e. earned from investments) that is more than $1,100 but less than $11,000.
Unlike tax deductions, which reduce the amount of income subject to tax, tax credits reduce the amount of taxes individuals owe the government. Following are the 2021 adjustments to some commonly used tax credits:
- The maximum credit for qualifying adoption expenses incurred in 2021 (the Adoption Credit) is $14,440. The credit begins to phase out with modified adjusted gross income (MAGI) above $216,660 and is completely phased out for taxpayers with MAGI of $256,660 or more.
- The Child Tax Credit is $2,000 per qualifying child, subject to phaseout limitations based on taxpayers’ income. Up to $1,400 of the credit is refundable.
- The maximum Earned Income Tax Credit (EITC) is $6,728 for married couples filing jointly with three or more qualifying children.
- The Lifetime Learning Credit, which can be as much as $2,000 for qualifying college tuition, fees and other expenses, begins to phaseout for married filing jointly taxpayers when modified adjusted gross income (MAGI) reaches $119,000. The credit is completely phased out when MAGI exceeds $139,000 for taxpayers filing joint tax returns.
Federal Estate Tax Exemption
The maximum amount individuals dying in 2021 can exclude from a 40 percent federal estate tax is $11.7 million. Married couples filing joint tax returns can shield from federal estate tax double that amount, or $23.4 million. It is important for taxpayers to remember that this exemption applies only at the federal level, and they may still owe estate and inheritance taxes at the state level, depending on where they live.
There are no changes to the maximum amount individuals may gift to others tax-free in 2021.
Individuals may continue to gift up to $15,000 to as many people as they wish in 2021 without incurring gift tax; for married couples, the annual gift-tax exclusion remains at $30,000. Exclusions to these limitations include gifts of future interest in property and gifts made between spouses who are both U.S. citizens. Under federal law, married couples can continue to make an unlimited number of tax-free gifts to each other.
Deduction for Pass-Through Business Owners
The Section 199A deduction of up to 20 percent of qualified business income (QBI) that is available to eligible sole proprietors and owners of pass-through businesses (i.e. S Corporations), is subject to income limitations. For 2021, the deduction is reduced when taxable income exceeds $164,900 for individuals, or $329,800 for married couples filing jointly and is phased out completely when individual income reaches $214,900, or $429,800 for married couples filing jointly.
Foreign Earned Income Exclusion
The foreign earned income exclusion in 2021 is $108,700, up from $107,600 the prior year.
Retirement Plan Contributions
The IRS has not changed the 2021 retirement plan contribution limits for 401(k) and 403(b) plans, which remain at $19,500 with an addition $6,500 catch-up contribution for individuals age 50 and older. Similarly, contribution limits to traditional individual retirement accounts (IRAs) and ROTH IRAs remain at $6,000, plus an addition $1,000 in catch up contributions for taxpayers age 50 and older.
However, self-employed taxpayers with solo 401(k)s and SEP IRAs may save an additional $1,000 in those plans in 2021 for a total of $58,000. That amount is based on their contributions as employers as a percentage of their salary.
Additional changes in 2021 apply to the income ranges taxpayers use for determining their eligibility for claiming tax deductions for their retirement plan contributions. For example, the deduction for a contribution to an IRA by an individual covered by workplace retirement plans phases out when his or her MAGI is between $66,000 and $76,000, a $1,000 increase from 2020. For married couples filing jointly, for which the spouse making the IRA contribution is covered by a workplace retirement plan, the income phase-out range is $105,000 to $125,000. When a contribution is made by a spouse who is not covered by a workplace retirement plan but is married to someone who is covered, the deduction phases out when their income is between $198,000 and $208,000.
Health Savings Accounts
Individuals with high deductible health plans (HDHPs) in 2021 may contribute up to $3,600 to an individual health savings account (HSA), or $7,200 for family coverage. An additional $1,000 in catch-up contributions are available for taxpayers age 55 and older.
For 2021, the definition of a HDHP with self-only coverage is one with an annual deductible that is not less than $1,400 and with out-of-pocket expenses that do not exceed $7,000 for self-only coverage. For family coverage, the annual deductible must be no less than $2,800 with a maximum out-of-pocket expense limit of $14,000.
About the Author: Tony Gutierrez, CPA, is a director of Tax Services with Berkowitz Pollack Brant Advisors + CPAs, where he focuses on tax and estate planning for high-net-worth individuals, family offices, and closely held businesses in the U.S. and abroad. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or email@example.com.