When the Tax Cuts and Jobs Act was signed into law in 2017, proponents said it would make filing taxes easier for millions of Americans. It hasn’t worked out that way.
While the tax overhaul nearly doubled the standard deduction, sharply reducing the number of taxpayers who need to itemize deductions, taxes have become even more fraught for millions of taxpayers. In part, that’s because lawmakers have tweaked the tax code to provide credits and deductions for non-itemizers. Those tax breaks could lower your tax bill but also require more work when it comes time to file.
In addition, as Congress scrambled to prevent the COVID-19 pandemic from torpedoing the economy, it funneled billions in economic stimulus payments through the IRS in the form of tax credits. When you file your 2021 tax return, you may need to reconcile those credits to claim funds you should have received or, in a few cases, pay some of that money back.
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We’ll walk you through the tax-filing minefield. We’ll alert you to tax breaks you may overlook, and help you decide whether you should do your own taxes or pay a professional. And we’ll look at whether IRS customer service, which was so bad during last year’s tax filing season that only 10% of taxpayers got through to an IRS representative, will improve for this year’s filing season.
As has always been the case, our first piece of advice is to start early. By now, you should have received all of the documents you need to file, such as your W-2 and 1099 forms from your financial service providers. Filing early means you’ll get your refund more quickly; if you owe money, it’s better to learn that now than on April 18 (this year’s federal tax filing deadline for most taxpayers). It’s also a lot easier to find a qualified tax preparer in February or March than it is in April. And filing early will protect you from outlaws who use stolen personal information to file bogus tax returns so they can claim fraudulent refunds.
Strategies for Non-Itemizers
In the past, non-itemizers who were charitably inclined had to hope that they’d be rewarded in the afterlife, because they didn’t get any tax breaks in this one. But in response to the pandemic, which placed higher demands on many charitable organizations, Congress created a new tax break for philanthropic non-itemizers. For 2021, taxpayers who claim the standard deduction can deduct up to $300 of cash donations to charity. The $300 amount is per person, so if you’re married, you can deduct a total of $600 on your 2021 tax return.
The deduction is limited to cash contributions; contributions of clothing and household goods to your local Goodwill aren’t eligible. Donations to donor-advised funds aren’t eligible, either. Keep a record of your contribution with your tax documents. For donations of less than $250, you need a bank record, such as a canceled check or credit card statement. For donations of $250 or more, you should obtain a written acknowledgement from the charity that shows the date of the contribution and the amount and states whether you received any goods or services in exchange for your donation.
The kids are alright. Raising a family is expensive, and luckily, most child-friendly tax breaks are available to taxpayers who claim the standard deduction.
Let’s start with the most generous: the expanded child tax credit. For the 2021 tax year, parents can claim $3,600 for each child younger than 6 and $3,000 for each child between 6 and 17. As your income rises, the tax credit is reduced in two stages. First, the credit is reduced to $2,000 per child if your 2021 income exceeds $150,000 on a joint return, or $75,000 for singles. The credit is reduced below $2,000 as income rises above $400,000 on joint returns and above $200,000 on single and head-of-household returns. The amount varies depending on income. There’s no limit to how many eligible kids you may claim on a return.
The IRS sent advance payments for the credit to families from July to December 2021. Unless you opted out, the amount you received in advance will be subtracted from your total child tax credit when you claim it on your 2021 return. You’ll need to reconcile the credit when you file your tax return. (For complete coverage, see Child Tax Credit FAQs for Your 2021 Tax Return.)
You may also qualify for a tax credit designed to reduce the cost of child care. For the 2021 tax year, if your children are younger than 13, you’re eligible for a 20% to 50% credit for up to $8,000 in child care expenses for one child or $16,000 for two or more.
You are eligible for the full credit if your adjusted gross income for 2021 doesn’t exceed $125,000. The percentage is gradually reduced from 50% to 20% for people with an AGI between $125,001 and $183,000. It stays at 20% for families with an AGI from $183,001 to $400,000, but then it’s gradually reduced again from 20% to 0% for taxpayers with an AGI between $400,001 and $438,000. Anyone making over $438,000 isn’t eligible for this credit. (See Your Child Care Tax Credit May Be Bigger on Your 2021 Tax Return for more information.)
If you adopted a child last year, make sure you take advantage of a tax credit to help cover expenses related to the adoption. For 2021, the adoption credit can be taken on up to $14,440 of qualified expenses per child. For example, if you had $5,000 in qualifying expenses, you can’t claim the full $14,440 credit, unless you adopted a child with special needs. In that case, you can claim the full credit even if your expenses were less than that. The credit phases out for families with 2021 AGI over $216,660; those with AGI over $256,660 are ineligible.
To qualify, the child you adopted must have been 17 years old or younger—or any age if physically or mentally incapable of caring for himself or herself.
Defraying the cost of education. The cost of college has risen at a faster pace than inflation for years, so if you’re paying for higher education, make sure to take advantage of college-related tax breaks.
If you’re a parent with a child in college, your best bet is the American Opportunity Credit, which is available for up to $2,500 of college tuition and related expenses (but not room and board) paid during the year. The full credit is available to individuals whose modified adjusted gross income is $80,000 or less ($160,000 or less for married couples filing a joint return). Single taxpayers with MAGI greater than $90,000 and married couples with MAGI above $180,000 are ineligible for the credit. The credit covers all four years of college. (Keep in mind that a credit is a dollar-for-dollar reduction in your tax bill, making it more valuable than a tax deduction.)
If you went back to school—whether to improve your employment prospects or just because you had a hankering to learn—you may qualify for the Lifetime Learning Credit. The credit is calculated as 20% of up to $10,000 of qualified expenses, so you can get back as much as $2,000 for 2021.
The income limits for the Lifetime Learning Credit are $90,000 if single and $180,000 if married. You can’t claim both this credit and the American Opportunity Credit for the same student in the same year.
Strategies for Itemizers
You may benefit by itemizing if you have a large mortgage, spent a lot on medical bills last year or were extremely generous.
Your home is your castle, and it may be deductible. For home loans acquired after December 15, 2017, you can deduct interest on a mortgage—or mortgages—of up to $750,000. (For loans taken out before that date, you can deduct interest on mortgage debt of up to $1 million.) You can also deduct property taxes, although if you live in a high-tax state, you may not be able to deduct the entire amount. The maximum that you can deduct for combined state and local property tax is $10,000 (or $5,000 if married filing separately).
Defray your medical expenses. The COVID-19 pandemic has left some families with large medical bills, not all of them covered by insurance. If you itemize, you can deduct unreimbursed medical expenses that exceed 7.5% of your adjusted gross income. If your AGI was $50,000, for example, you would only be allowed to deduct the unreimbursed medical expenses that exceeded $3,750. The list of eligible expenses is long, ranging from the costs of long-term care to prescription drugs. COVID-19 at-home tests and personal protective equipment, such as masks, hand sanitizer and sanitizing wipes, are deductible medical expenses if they’re used primarily for preventing the spread of COVID-19. Costs for dental and vision care that aren’t covered by your insurance are also deductible.
Charitable giving. It’s too late to make charitable contributions for 2021, but if you itemize, make sure you claim credit for all of the donations you made last year.
If you made large charitable contributions last year—perhaps as part of your estate plans—you’ll be able to deduct donations worth up to 100% of your adjusted gross income. (In the past, the maximum deduction for cash contributions was 60% of AGI, but Congress expanded the tax break to encourage charitable giving during the pandemic.)
If you cleaned out your attic and closets last year, keep in mind that you can deduct the fair market value of donations of clothes, books and other noncash items. Some tax software will help you estimate the value of donated items.
Tax Breaks for Disaster Victims
Although April 18 is the deadline for most taxpayers (who don’t request an extension), victims of the tornadoes that devastated parts of Kentucky, Arkansas, Illinois and Tennessee, as well as victims of Colorado wildfires, have until May 16 to file individual and business tax returns and pay any taxes owed. Taxpayers in the affected areas have until May 16 to contribute to their 2021 IRAs, too.
Tornado and wildfire victims will also get more time to make the quarterly estimated tax payments that are due on January 18 and April 18, 2022. If you missed the estimated tax payment for the fourth quarter of 2021 that’s normally due on January 18, you can include it with your 2021 tax return that’s due May 16.
If you live in the affected areas, you don’t need to contact the IRS to get this relief. However, if you receive a late-filing or late-payment penalty notice from the IRS, call the number on the notice to have the penalty abated.
The IRS says it will work with taxpayers who live outside the affected areas but had tax records in the disaster zones. This includes workers assisting the disaster-relief activities who are affiliated with a recognized government or philanthropic organization.
Deducting your losses. The 2017 Tax Cuts and Jobs Act limited the deduction for unreimbursed casualty losses, but it’s still available if the losses occurred in a federally declared disaster area—which means victims of tornadoes, wildfires, hurricanes and other disasters may still be able to claim a portion of their losses.
You must itemize to claim this deduction. But even if you ordinarily claim the standard deduction, your losses, combined with other deductible expenses, could push you over the standard-deduction threshold. You must subtract reimbursement from your insurance provider and funds from government assistance when you calculate your loss, along with any reimbursements you expect to receive.
Once you’ve determined that you have enough deductions to get over the threshold to itemize, you must reduce the amount of your unreimbursed losses by $100. After you’ve done that, you can only deduct unreimbursed losses that exceed 10% of your adjusted gross income. If, for example, your adjusted gross income last year was $150,000 and your total net loss was $83,000, you would first reduce it to $82,900, then knock off $15,000, leaving you with a net deduction of $67,900.
To compute and report casualty losses, fill out IRS Form 4684 (tax software will walk you through this process). You must enter the FEMA disaster declaration number on that form.
Taxpayers who are eligible for the casualty loss deduction have the option to claim the loss in the year it occurred—2021 in the case of the December tornadoes—or for the previous year. That allows you to choose the year that will give you the biggest tax break. If you decide to claim it for 2020, you can amend your 2020 return by filing Form 1040X. You must file your amended prior-year return no later than six months after the due date for filing your current-year return (without extensions) for the year in which the loss took place. That means for tornado losses in 2021, you would need to file an amended 2020 return by October 17, 2022.
If your losses were caused by another weather-related event in 2021, don’t assume you’re ineligible for this deduction just because your local disaster didn’t make the national news. You can get a complete list of disaster declarations by state on the Federal Emergency Management Agency's website.
Taxes on Your Investments
Free trading apps such as Robinhood have made it easier than ever to take a flier on hot stocks, turning thousands of novice investors into day traders. But if you managed to make money trading GameStop or other hot tickets, your day of reckoning is April 18. Unless you did your trading in a tax-deferred account, such as your IRA, you’ll be required to share some of your booty with the IRS.
Capital gains on stocks, exchange-traded funds, mutual funds and other assets held for one year or less are taxed at your ordinary income tax rate, which currently ranges from 10% to 37%. If you bailed out at a loss, the tax code limits the amount of relief you can obtain. First, you must use your losses to offset any capital gains of the same type—short-term losses are first deducted against short-term gains, and long-term losses are deducted against long-term gains. (After that, net losses of either type can be deducted against the other type of gain.) If you go through those steps and still have losses, you can deduct up to $3,000 against other income, such as your salary. Losses that exceed that amount can be carried over to future years, so keep good records.
The tax code is more forgiving for investors who sell stocks or other assets held for more than a year. Tax rates on long-term capital gains range from 0% to 20%, depending on your income. If you are single and your 2021 taxable income was less than $40,400 (or $80,800 if you’re married and file jointly), you won’t have to pay any taxes on gains from the sale of assets held for more than a year.
To avoid paying more than you owe, make sure you have the correct cost basis for any investment you sold in 2021. The cost basis is the price you paid for your shares, plus any reinvested dividends, capital gains distributions, sales commissions or transaction fees. The higher your basis, the lower the amount of gain that will be taxed. Financial services firms are required by law to track the cost basis of shares in mutual funds or stocks purchased in 2011 or later and provide that basis to investors when the securities are sold. For securities purchased before 2011, you may need to do some detective work, but it’s worth the effort—without a cost basis, the IRS will tax you on the entire proceeds of the sale.
Don’t forget that gains on bitcoin—along with other cryptocurrencies—are subject to the same short- and long-term capital gains rates that apply to stocks, mutual funds and other assets, says Lisa Lewis, a certified public accountant and editor at TurboTax. Even if you used your cryptocurrency to buy something, you’ll owe taxes on the difference between what you paid for the currency and its value when you used it to make a purchase.
Some cryptocurrency platforms are sending investors statements that provide a record of their transactions, Lewis says. But even if you didn’t get a statement, you’re responsible for paying taxes on your crypto gains. The IRS has taken pains to remind taxpayers that cryptocurrency profits are taxable, adding a line to Form 1040 asking whether you’ve bought or sold cryptocurrency.
Taxes on Home Sales
Skyrocketing housing prices could force some taxpayers to do something they haven’t done for nearly 25 years: Pay taxes on profits from the sale of their home.
Since 1997, taxpayers who sell a primary residence they’ve lived in for at least two out of the past five years can exclude up to $500,000 in profits from taxes if they’re a married couple filing jointly, or $250,000 for a single homeowner.
The threshold wasn’t adjusted for inflation, but the vast majority of homeowners have qualified for the exclusion. Now, though, homeowners in some parts of the U.S. where home prices have soared are netting more than the excluded amount. When that happens, the excess gain must be reported on Schedule D with other capital gains. Long-term capital gains are usually taxed at 15% to 20%, depending on your income. In addition, the increase in your adjusted gross income could have other tax consequences, such as a 3.8% surtax on net investment income, which kicks in if you have modified adjusted gross income over $200,000, or $250,000 if you’re married and file jointly. If you’re older, the increase in your AGI could trigger a high-income surtax on Medicare Part B premiums.
There are, however, steps you can take that will lower or even eliminate taxes on your home-sale gains. Your tax bill will be based on your net gain—the amount you sold your home for minus its adjusted basis, which is the amount you paid plus the cost of any home improvements. The higher your basis, the lower your tax bill. “So many people remodeled their homes during the pandemic, and that adds to the basis of the property,” says John Schultz, a certified public accountant in Ontario, Calif.
Ideally, you should have records documenting the cost of your improvements. If you don’t, the contractor that did the work may be able to provide invoices, Schultz says. Building permits may also help you document your expenses. If you can’t track down receipts for every expense, the IRS will usually accept a reasonable estimate, Schultz says.
Allowable improvements that will add to your basis include a new roof, kitchen upgrade, an addition or anything else that would improve the resale value of your home, says Annette Nellen, a CPA and professor at San Jose State University. However, you can’t include routine repair and maintenance costs when calculating your basis. For a complete rundown on allowable expenses, see IRS Publication 523.
Some homeowners mistakenly believe that they can avoid capital gains taxes by reinvesting the proceeds from the sale of their home in another home. Although that was a legitimate strategy before 1997, it’s no longer the case, unless you’re selling real estate purchased for business purposes, Schultz says.
The housing market could slow in 2022 but shows no signs of stalling, so if you’re considering selling your home, start pulling together records of home improvements.
Advice for the Self-Employed
In what’s been dubbed the Great Resignation, millions of Americans quit their 9-to-5 jobs in 2021. If you decided to work for yourself (or pursued a side gig to generate extra income), your taxes are likely to be more complicated. Self-employed taxpayers must pay income taxes on their profits as well as 15.3% in Medicare and Social Security taxes. (When you work for someone else, your employer picks up 50% of that amount.) However, you can deduct half of that amount on your tax return.
And that’s just one of a host of potential deductions that could lower taxes on your income. In addition to expenses associated with running your business, you can deduct the cost of health insurance premiums for yourself and your family. Self-employed individuals who are eligible for Medicare can deduct the cost of Medicare Part B and Part D premiums, as well as the cost of supplemental Medicare (medigap) policies or a Medicare Advantage plan. If after leaving your job you signed up for COBRA, which allows you to stay on your employer’s health insurance for up to 18 months, those premiums are deductible, too.
Most remote workers aren’t eligible to deduct the costs of their home offices. Once you start working for yourself, though, you’re eligible to claim this money-saving deduction. If you use part of your home or apartment regularly and exclusively for your business, you can deduct part of your utility bills and insurance costs.
In the past, many work-at-home taxpayers skipped this tax break because of fears it would trigger an audit. Others were put off by the recordkeeping needed to support the deduction. In recent years, though, the IRS has come up with a simplified method that allows taxpayers to deduct $5 for every square foot that qualifies for the deduction. For example, if you have a 300-square-foot home office (the maximum size allowed for this method), you can deduct $1,500.
If you went into business for yourself because you were laid off last year, keep in mind that unemployment benefits are taxable on your federal tax return, and many states tax unemployment benefits, too. In response to the pandemic, Congress waived taxes on a portion of unemployment benefits in 2020 but didn’t extend the exclusion into 2021. You should receive a Form 1099-G, “Certain Government Payments,” showing the amount of your benefits. Report them as “additional income” on Schedule 1 of your federal tax return.
Tax Advice for Retirees
Millions of older workers left their jobs last year for a variety of reasons: big gains in their stock portfolios, rising home values and concerns about the pandemic. If you are part of the Gray Resignation, make sure you take advantage of all the tax breaks available to you.
In 2021, taxpayers 65 and older can claim a standard deduction of $14,250 (compared with $12,550 for younger taxpayers). If you’re married and both spouses are 65 or older, your total standard deduction for 2021 is $27,800.
For that reason, most retirees are better off taking the standard deduction than itemizing. However, if you still have a mortgage and had high medical bills in 2021, you may want to run the numbers to see if you’ll get a lower tax bill by itemizing.
Retirees who are 70½ or older can donate up to $100,000 a year from their IRAs to charity via a qualified charitable distribution. After you reach age 72, the QCD counts toward your required minimum distribution. A QCD isn’t deductible, but it will reduce your adjusted gross income.
If you made a QCD last year, make sure you won’t be taxed on the distribution. You—or your tax preparer—must report it under “tax withdrawals” on the line for IRA distributions. On the line for the taxable amount, enter zero if the full amount was a qualified charitable distribution. Enter “QCD” next to this line. Tax software will walk you through this process.
