Within days, the IRS will begin accepting and processing income tax returns. If February 12 sounds a little late too you, your hunch is correct. Last year, tax season officially sprouted wings January 27. The delayed start this year provides a little breathing room for an agency that still had to process one million returns from last tax season as of December. As the agency works out pandemic- and stimulus fund-related kinks, we encourage you to not miss out on big opportunities to reduce your tax debt in a year unlike any other in recent memory.
The power of tax credits
Generally, tax credits are subtracted from the total amount of tax that is owed to the IRS. They differ from deductions, which are subtracted from your income before the amount that you owe is calculated. “Nonrefundable” credits apply to refunds that are only up to the amount owed, whereas “refundable” credits are those refunds that may be more than what you owe.
The notion of credits as a vehicle for taxpayers to save money is considerable; for instance, the IRS reports that, for the Earned Income Tax Credit alone, the total credits were valued at almost $65 billion across 26.5 million returns in 2018. For comparison, in 1999, EITC totaled $31.9 billion across 19.3 million returns. Of the years tracked (since 1999), the “value” peaked at $68.1 billion (for almost 29 million returns). For Nebraska, the EITC “participation” rate remained unchanged for the first tracked year available, 2011, and tax year 2017 (at 77.6%). Participation reportedly peaked in 2016 at 82.4%. The national participation rate, for the most recent tax year featured (2017), stood at around 78%.
Opportunities to slash your tax bill
Due to legislation rising from volatile and uncertain times, there are new credits, as well as changes to “bread and butter” credits in 2021.
Earned Income Tax Credit
Since we mentioned the EITC, let’s start there. As its name suggests, this credit allows for tax relief to taxpayers whose “earned income” is within specific Adjusted Gross Income (AGI) standards. For this tax year, if your earned income was higher in 2019 than 2020, the 2019 amount can be used to calculate the EITC. This change was legislated in the Taxpayer Certainty and Disaster Tax Relief Act. Generally, all taxable income and wages should be accounted for, including income from jobs where employers didn’t withhold tax. This applies to “gig economy” work, such as driving for delivery services, or selling goods on online platforms. If it isn’t interests and dividends, pensions and annuities, Social Security monies, unemployment, alimony and child support, it’s earned income. The maximum credit amount that can be claimed depends on how the taxpayer files, and his or her number of dependents (if there are any). These amounts range from $543 (no children) to $6,728 (at least three children).
EITC represents one of four different categories of credits: income and savings. Other credits are related to homeownership, health care coverage, and qualifying family members and dependents. This last category includes credits related to any children or dependents that are claimed when you file.
Child tax credit
For each and every qualifying child aged 16 and younger, you may claim $2,000 towards this credit. The maximum credit amount also depends on the AGI for your respective filing status (i.e. married and filing jointly). There are also additional credits for “other dependents.” You may not claim the same dependent for both types of credits. Eligible relationships for the child tax credit include your qualifying biological sons and daughters, stepchildren, siblings, stepsiblings, foster children, half-siblings and their descendants (such as grandchildren and nieces and nephews).
Credits are also available to taxpayers aged 65 and older or disabled taxpayers under age 65 who meet qualifying standards.
Credits to support dependents
Let’s say that you pay another individual or firm to take care of a child or dependent aged 12 and younger, or an adult partner or dependent who is unable to take care of himself or herself. Qualifying expenses must be for those services that enable you to earn an income or to actively pursue employment. There are percentage and dollar limits placed on the amount of expense that can be claimed; for instance, the credit can be for no more than 35% of care-related costs. Annual work-related expenses claimed must also be no more than $3,000 for a single person who qualifies as a dependent.
Adoption assistance credit
Out-of-pocket expenses that may qualify for this tax credit are related to those incurred during the process of adopting a child. Attorney’s fees and travel expenses, such as related flights, fuel, lodging and meals, are eligible. The IRS provides an Interactive Tax Assistant. So, taxpayers can plug in their info and determine if they are able to claim the credit.
Well before COVID-19 was a household name, Bankrate crunched Federal Reserve data in 2018 to determine that around one of every four Americans had nothing (yes, $0) tucked away for emergency savings. Only 29% of those surveyed had the recommended emergency fund to cover at least six months-worth of expenses. To encourage nest eggs, the Retirement Savings Contributions Credit allows for you to claim a portion of what you have saved during the year. The amount may be 50%, 20% or 10%, and applies to eligible contributions to traditional or Roth IRAs, employer-sponsored retirement plans, and Achieving A Better Life Experience (ABLE) accounts as a designated beneficiary.
Additional income and savings credits that may be of interest to you or suit your specific circumstances include those related to:
Foreign taxes paid or accrued in other countries or U.S. possessions
Alternative Minimum Tax incurred in prior tax years for individuals, estate and trusts (Form 8801)
Undistributed long-term capital gains for Regulated Investment Company and Real Estate Investment Income shareholders (Form 2439)
Homeowner, health care and education credits present opportunities to reduce tax liabilities and reinvest back into other areas that will enrich your life and well-being. These credits include those related to:
Residential energy efficiency – Retroactively extended through December 31, 2021, these credits apply to qualifying “nonbusiness” energy-efficient properties. Credits are also available for renewable energy products, such as geothermal heat pumps.
Low-income housing – You may be interested in Form 8586 if you own qualifying rental properties.
Affordable Care Act health insurance coverage – The Premium Tax Credit applies to coverage that you or a member of your household may have obtained through the Health Insurance Marketplace®. This credit helps to lower your monthly insurance premiums. You may qualify if your earnings fall within specified income thresholds.
Health Coverage – This federal tax credit has been extended for all coverage months beginning in 2021. So, the HCTC can offset costs of premiums for qualifying taxpayers who have eligible coverage (not offered through the Marketplace®). The extension presents an opportunity for those to get back on HCTC-qualifying coverage, or to reenroll in the Advance Monthly Payment program, which allows for 72.5% of qualifying premiums to be paid in advance to your plan administrator each month. This arrangement effectively lowers your out-of-pocket insurance burden.
Education – The American Opportunity Tax Credit allows you to claim up to $2,500 per eligible student each year. The credit applies to qualified educational expenses during the first four years that the student is enrolled in an institution of higher learning. The Lifetime Learning Credit applies to qualifying tuition and related educational expenses up to $2,000 (per tax return). There is no limit on the number of years that the credit can be claimed, and it can even be used for training to improve or build professional or technical skills. The IRS has created a handy chart. So, you can clearly see how the criteria, maximum benefit, AGI limits and qualifying programs and windows differ between the AOTC and the LLC.
COVID-19 relief credits
You may also be eligible for the Recovery Rebate Credit if you didn’t receive the Economic Impact Payment or the Economic Impact Payment was less than $1,200 ($2,400 for married, joint filers), plus $500 for each child claimed in 2020. Even those who don’t normally file may qualify for this credit.
Employers could be missing out on the Employee Retention Credit. You may be eligible to claim 50% of up to $10,000 in qualified wages paid to an employee if your business has been partly of fully suspended due to shutdown orders. Alternately, businesses may qualify if they have sustained considerable declines in gross receipts year-on-year (2019 to 2020). Applicable wages must be paid between the day when COVID-19 was declared a national emergency (March 13) and the end of 2020.
Leave credits apply to required paid sick and family leave, as well as applicable health expenses, including Medicare taxes related to the leave. Eligible wages and expenses must have been paid and accounted for between April 1 and December 31, 2020. This flow chart is particularly helpful for those visual learners out there who are trying to determine if their business and expenses qualify for these new credits.
Unless you apply for an extension, and arrange a repayment plan, April 15 is the filing deadline and the deadline to pay what you owe.
Fear no tax season. Our professionals at O’Donnell, Ficenec, Wills & Ferdig welcome your questions. We have partnered with individuals and organizations in the metro area for 70 years. In good times and bad, we are your authority for tax, accounting, and business support services that you can trust.