What do the 2021 cost-of-living adjustment numbers mean for you?
The IRS has announced its 2021 cost-of-living adjustments to tax amounts that might affect you. Many increased to account for inflation, but some remained at 2020 levels. As you implement 2020 year-end tax planning strategies, be sure to take these 2021 adjustments into account in your planning.
Also, keep in mind that, under the Tax Cuts and Jobs Act (TCJA), annual inflation adjustments are calculated using the chained consumer price index (also known as C-CPI-U). This increases tax bracket thresholds, the standard deduction, certain exemptions and other figures at a slower rate than was the case with the consumer price index previously used, potentially pushing taxpayers into higher tax brackets and making various breaks worth less over time. The TCJA adopted the C-CPI-U on a permanent basis.
Individual income taxes
Tax-bracket thresholds increase for each filing status but, because they’re based on percentages, they increase more significantly for the higher brackets. For example, the top of the 10% bracket increases by $75 to $150, depending on filing status, but the top of the 35% bracket increases by $3,125 to $6,250, again depending on filing status.
2021 ordinary-income tax brackets | ||||
Tax rate | Single | Head of household | Married filing jointly or surviving spouse | Married filing separately |
10% | $0 - $9,950 | $0 - $14,200 | $0 - $19,900 | $0 - $9,950 |
12% | $9,951 - $40,525 | $14,201 - $54,200 | $19,901 - $81,050 | $9,951 - $40,525 |
22% | $40,526 - $86,375 | $54,201 - $86,350 | $81,051 - $172,750 | $40,526 - $86,375 |
24% | $86,376 - $164,925 | $86,351 - $164,900 | $172,751 - $329,850 | $86,376 - $164,925 |
32% | $164,926 - $209,425 | $164,901 - $209,400 | $329,851 - $418,850 | $164,926 - $209,425 |
35% | $209,426 - $523,600 | $209,401 - $523,600 | $418,851 - $628,300 | $209,426 - $314,150 |
37% | Over $523,600 | Over $523,600 | Over $628,300 | Over $314,150 |
The TCJA suspended personal exemptions through 2025. However, it nearly doubled the standard deduction, indexed annually for inflation through 2025. For 2021, the standard deduction is $25,100 (married couples filing jointly), $18,800 (heads of households), and $12,550 (singles and married couples filing separately). After 2025, standard deduction amounts are scheduled to drop back to the amounts under pre-TCJA law.
Changes to the standard deduction could help some taxpayers make up for the loss of personal exemptions. But it might not help taxpayers who typically itemize deductions.
AMT
The alternative minimum tax (AMT) is a separate tax system that limits some deductions, doesn’t permit others and treats certain income items differently. If your AMT liability is greater than your regular tax liability, you must pay the AMT.
Like the regular tax brackets, the AMT brackets are annually indexed for inflation. For 2021, the threshold for the 28% bracket increased by $2,000 for all filing statuses except married filing separately, which increased by half that amount.
2021 AMT brackets | ||||
Tax rate | Single | Head of household | Married filing jointly or surviving spouse | Married filing separately |
26% | $0 - $199,900 | $0 - $199,900 | $0 - $199,900 | $0 - $99,950 |
28% | Over $199,900 | Over $199,900 | Over $199,900 | Over $99,950 |
The AMT exemptions and exemption phaseouts are also indexed. The exemption amounts for 2021 are $73,600 for singles and heads of households and $114,600 for joint filers, increasing by $700 and $1,200, respectively, over 2020 amounts. The inflation-adjusted phaseout ranges for 2021 are $523,600–$818,000 (singles and heads of households) and $1,047,200–$1,505,600 (joint filers). Amounts for separate filers are half of those for joint filers.
Education and child-related breaks
The maximum benefits of various education and child-related breaks generally remain the same for 2021. But most of these breaks are limited based on a taxpayer’s modified adjusted gross income (MAGI). Taxpayers whose MAGIs are within an applicable phaseout range are eligible for a partial break — and breaks are eliminated for those whose MAGIs exceed the top of the range.
The MAGI phaseout ranges generally remain the same or increase modestly for 2021, depending on the break. For example:
The American Opportunity credit. The phaseout ranges for this education credit (maximum $2,500 per eligible student) remain the same for 2021: $160,000–$180,000 for joint filers and $80,000–$90,000 for other filers.
The Lifetime Learning credit. The phaseout ranges for this education credit (maximum $2,000 per tax return) increase for 2021. They’re $119,000–$139,000 for joint filers and $59,000–$69,000 for other filers — up $1,000 for joint filers but the same as 2020 for others.
The adoption credit. The phaseout ranges for eligible taxpayers adopting a child will also increase for 2021 — by $2,140 to $216,660–$256,660 for joint, head-of-household and single filers. The maximum credit increases by $140, to $14,440 for 2021.
(Note: Married couples filing separately generally aren’t eligible for these credits.)
These are only some of the education and child-related breaks that may benefit you. Keep in mind that, if your MAGI is too high for you to qualify for a break for your child’s education, your child might be eligible to claim one on his or her tax return.
Gift and estate taxes
The unified gift and estate tax exemption and the generation-skipping transfer (GST) tax exemption are both adjusted annually for inflation. For 2021, the amount is $11.7 million (up from $11.58 million for 2020).
The annual gift tax exclusion remains at $15,000 for 2021. It’s adjusted only in $1,000 increments, so it typically increases only every few years. (It increased to $15,000 in 2018.)
Retirement plans
Not all of the retirement-plan-related limits increase for 2021. Thus, you may have limited opportunities to increase your retirement savings if you’ve already been contributing the maximum amount allowed:
Type of limitation | 2020 limit | 2021 limit |
Elective deferrals to 401(k), 403(b), 457(b)(2) and 457(c)(1) plans | $19,500 | $19,500 |
Annual benefit limit for defined benefit plans | $230,000 | $230,000 |
Contributions to defined contribution plans | $57,000 | $58,000 |
Contributions to SIMPLEs | $13,500 | $13,500 |
Contributions to IRAs | $6,000 | $6,000 |
“Catch-up” contributions to 401(k), 403(b), 457(b)(2) and 457(c)(1) plans for those age 50 and older | $6,500 | $6,500 |
Catch-up contributions to SIMPLEs | $3,000 | $3,000 |
Catch-up contributions to IRAs | $1,000 | $1,000 |
Compensation for benefit purposes for qualified plans and SEPs | $285,000 | $290,000 |
Minimum compensation for SEP coverage | $600 | $650 |
Highly compensated employee threshold | $130,000 | $130,000 |
Your MAGI may reduce or even eliminate your ability to take advantage of IRAs. Fortunately, IRA-related MAGI phaseout range limits all will increase for 2021:
Traditional IRAs. MAGI phaseout ranges apply to the deductibility of contributions if a taxpayer (or his or her spouse) participates in an employer-sponsored retirement plan:
- For married taxpayers filing jointly, the phaseout range is specific to each spouse based on whether he or she is a participant in an employer-sponsored plan:
- For a spouse who participates, the 2021 phaseout range limits increase by $1,000, to $105,000–$125,000.
- For a spouse who doesn’t participate, the 2021 phaseout range limits increase by $2,000, to $198,000–$208,000.
- For single and head-of-household taxpayers participating in an employer-sponsored plan, the 2021 phaseout range limits increase by $1,000, to $66,000–$76,000.
Taxpayers with MAGIs in the applicable range can deduct a partial contribution; those with MAGIs exceeding the applicable range can’t deduct any IRA contribution.
But a taxpayer whose deduction is reduced or eliminated can make nondeductible traditional IRA contributions. The $6,000 contribution limit (plus $1,000 catch-up if applicable and reduced by any Roth IRA contributions) still applies. Nondeductible traditional IRA contributions may be beneficial if your MAGI is also too high for you to contribute (or fully contribute) to a Roth IRA.
Roth IRAs. Whether you participate in an employer-sponsored plan doesn’t affect your ability to contribute to a Roth IRA, but MAGI limits may reduce or eliminate your ability to contribute:
- For married taxpayers filing jointly, the 2021 phaseout range limits increase by $2,000, to $198,000–$208,000.
- For single and head-of-household taxpayers, the 2021 phaseout range limits increase by $1,000, to $125,000–$140,000.
You can make a partial contribution if your MAGI falls within the applicable range, but no contribution if it exceeds the top of the range.
(Note: Married taxpayers filing separately are subject to much lower phaseout ranges for both traditional and Roth IRAs.)
Crunching the numbers
With the 2021 cost-of-living adjustment amounts inching slightly higher than 2020 amounts, it’s important to understand how they might affect your tax and financial situation. Our team at DSF would be happy to help crunch the numbers and explain the best tax-saving strategies to implement based on the 2021 numbers.
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