President Trump signed into law billions of dollars in long-awaited COVID-19 and economic relief. The relief package is part of the nearly 5,600-page Consolidated Appropriations Act (CAA), which also contains numerous other tax, payroll and retirement provisions. Here are some of the provisions most likely to affect individual taxpayers.
The most headline-grabbing component of the CAA is the second round of direct payments. The law calls for nontaxable “recovery rebates” of $600 per eligible taxpayer ($1,200 for married couples filing jointly) plus an additional $600 per qualifying child.
The payments begin phasing out at $75,000 of modified adjusted gross income (MAGI) for single filers, $112,500 for heads of household and $150,000 for married couples filing jointly. Payments are reduced by $5 for every $100 of income above these thresholds, and phaseouts reduce the total payment amount, including the amounts for qualifying children.
The CAA expands eligibility for the payments to so-called mixed-status households, meaning those where not every family member has a Social Security Number (SSN). This change is retroactive to the CARES Act. Eligible families who didn’t receive a payment in the first round because one spouse lacked an SSN can claim a credit for that payment on their 2020 federal tax returns.
Because the rebates are based on your 2019 tax returns, you could receive a payment that’s less than you’re entitled to under the law. If your income was lower in 2020 or your family grew, you may be able to claim an additional credit for the difference on your 2020 tax return. But, if you receive a payment and it turns out your actual 2020 income is high enough that your payment should have been phased out, you won’t have to repay the difference.
The CAA provides an extra $300 per week in unemployment benefits, over and above state unemployment benefits, for 11 weeks. It also extends for 11 weeks the Pandemic Unemployment Assistance program, which makes unemployment benefits available to workers who typically don’t qualify, including the self-employed, gig economy workers and others in nontraditional employment.
The new law includes multiple types of relief for those struggling with their housing costs. For example, the federal eviction moratorium is extended through January 31, 2021. The CAA also offers rental assistance for families affected by COVID-19. Eligible households can apply the funds to rent, utilities and energy costs — including amounts in arrears. And mortgage insurance premiums remain deductible through 2021 (subject to phaseout limits).
The CARES Act provides several forms of temporary relief related to retirement plan requirements. For example, it permits penalty-free withdrawals from certain retirement plans for expenses related to COVID-19 and lifts the limit on retirement plan loans. The CAA clarifies that money purchase pension plans are included among the retirement plans subject to the temporary relief measures under the CARES Act.
Unfortunately, the pandemic wasn’t the only disaster to befall taxpayers this year, and the CAA recognizes that. It includes tax relief for taxpayers in federally declared disaster areas for major disasters (not related to COVID-19) declared from January 1, 2020, through February 25, 2021.
The relief under the CAA mirrors some of the relief afforded under the CARES Act. For example, it provides that residents of qualified disaster areas can take distributions of up to $100,000 from retirement plans without the normal 10% early withdrawal penalty. A “qualified disaster distribution” must be made no later than June 25, 2021. The CAA also contains special rules for the recontribution of retirement plan distributions applied to a home purchase in a qualified disaster area and raises the limit for retirement plan loans made following a qualified disaster.
Be aware that the CAA doesn’t extend the CARES Act’s temporary waiver of required minimum distributions. Affected taxpayers should plan on resuming those distributions for 2021.
Earned income and child tax credits
The CAA includes a temporary change that could result in larger earned income tax credits (EITCs) and child tax credits (CTCs). It allows lower-income individuals to use their earned income from the 2019 tax year to determine their EITC and the refundable portion of their CTC for the 2020 tax year. This could produce larger credits for eligible taxpayers who earned lower wages in 2020 due to the pandemic.
Medical expense deductions
For tax years beginning before January 1, 2021, you could claim an itemized deduction for unreimbursed medical expenses that exceeded 7.5% of your adjusted gross income (AGI). The threshold was scheduled to jump to 10% of AGI for 2021, which would make it more difficult to qualify for a medical expense deduction. The CAA permanently sets the threshold at 7.5% of AGI for tax years beginning after December 31, 2020.
Under the CARES Act, taxpayers who don’t itemize their deductions on their tax returns can nonetheless claim a $300 “above-the-line” deduction for cash contributions to qualified charitable organizations in 2020. The CAA extends that deduction through 2021 and doubles the deduction for married filers to $600. Contributions to donor-advised funds and supporting organizations don’t qualify for the deduction.
The CARES Act also loosened the limitations on charitable deductions for cash contributions made in 2020, boosting it from 50% to 100% of AGI. The CAA carries that over for 2021. Cash contributions remain limited to the excess of AGI over the amount of all other charitable contributions. Any excess cash contributions are carried forward to later years.
Under the CARES Act, employers can provide up to $5,250 annually toward employee student loan payments on a tax-free basis before January 1, 2021. The payment can be made to the employee or the lender. The CAA extends the exclusion through 2025. The longer term may make employers more willing to offer this benefit.
The CARES Act also temporarily halted collections on defaulted loans, suspended loan payments and reduced the interest rate to zero through September 30, 2020. Subsequent executive branch actions extended this relief through January 31, 2021. The CAA leaves in place that expiration date.
Education tax credits
Qualified taxpayers generally can claim an education tax break with the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC). Previously, though, the two credits were subject to different phaseout rules, with the AOTC available at a greater MAGI than the LLC. In addition, before the new law, taxpayers could claim a “higher education expense deduction” for qualified tuition and related expenses.
The CAA adopts a single phaseout for both the AOTC and the LLC, effective for tax years beginning after December 31, 2020. The credits will phase out beginning at $80,000 for single filers and ending at $90,000. For joint filers, they will begin to phase at $160,000 and disappear at $180,000.
The new law also repeals the higher education expense deduction. Instead, taxpayers can apply the LLC credit.
Discharged mortgage debt
The tax code provision allowing taxpayers to exclude the discharge of qualified debt on their principal residence up to $2 million (or $1 million for married individuals filing separately) from their gross income was scheduled to expire at the end of 2020. The CAA extends the exclusion to such debt discharged through 2025. But it also reduces the maximum acquisition debt limits to $750,000 for individuals — and $375,000 for married individuals filing separately — for debt discharged after 2020.
Flexible Spending Accounts
The CAA loosens certain rules related to health and dependent care Flexible Spending Accounts (FSAs) that could lead to taxpayers forfeiting unspent funds. It allows unused amounts from 2020 FSAs to roll over to 2021and unused amounts from 2021 FSAs to roll over to 2022. Grace periods for plan years ending in 2021 or 2022 may be extended to 12 months after the end of the plan year. For 2021, employees can make mid-year prospective changes in their FSA contribution amounts without a change in status.
These changes are voluntary for employers. If you have an FSA, check with your employer to see if it’s adopting the available relief.
Repayment of deferred payroll taxes
In August 2020, President Trump issued an executive order allowing employees to defer their share of Social Security taxes. Subsequent IRS guidance allowed, but didn’t require, employers to suspend withholding of such taxes. If your Social Security taxes were deferred, the CAA includes a change that could affect your expected cash flow for 2021.
Originally, the IRS issued guidance requiring employees to pay any deferred employment taxes on a prorated basis from January 1, 2021, through April 30, 2021. The CAA gives employees the entire year in 2021 to make up those deferred payments. That means you could have modestly more cash flow than you would have without the law.
The CAA is one of the longest pieces of legislation in congressional history, and the provisions outlined above are only a sampling of those that could affect you. Feel free to contact your H2R CPA liaison and they will be happy to assist you with any questions or concerns about these new tax changes.