Tax Time: The American Rescue Plan Act and its Potential Impact on Individuals

by | Mar 22, 2021 | Financial Planning

On March 11, 2021, President Biden signed the American Rescue Plan Act of 2021 into law. This legislation is designed to assist in the recovery from both the health and economic impacts brought about by COVID-19. This $1.9 trillion stimulus package made various changes to the tax code, impacting many individuals and businesses in the United States. We want to provide a quick overview of the key points in this legislation and how it may impact you. 

2021 Recovery Rebates 

The American Rescue Plan Act provides a $1,400 refundable tax credit to individuals ($2,800 for joint filers) with up to $75,000 in adjusted gross income (or $112,500 for heads of household and $150,000 for married couples filing jointly). It also provides $1,400 for dependents (both child and non-child). Essentially, assuming you are under the income limits, you should receive $1,400 per taxpayer and dependent – with no upper limit. A married couple with three dependent kids and one dependent parent would receive $8,400 (6 x $1,400)!  

The credit will be phased out entirely for those with income above $80,000 (or $120,000 for heads of household and $160,000 for married couples filing jointly). The IRS will use the most recent adjusted gross income in its system (2019 or 2020). If an individual qualifies for a larger payment using 2021 income, the difference will be claimed as a credit on the individual’s 2021 return.

Financial Planning Note: If your adjusted gross income (AGI) is right around the phase-out ranges listed above, consider the items below: 

  • If your AGI in 2019 was lower than the phase-out limit, but your AGI in 2020 is higher, consider waiting to file your tax return until you receive your stimulus check(s). 
  • If your AGI in 2020 was lower than the phase-out limit, but you haven’t filed yet – good news. The American Rescue Plan Act created what is called the Additional Determination Date, which is the earlier of 90 days after the 2020 calendar year filing deadline, or September 1st, 2021. As long as you file your 2020 tax return before then, your Recovery Rebate amount (stimulus check) will be recalculated based on your 2020 AGI. 
  • Even though 2019 and/or 2020 tax returns are used to determine your Recovery Rebate amount, this is a 2021 tax credit. If both your 2019 and 2020 tax returns do not allow for Recovery Rebates, your 2021 tax return will be used to calculate whether you qualify for a stimulus check. 
  • The IRS has stated that there is no clawback on a taxpayer’s 2021 tax return. This means that if you qualify for a stimulus check based on your 2019/2020 tax return, but do not qualify based on your 2021 return, you will not be required to return the stimulus money you received. 

Child Tax Credit

The American Rescue Plan Act increases the child tax credit amount for 2021 only, to $3,600 for children under age 6, and $3,000 for children ages 6 to 17. The new legislation makes the child tax credit fully refundable for 2021 and expands the definition of a “qualifying child” to include 17-year-olds. There are now two phase-out limitations for this tax credit: 

  • The total enhanced credit amount – $3,000 per child age 6 or over; $3,600 per child under age 6 – is phased out for joint filers with a modified adjusted gross income above $150,000 ($75,000 for single filers). 
  • The regular Child Tax Credit amount – $2,000 per child – is phased out for joint filers with a modified adjusted gross income above $400,000 ($200,000 for single filers).

Financial Planning Note: Notice that the phase-out ranges here are very similar to the ones mentioned in the previous section. As before, if your income is close to the phase-out ranges for 2021, consider implementing certain tax planning strategies to lower your 2021 AGI to qualify for the credit such as, increasing your pre-tax retirement plan contributions, increasing your charitable giving (assuming you itemize your deductions), etc. 

The IRS will make periodic advanced payments of the child tax credit from July 2021 through December 2021, which will be based on the household’s 2019 or 2020 tax return. These payments will be comprised of half of the entitled child tax credit, with the remaining half claimed on the 2021 tax return. 

Child and Dependent Care Tax Credit

The household and dependent care tax credit is made refundable for 2021, and the maximum credit amount is increased to $8,000 for one qualifying individual (children who are under the age of 13 for the entire year) or $16,000 for two or more qualifying individuals. 

Before the enactment of this law, the maximum applicable percentage for qualified expenses was 35% and was then reduced to a 20% floor for households with adjusted gross income (AGI) over $45,000. However, for 2021, the maximum applicable percentage is increased to 50%, which is then reduced after your AGI exceeds $125,000. From $125,000 to $400,000 of AGI, the phaseout percentage is 20%, which is then reduced to $0 for AGI exceeding $440,000 in 2021. In summary, the Child and Dependent Care Tax Credit has increased both the maximum potential credit amount as well as the applicable percentage amount for qualified expenses, which may drastically increase the credit for most households, but eliminates the credit for high-income-earning households. 

Student Loan Forgiveness 

The American Rescue Plan Act sets the stage for future student loan forgiveness by stating that all eligible student loans discharged from 2021 through 2025 will be excluded from income. This provides a runway for potential future student loan forgiveness – but as of now, no student debt has been forgiven.  

Suspension of Income Tax on Portion of Unemployment Compensation

Many people in the United States experienced a change in their employment hours and/or status and as a result, applied for unemployment benefits. The American Rescue Plan Act extends a lot of the unemployment assistance including the Federal subsidies to states, the additional $300 per week in addition to state unemployment benefits, and the inclusion of qualifying self-employed individuals until September 6th, 2021. 

For 2020, the act provides an exclusion from gross income of up to $10,200 of unemployment compensation received for individuals with adjusted gross income (AGI) of less than $150,000. Unlike the other phase-outs, this is essentially a cliff threshold, meaning if you earn $149,999 – you qualify for the exclusion, but if you earn $150,000 – all of the unemployment compensation you received is considered taxable income. To make it even more interesting, when calculating your AGI, the calculation includes the unemployment compensation you received throughout the year. 

2021 COBRA Subsidies for Terminated Employees

In a normal year, if you were to lose your job, you may have the opportunity to elect to stay on your employer’s group health insurance plan via the Consolidated Omnibus Budget Reconciliation Act (COBRA). Qualified individuals may be required to pay up to 102% of the entire premium for health coverage (no longer subsidized by the employer) – which can be costly. However, from April 2021 through September 2021, the American Rescue Plan Act allows qualified individuals to maintain COBRA coverage at no cost to them. This piece of legislation could provide an extensive amount of support as health insurance costs are continuously rising.  

Now what? 

If you feel that any of the changes noted above may impact you and your financial plan, please call our office at (757) 436-1122 to discuss your specific tax situation, and a financial advisor will reach out to you to see how we may assist with your tax planning needs. 

We recommend you consult with your tax professional before making any tax-related decisions. Please note that the financial planning services concepts mentioned in this article are general in nature and are not meant to be financial advice for your specific tax situation. 

Reproduced with permission from Bloomberg Tax & Accounting. Published 3/12/2021. Copyright 2021 by The Bureau of National Affairs, Inc. (800-372-1033) https://pro.bloombergtax.com

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