Getting Ready for Your 2021 Tax Return

Standard Deduction versus Itemized Deductions

The Tax Cuts and Jobs Act of 2017 (TCJA) substantially increased the standard deduction amounts, making itemized deductions less attractive for many individuals. For 2021, the standard deduction amounts are:

• $12,550 (single);
• $18,800 (head of household);
• $25,100 (married filing jointly); and
• $12,550 (married filing separately).

An additional standard deduction amount of $1,350 applies for taxpayers who are 65 or older or blind. This additional amount is increased to $1,700 if the individual is unmarried and not a surviving spouse. If the taxpayer is 65 or older and blind, the deduction is doubled.

The TCJA capped the amount of State and Local Taxes (SALT) that can be deducted on Schedule A to $10,000 (single and married filers) and $5,000 for clients filing married filing separately. With the SALT limitation, many clients pay less tax with the standard deduction than itemizing their medical expenses, taxes, mortgage interest, and charitable contributions.

Most of the provisions in the TCJA will expire after the 2025 tax return year. Some members of Congress are trying to remove the SALT provisions before the expiration date. I encourage you to continue submitting your property tax, mortgage interest, and charitable contribution documents to see if you may benefit by itemizing your deductions. However, don’t be surprised if you see the standard deduction on your tax return.

Medical Expenses, Health Savings Accounts, and Flexible Savings Accounts

As a result of the COVID-19 pandemic, many individuals have incurred more medical expenses than usual. For 2021, out-of-pocket medical expenses you have paid in 2021 are deductible as an itemized deduction to the extent they exceed 7.5 percent of your adjusted gross income. Deductible medical care expenses must be primarily to alleviate or prevent a physical or mental disability or illness. They don’t include expenses that are merely beneficial to general health, such as vitamins or a vacation. Deductible expenses include hospitalization expenses and health insurance premiums, and the amounts you pay for transportation to get medical care. Medical expenses also include amounts paid for qualified long-term care services and limited amounts paid for any qualified long-term care insurance contract. Depending on what your taxable income is expected to be in 2021 and 2022 and whether itemizing deductions would be advantageous for you in either year, you may want to accelerate any optional medical expenses into 2021 or defer them until 2022. The right approach depends on your income for each year, expected medical expenses, as well as your other itemized deductions.

If you don’t already have one, you may also want to consider health savings accounts (HSAs). These are tax-advantaged accounts that help individuals who have high-deductible health plans. If you are eligible to set up such an account, you can deduct the amount you contribute to the account in computing adjusted gross income. These contributions are deductible whether you itemize deductions or not. Distributions from an HSA are tax-free to the extent they are used to pay for qualified medical expenses (i.e., medical, dental, and vision expenses). For 2021, the annual contribution limits are $3,600 for an individual with self-only coverage and $7,200 for an individual with family coverage.

In addition, if your employer offers a Flexible Spending Account (FSA), consider setting aside some of your earnings tax-free in such an account so you can pay medical and dental bills with pre-tax money. The maximum amount that the IRS will allow to be set aside for 2021 is $2,750. Since you don’t pay taxes on this money, you’ll save an amount equal to the taxes you would have paid on the money you set aside. FSA funds can be used to pay deductibles and copayments, but not for insurance premiums. You can also spend FSA funds on prescription medications, as well as over-the-counter medicines, generally with a doctor’s prescription. Reimbursements for insulin are allowed without a prescription. And finally, FSAs may also be used to cover medical equipment costs (e.g., crutches), feminine hygiene and medical supplies, and diagnostic devices like blood sugar test kits.

Charitable Contributions

While the tax benefits of making charitable contributions and taking an itemized deduction for such contributions were reduced due to the increases made to the standard deduction amounts, a law passed at the end of 2020 modified the charitable contribution rules for 2021 tax returns. As a result, eligible individuals can claim a deduction of up to $300 ($600 in the case of a joint return) for qualified cash charitable contributions made during 2021. An eligible individual is an individual who does not elect to itemize deductions. A qualified charitable contribution is a cash contribution paid in 2021 to an eligible charitable organization (e.g., a 503(c)(3) non-profit, schools, and hospitals). Go Fund Me and political campaign contributions are not eligible. Also, contributions of non-cash property, such as securities or items to Goodwill, are not qualified contributions. Look for a question about your contributions on the 2021 Tax Return Checklist you will be asked to compete.

If you are itemizing your deductions, you can reap a more significant tax benefit by donating appreciated assets, such as stock, to a charity. Generally, the higher the appreciated value of an asset, the bigger the potential value of the tax benefit. Donating appreciated assets not only entitles you to a charitable contribution deduction but also helps you avoid the capital gains tax that would otherwise be due if you sold your stock.

For example, if you own stock with a fair market value of $1,000 that was purchased for $250 and your capital gains tax rate is 15 percent, the capital gains tax you would owe if you sold that stock is $113 ($750 gain x 15%). If you donate that stock instead of selling it and you are in the 24 percent tax bracket, your ordinary income deduction is worth $240 ($1,000 FMV x 24% tax rate). You also save the $113 in capital gains tax you would otherwise pay if you sold the stock; that amount goes to the charity. Thus, the after-tax cost of the gift of appreciated stock is $647 ($1,000 - $240 - $113) compared to the after-tax cost of a donation of $1,000 cash which would be $760 ($1,000 - $240).

Finally, if you have an individual retirement account and are 70 1/2 years old and older, you are eligible to make a charitable contribution directly from your IRA. This is more advantageous than taking a distribution and donating to the charity that may or may not be deductible as an itemized deduction. If your itemized deductions, including the contribution, are less than your standard deduction, then you receive no tax benefit from taking a taxable distribution and donating that distribution. You eliminate having the IRA distribution included in your income by donating directly from your IRA to a charity. The IRA donation reduces your adjusted gross income (AGI). Lower AGI can potentially increase your medical expense deduction, reduce the tax on social security income, and reduce any net investment income tax since these items are calculated based on your adjusted gross income.

Expenses Incurred While Working from Home

Although more people have been working from home this year due to the pandemic, related expenses are not deductible if you are an employee. You may want to ask your employer for reimbursements for new office equipment (e.g., desk, chairs, computers, etc.) Your employer can probably deduct the expense on their business tax return.

If you are self-employed and working from home during the year, tax deductions are still available. Thus, if you have been working from home as an independent contractor, we should discuss what expenses you have incurred that might offset that taxable income.

Mortgage Interest Deduction

If you sold your principal residence during the year and acquired a new principal residence, the deduction for any interest on your acquisition indebtedness (i.e., your mortgage) could be limited. The interest deduction on mortgages of more than $750,000 obtained after December 14, 2017, is limited to the portion of the interest allocable to $750,000 ($375,000 in the case of married taxpayers filing separately). If you have a mortgage on a principal residence acquired before December 15, 2017, the mortgage interest limitation applies to mortgages of $1,000,000 ($500,000 in the case of married taxpayers filing separately) or less. However, if you operate a business from your home and take the “home office deduction,” a portion of your mortgage interest is not subject to these limitations.

Interest on Home Equity Loans and Loan Refinancing

You can potentially deduct interest paid on home equity loans (HELOCs), but only if you used the debt to buy, build, or substantially improve your home. Thus, for example, interest on a home equity loan used to build an addition to your existing home is typically deductible, while interest on the same loan used to pay personal expenses, such as credit card debt, vacations, or a new automobile, is not.

The same concept applies if you refinanced your home in 2021. If all the proceeds from the new loan are applied to your home’s principal, all the mortgage interest is deductible. However, if you refinanced your home and used a portion of the proceeds for other purposes, a portion of your mortgage interest is not deductible. You will need to let me know if you refinanced your home mortgage in 2021 to determine whether all your mortgage interest is deductible.

Sale of a Home.

If you sold your home this year, up to $250,000 ($500,000 for married filing jointly) of the gain on the sale is excludible from income. However, this amount is reduced if part of your home was rented out or used for business purposes. Generally, a loss on the sale of a home is not deductible. But again, if you rented part of your home or otherwise used it for business, the loss attributable to that portion of the home is deductible.

Discharge of Qualified Principal Residence Indebtedness

If you had a qualified principal residence mortgage and the bank discharged (forgave) the loan in 2021, it is not included in gross income. (Usually, when a loan is forgiven, the IRS considers the amount of debt forgiven as taxable income.)

Deductions for Mortgage Insurance Premiums

You might be entitled to treat amounts paid during the year for any qualified mortgage insurance as deductible qualified residence interest if the insurance was obtained in connection with acquisition debt for a qualified residence.