A bevy of federal income tax breaks were set to expire at the end of 2020, but the latest pandemic stimulus bill gave some of them new life.
The 5,593-page Consolidated Appropriations Act (the CAA) — which combined $900 billion in pandemic relief with a $1.4 trillion omnibus spending bill — was signed into law on Dec. 27, 2020. In this column, I’ll explain what the CAA has to say about so-called “tax extenders” that benefit individuals. The extenders are tax breaks that Congress has repeatedly allowed to expire before restoring them — often retroactively. I’ll also cover some other important tax changes included in the CAA that benefit individuals. Here’s the story.
College tuition deduction replaced by liberalized Lifetime Learning credit
For 2020, this deduction could be up to $4,000 at lower income levels or up to $2,000 at middle income levels. If your 2020 income allows you to be eligible for the deduction, you can claim it whether you itemize or not.
New law: Before the CAA, an unfavorable income phase-out rule applied to the Lifetime Learning Credit, which can be worth up to $2,000 annually. For 2021 and beyond, the new law aligns the phase-out rule for the Lifetime Learning Credit with the more favorable phase-out rule for the American Opportunity Credit, which can be worth up to $2,500 per student. In turn, the CAA repeals the college tuition write-off for 2021 and beyond.
In effect, the new law trades the old-law write-off for the more favorable new-law Lifetime Learning Credit income phase-out rule. After this change, both education tax credits are phased out for 2021 and beyond between a modified adjusted gross income (MAGI) of $80,001 and $90,000 for unmarried individuals and between MAGI of $160,001 and $180,000 for married joint-filing couples.
Lower itemized medical expense deduction threshold made permanent
The Tax Cuts and Jobs Act (TCJA) set the threshold for itemized medical expense deductions at 7.5% of adjusted gross income (AGI). The threshold was scheduled to increase to a daunting 10% of AGI for 2021 and beyond.
New law: The CAA makes the 7.5%-of-AGI threshold permanent for 2021 and beyond.
Tax-free treatment for forgiven principal residence mortgage debt extended with lower limits
For federal income tax purposes, a forgiven debt generally counts as taxable cancellation of debt (COD) income. However, an exception applies to COD income from cancelled mortgage debt that was used to acquire a principal residence. Under the exception, up to $2 million of COD income from principal residence acquisition debt that was cancelled in 2007-2020 qualified as a federal-income tax-free item ($1 million for married individuals who filed separately for those years).
New law: The CAA extends this break to cover principal residence mortgage debt that’s forgiven in 2021-2025. However, the maximum amount of forgiven debt that can be treated as tax-free for those years is reduced to only $750,000 ($375,000 for married individuals who file separately).
Mortgage insurance premium write-off extended
You can treat premiums for qualified mortgage insurance on debt to acquire, construct, or improve a first or second residence as deductible qualified residence interest. The deduction is phased out for higher-income individuals.
New law: The CAA extends this break through 2021.
Liberalized rule for calculating 2020 refundable child credit and earned income tax credit
You can collect so-called refundable tax credits even if you have no federal income tax liability. Eligible taxpayers can claim a refundable child tax credit (CTC) equal to 15% of earned income in excess of $2,500. The refundable earned income tax credit (EITC) equals the applicable percentage of an eligible taxpayer’s earned income. Earned income means wages, salaries, tips, other taxable employee compensation, and self-employment income.
More earned income can translate into bigger refundable credits, and less earned income can translate into smaller refundable credits. Obviously, lots of folks had lower earned income in 2020 due to COVID-19 economic fallout, which could result in lower refundable credits for many cash-strapped workers. Not good.
New law: For purposes of calculating allowable CTCs and EITCs for the 2020 tax year, the CAA allows you to use either your 2020 earned income or your 2019 earned income amount if that’s more than the 2020 figure.
Tax-free treatment for employer payments towards employee student loans extended
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) allows federal-income-tax-free treatment for payments made by your employer’s Section 127 educational assistance plan towards your student loan debt. Between 3/28/20 and 12/31/20, up to $5,250 per-employee could be paid out (towards principal or interest) with no federal income tax hit for the employee. Employers can deduct the payments.
New law: The CAA extends this break to cover qualifying student loan debt payments made under Section 127 plans through 12/31/25.
Charitable deductions for non-itemizers extended and expanded
For 2020, individuals who don’t itemize deductions can claim a federal income tax write-off for up to $300 of cash contributions to IRS-approved charities. The same $300 limit applies to both unmarried taxpayers and married joint-filing couples.
New law: The CAA extends the $300 break to cover cash contributions made in 2021 and doubles the deduction limit to $600 for married joint-filing couples for cash contributions made in 2021.
Bigger charitable deduction limit for generous donors extended
Before 2020, you could not claim an itemized charitable deduction for cash contributions to IRS-approved charities that exceeded 60% of your adjusted gross income (AGI). The Cares Act suspended the AGI limit for qualifying charitable contributions made in 2020.
New law: The CAA extends the taxpayer-friendly suspension into 2021.
Liberalized rules for using up your flexible spending account (FSA) balance
An employer-sponsored healthcare flexible spending account (FSA) plan can allow you to carry over of up to $550 of your unused FSA balance into the following plan year. This rule is called the carryover rule. At the employer’s option, a separate grace period rule can be offered, to give you up to 2½ months after the plan year-end to submit qualifying expenses for reimbursement and thereby use up your FSA balance. Healthcare FSAs can offer either the carryover rule or the grace period rule, but not both. For a dependent care FSA, your employer cannot offer the carryover rule, but it can offer the grace period rule
New law: For plan years ending in 2020 and 2021, the CAA allows employers to extend healthcare FSA and dependent care FSA grace periods for up to 12 months into the following plan year. For these plan years, both types of FSA plans can apparently also allow the carryover rule in addition to the grace period rule — although this is not entirely clear. We need IRS guidance.
Liberalized educator expense deduction
Eligible K-12 teachers and instructors are entitled to a $250 annual above-the-line deduction for certain school-related expenses paid out of their own pockets.
New law: The CAA stipulates that by no later than 2/28/21, the IRS must issue official guidance to clarify that the cost of personal protective equipment (PPE), disinfectant, and other supplies used to prevent the spread of COVID-19 count as allowable expenses for the $250 education deduction. This guidance will apply to such expenses paid or incurred after 3/12/20.
$500 credit for energy-efficient home improvements extended
This break allows you to claim a federal income tax credit of up to $500 for the installation of certain energy-saving improvements to a principal residence. However, the $500 maximum allowance must be reduced by any credits claimed in earlier years. In other words, the $500 amount is a lifetime limitation.
New law: The CAA extends this break to cover qualifying improvements placed in service in 2021. But if you’ve already claimed the credit for an earlier year, you may be ineligible for any further credit.
Bigger credit for residential solar energy equipment extended
You can claim a generous federal income tax credit for qualifying solar energy equipment expenditures for your home. For equipment placed in service in 2020, the credit rate is 26%. The rate was scheduled to drop to 22% for equipment placed in service in 2021 before vanishing entirely for 2022 and beyond.
New law: The CAA extends the 26% credit rate to cover equipment placed in service in 2021 and 2022 and extends the 22% rate to cover equipment placed in service in 2023. For 2024 and beyond, the credit is scheduled to vanish.
Credit for alternative fuel vehicle refueling equipment extended
You can claim a federal income tax credit for up to 30% of the cost of installing non-hydrogen alternative fuel vehicle refueling equipment. For your Tesla
or other EV.
New law: The CAA extends this break to cover qualifying 2021 expenditures.
Credit for electric motorcycles extended
You can claim a 10% federal income tax credit for the purchase of a qualifying electric-powered 2-wheeled vehicle manufactured primarily for use on public roads (i.e., electric-powered motorcycles). The credit can be worth up to $2,500.
New law: The CAA extends this break to cover qualifying 2021 purchases.
Credit for fuel cell vehicles extended
You can claim a federal income tax credit for vehicles propelled by chemically combining oxygen with hydrogen to create electricity. The base credit is $4,000 for vehicles weighing 8,500 pounds or less. Heavier vehicles can qualify for credits of up to $40,000. An additional $1,000 to $4,000 credit is available to cars and light trucks to the extent their fuel economy meets federal standards.
New law: The CAA extends this break to cover qualifying 2021 purchases.
The bottom line
There you have it: updated information on the status of tax extenders that benefit individuals and explanations of some other important tax changes that can benefit you or members of your family. As the new Biden Administration takes charge, stay tuned for more tax changes. I’ll do my best to keep you informed.