Although there were improvements in 2021, many individuals still faced economic challenges that began in 2020. Most Americans, however, received two stimulus payments in 2020 to help out (and those were thankfully tax free). There was a third in 2021 of up to $1,400. And then there was the Advanced Child Tax Credit for eligible parents. The IRS sent advance payments from July to December of up to $300 per child. As tax season rolls around and people file taxes on their 2021 income, there are many opportunities to make a little bit of lemonade out of 2021’s lemons. For people in certain situations, 2021 offers tax benefits that may result in a much larger refund check than expected.
Tax benefits if you tapped your 401(k) in 2020
So, what does this mean if you withdrew money early from your 401(k) in 2020? Let’s say you withdrew $30,000 in order to survive the year. In an ordinary year, you would have to treat this as ordinary income, pay income taxes on it, and pay an additional 10% penalty – another $3,000. In this example, however, you now have more options. You have the opportunity to spread that income across three years if you like, reporting $10,000 on your return in 2020, 2021 and 2022. Furthermore, if you decide to repay that $30,000 by the end of 2022, you can file an amended return for the earlier years and claim a refund on the taxes you paid on the $10,000 for each year. Also: Tax identity theft: How to protect your credit and finances
Opportunity to get any stimulus checks you may have missed
If you were eligible to receive stimulus money in 2020 and 2021 (referred to by the IRS as an Economic Impact Payment), and you didn’t receive all of it, don’t worry. You can claim the missing amount as a Recovery Rebate Credit on your taxes that you file this spring, which will reduce the taxes you owe by the amount you’re still missing from your stimulus payment. This means that you’ll essentially receive your payment as part of your tax refund (or in the form of a smaller tax bill, in some cases). The IRS addresses most questions you may have about this on their Recovery Rebate Credit page.
Potential eligibility for the Earned Income Tax Credit
Some people who experienced a drop in income in 2020 and/or 2021 may now be eligible for the Earned Income Tax Credit, which is a direct reduction in your tax bill that applies to lower-income households, particularly those with children. However, more workers will qualify for EITC in 2021 (including those without kids) and receive more than the previous year. As a quick check, if you earned $57,000 or less in household income in 2021 and have three or more children, you’re likely eligible for the credit. For fewer children, the income limit drops significantly, down to $48,000 in household income for one child and just $21,000 if you don’t have any. The IRS EITC Fast Facts page explains the basics. What’s the benefit of this credit? The size of the credit goes as high as $6,728 (if you have three or more qualifying children). In addition, individuals and families eligible for Federal EITC could receive a similar credit from their local government in 28 states, D.C. and New York City. For many people, that becomes a direct boost to their tax return, or they can turn a situation where they owe taxes into a situation where they get a refund instead.
Child Tax Credits
If you received advanced child tax credits in the last half of 2021, the amounts are not taxable. However, they’re an advance of the credit you’d receive at tax time which will be deducted from the credit owed to you.
The Standard Deduction
The IRS increased the standard deduction for tax year 2021 filings to keep up with inflation. Married couples can now take $25,100 (instead of $24,800 last year) and $1,350 per spouse over 65. Filing as head-of-household amounts to $18,800 for 2021 income plus $1,700 for filers 65 or older. Individuals filing as single can deduct $12,550 or $14,250 if they’re 65 or older.
Child and Dependent Care Credit
If you pay for childcare, your annual credit is higher this year than the previous year. Qualifying families could receive 50%, compared to 35% off for 2020. The maximum is a credit of $4,000 on up to $8,000 in qualifying childcare expenses for one child and up to $8,000 on $16,000 in eligible childcare expenses for two or more kids.
What if you receive a large tax refund?
These factors combined may cause you to receive a larger-than-usual tax refund this year. If you’re due to receive a big check from the IRS, be smart with your tax refund. Here are some things to consider:
Pay off high interest debts
If 2021 saw you racking up credit card debt or payday loan debt, your income tax refund check should be used to eliminate some or all of that debt. Start by constructing a debt repayment plan (it’s easy!) and use that to determine which of your debts you should pay off first.
Start an emergency fund
If you don’t have any outstanding high interest debts, consider putting some of the money aside in an emergency fund. An emergency fund is just what it sounds like: a reserve of cash saved for emergencies. Building an emergency fund isn’t hard, especially if you start with a bit of cash.
Save for a known upcoming expense
If you have an appliance that will have to be replaced soon, for example, hold onto that cash until it’s time to make that big purchase. Having a down payment – or enough to pay for the whole thing – will save you quite a lot compared to using credit or taking out a loan. Also: How to file your taxes if you received unemployment benefits in 2021
Bad news: You do owe taxes on unemployment benefits… but there’s help
If you received unemployment benefits in 2021, bad news: You do owe income taxes on those benefits, just like you do on ordinary income. Don’t worry if you’re in this situation, however: If you elected to have taxes taken out of your unemployment checks, you’re in good shape. What if you didn’t do that? First, prepare your income taxes and see how much you owe. Start saving as much as possible as soon as possible so you can afford the tax bill. Next, be proactive and contact the IRS directly to set up a payment plan.
