Marriage, divorce, side hustles, giving birth, getting sick — all these life changes trickle onto your tax return. These tips can help.
Yep, we’ve been through it this year. Oh – I’m not talking about the pandemic. I’m talking about all the other real life sh*t that didn’t grind to a halt, some of it blissful, some not so much. Think marriage, divorce, giving birth, emptying your nest, surviving a costly health crisis, starting a business or side hustle, or retiring from/re-entering the workforce. All of it can impact your overall tax filing picture.
If you went through anything out of the ordinary in 2021, and we’re guessing (that pandemic, again) that you did, here’s a rundown of what to consider as you (or your tax pro) prepare to file.
A NOTE ABOUT STATE AND FEDERAL 2021 TAX FILING AND PAYMENT DEADLINES:
If you’re still not ready to turn in your homework by April 18, file an extension using Form 4868. That gives you until October 17, 2022 to file your 2021 return. (Yes, for those of you doing the math in your head, that’s six more months.) Note: The extension applies only to filing, not to paying. If you owe money, you need to pay it by April 18 for your federal return. To avoid possible penalties, estimate and pay any owed taxes by the filing deadline. State tax filing and payment deadlines may be different. Check your state tax agency for deadline information.
If You Lost Your Job
The $1.9 trillion American Rescue Plan Act of 2021 was signed into law on March 11, 2021. This brought some tax-relief measures to households across the country.
Thanks to the American Rescue Plan, we saw the extension of unemployment benefits on a state and federal level through Labor Day 2021. It’s important to know that unemployment benefits are taxable income (stimulus payments are not).
If you received unemployment benefits in 2021, you should have received form 1099-G in the mail. It will show the gross amount of unemployment income you received and how much was withheld for taxes.
If it seems counterintuitive that you’re paying taxes on unemployment income because you are out of work and not bringing in income you’re not alone. And, depending on how long you were out of work, you may find yourself with a tax bill you can’t afford to pay. You still want to file your taxes by the April 18th deadline and work with the IRS on creating a payment plan.
If You Withdrew from a Retirement Account
The CARES Act opened the door to withdrawing up to $100,000 from your 401(k), IRA or similar retirement account as what many people were calling a “tax-free loan.” How’d that work? You could withdraw the money penalty free. If you were able to repay it within three years, you wouldn’t owe income taxes that you normally would upon making a withdrawal. However, now it’s tax time and it’s a little more complicated than that.
If you made a withdrawal, you have to report one-third of it as income over each of the three subsequent years starting with 2020. (You can report it all, but you must report at least one-third.) If you repay the funds during that three-year period (2020-2022), you can file an amended tax return now and the taxes paid will be refunded. But for now, it’s important to know that you’re on the hook.
If Your Relationship Status Changed
A change in relationship status may call for a change in your 2021 tax filing status (e.g. whether you file as single, head-of-household, married filing separately, married filing jointly). Your filing status determines your income tax rate, the amount you’re allowed to claim for the standard deduction, which credits you’re entitled to and more.
Your relationship status on the last day of 2021 — and every year — determines what filing status you can use. Strategically, you should pick the filing status that will save you the most in taxes. Some things to keep in mind:
If you officially coupled up in 2021, the “married filing jointly” filing status is often more financially beneficial than choosing “married filing separately,” says CPA Ross Riskin, assistant professor of taxation at The American College of Financial Services.
There are, of course, exceptions. (It’s taxes. Of course there are.) Riskin notes that if you and your spouse are both high earners with similar incomes, the combination could push you into a higher tax bracket when filing jointly.
Also tread carefully if you’re dealing with student loans, particularly if you’re on an income-driven repayment plan such as an income-based repayment (IBR) or pay-as-you-earn (PAYE) plan. “If you’ve got student loans and are married to a high earner, filing separately may allow you to reduce your monthly loan payment by isolating the borrower’s income, but it may also come at the expense of paying more in taxes collectively,” Riskin says. “However, if you are on the revised pay-as-you earn (REPAYE) plan, then both spouses’ incomes will be taken into consideration when determining the monthly payment regardless of filing status.”
If you got divorced in 2021 and are paying or receiving alimony, the Tax Cuts and Jobs Act of 2017 means it is no longer counted as taxable income (yay, if you’re the recipient!). Nor is it deductible for the person paying it (whomp, whomp). Your marital status on December 31, 2021 will affect how you file. If you aren’t officially divorced by the end of the year, you may still file your taxes jointly, which can save you both money.
Another thing to hash out is who claims the children as dependents. “Normally the custodial parent will claim the child,” Riskin says, “but it’s not uncommon for the custodial parent to release the exemption to the non-custodial parent, or for parents to alternate years when claiming the child on their taxes.” For 2021, the child tax credit has increased from $2,000 per child to $3,600 per child 5 years old and younger, or $3,000 per child 6 to 17 years old. Note: that temporary increase will not be the case in 2022 when the credit goes back to $2,000 per child.
Riskin says that the value in claiming the child may appear to no longer exist since dependency exemptions have been suspended under the Tax Cuts and Jobs Act. But claiming the child may allow you to claim other tax credits. For example, if you plan on claiming the American Opportunity Tax Credit for your college student, the child must be listed as your dependent on your return, regardless of whether or not you’re the parent paying for the college expenses.
MORE ON HERMONEY: Divorcing? How to Financial Protect Yourself When the S**T Hits the Fan
Death of a spouse
We’ve lost close to a million Americans and counting to COVID-19 alone. If your beloved passed away in 2021, you can continue to use the same filing designation you used when they were alive (e.g. married filing jointly) for your taxes, says CPA Sophia Duffy, assistant professor of business planning at The American College of Financial Services.
For the tax years after their death, however, you will need to adjust your filing status. The most financially advantageous is the qualifying widow status, which allows you to claim double the standard deduction of a single status filer. You’re allowed to use that on your 2021 tax returns if …
- You qualified for married filing jointly with your spouse for the year they died.
- You didn’t remarry in the tax year in which your spouse died.
- You claim a child (stepchild or adopted child) as a dependent. This does not apply to a foster child.
- You paid more than half of the expenses of maintaining your home.
- Otherwise you’ll need to file as single and/or head of household.
A spouse’s death also affects how you’re taxed if you sell property you inherited, most notably on investment account assets. “You get a step-up in basis on inherited property, which means you’ll pay lower capital gains when you sell the property, compared to what you would have if you sold the property when your spouse was alive,” Duffy says.
If you added or subtracted dependents
New baby, expanding the family through adoption, launching your kid into the real world, taking adult family members (like parents) under your wing … are all things that affect how you account for dependents when you fill out your tax return. For 2021, it may also mean additional stimulus dollars in your pockets via your refund (or a reduction of taxes owed).
The American Rescue Plan Act of 2021 increased the child tax credit from $2,000 per child to $3,600 per child 5 years old and younger, or $3,000 per child 6 to 17 years old. If you received advance Child Tax Credit payments, you will need to report the total received when you file your taxes. You should have received Letter 6419 from the IRS in January.
If you blended a family in 2021 and added older kids to the household who are still dependents (e.g. full-time college students), look into the Family Tax Credit, which is worth up to $500 per kid.
Then there are the stimulus payments. If you qualified (singles with income up to $75,000, married couples with incomes of up to $150,000 and heads of household with incomes of up to $112,500 qualified for full payments), you were eligible for rounds of stimulus. The first two were dispersed in 2020 (March and December). The third, dispersed in March 2021, provided $1,400 for dependents of any age.
If you had a baby in 2021, you are most likely eligible to receive the child tax credit if you live in the U.S. and your child is an American citizen.
Another note for divorced parents of college-age children: Just because one parent claims the child as a dependent doesn’t mean that only their information is reported for financial aid purposes. “When you’re dealing with divorced families, you can get to the point where as many as four parents’ finances — both parents and their spouses, if they remarried — are reported when you’re filling out financial aid applications at selective private colleges,” Riskin says.
Caring for other family members:
The IRS’s definition of dependent isn’t limited to young’uns. If you’re caring for an elderly parent or another relative with special needs, Duffy recommends seeing if you are eligible for the deductions and credits for a qualifying dependent, such as the Dependent Care Credit or Credit for Other Dependents. And if you were using a Flexible Spending Account to pay for dependent care costs and were unable to use up all of those funds in 2021 thanks to the pandemic, you may roll unused funds from 2021 into 2022. Check with your employer, however. They have to accept these government-okayed changes for them to pertain to you.
If you expanded your family tree through an adoption that was finalized in 2021, the Child Adoption Credit may be worth up to $14,440 tax credit, depending on your family’s modified adjusted gross income. According to the North American Council on Adoptable Children (NACCA), parents can only use the credit if they have federal income tax liability. It’s important to note that the adoption credit doesn’t apply to adopting a stepchild. However, it is open to grandparents who adopt a grandchild.
Emptying the nest
If 2021 marked the year some of your chicks left the nest and you no longer claim them as dependents, be sure to update your withholding (Form W-4 filed with your employer) so you don’t get a surprise when filing your taxes.
If you re-entered or exited the workforce, or started a side hustle
Was 2021 the year your side hustle took off, you finally started your own business, you went back to work after a break, or you entered retirement either by choice or…well…not? If so, be prepared for tax season changes.
If your one-income household became a two-income one, put some thought into filling out your W-4. “You may end up under-withholding, especially if you file with a spouse who makes significantly more money and you don’t properly account for this when selecting your withholding allowance,” Riskin says. That can lead to a lower refund than expected, or worse — owing money to the IRS. Don’t forget to keep withholding in mind for both your state and federal returns as well.
If you worked only part of the year or had a low income, don’t overestimate the impact of claiming the Earned Income Tax Credit (EITC). “You get the maximum benefit only if you fall within certain thresholds,” Riskin says. Use the EITC Assistant on the IRS.gov website to see if you are eligible for the credit and get an estimate of the amount.
If you started a side hustle in 2021, staying in the IRS’s good graces means understanding how you’re compensated. Tax filing is less onerous if you’re a full-time employee who filled out Form W-2 because employers deduct federal and state taxes from your wages upfront. It’s more complicated if you took on side work and/or any gig for which you received a 1099 (the tax form sent to you and the IRS to indicate how much you were paid for the job). As a “1099 worker” you’re responsible for paying both the employee share of taxes (Social Security and Medicare) and the employer share (FICA). On the plus side, if you itemize, you can write off side hustle-related business expenses whether you itemize or not. (For more see: Do I Have to Pay Taxes on Side Hustle Income?) By the way, if your kid earns income, better check to see if your child has to file a tax return.
If you launched a business that you run from your home, Duffy recommends seeing if you can benefit from the home office deduction, which is usually around $5 per square foot of space devoted to running your empire. Another big tax saving is the ability to itemize and deduct qualified business-related purchases, such as office furniture, computers, software, and day-to-day operating expenses. “That can be a pretty significant tax break, especially in the first few years you start a business and your income exceeds certain thresholds,” she says. Be sure you save and organize all of your receipts for these business purposes.
If you worked from home but as an employee, like many people you probably had to outfit your space. Unfortunately, unless you’ve got 1099 income you’re not eligible to take that home office deduction or to write off those expenses. Not fair? We agree. But trying to do so will raise red flags.
Whether it’s a side hustle or new business, keep really good records and documentation. Duffy says the IRS is more likely to scrutinize the returns if you have:
- Variable income (e.g. a combination of salary and commission-based compensation)
- Multiple sources of income (having a mix of side hustles)
- You own your own business
MORE ON HERMONEY: 5 Ways Small-Business Owners Can Prepare for Tax Season
If you retired in 2021, be careful about when you claim your Social Security benefits. If you start taking it before you reach full retirement age (which is 67 if you were born after 1960), you’ll permanently reduce your monthly payout. Another potential tax gotcha is continuing to work or taking on side work when receiving Social Security. “Be aware that there are earnings limitations that are fairly low that apply to those who claim Social Security benefits before they reach full retirement age” Riskin says. “If you make more than that, your benefits can be reduced, and you may owe taxes on your Social Security income as well, depending on how much other income you receive throughout the year.”
MORE ON HERMONEY: When To Do Your Taxes Yourself or Hire an Expert
If You Went Through a Costly Health Crisis
The pandemic didn’t just rock our economy, it wreaked havoc with our health system on a national scale – and perhaps for you on a very personal one. And that’s not counting the other health issues that plague Americans every day. As if being unwell isn’t bad enough, medical issues can become tax issues if you don’t follow the IRS’s rules to the letter. That said, when you fill out your 2021 return, be sure not to overlook opportunities for financial relief from Uncle Sam.
The bar is pretty high for deducting unreimbursed medical expenses. In 2021, you can only take the deduction if costs exceed 7.5% of your adjusted gross income (AGI). This has been lowered from 10% in previous years. But an adjustment in your filing status — filing as married filing separately instead of married filing jointly — may put that deduction threshold within reach, Duffy says. Keep in mind that you can’t write off all of your out-of-pocket expenses; just those that are over 7.5% of your AGI. Also note that if you became disabled, any money you received from disability income insurance or your employer is counted as ordinary income and is taxable.
Relatedly, if you became disabled (and meet the IRS definition of disabled), you may be able to claim a larger standard deduction on your taxes. Plus, Duffy notes, you can fully deduct all qualified expenses you incur that allow you to work and are related to your disability — e.g. a special keyboard or office chair, retrofitting the vehicle you use to commute to work to accommodate a wheelchair.
If You Celebrated a Milestone Birthday (50 or 70½)
If you had a big birthday in 2021, Uncle Sam would like to help you celebrate — or, in the case of turning 70 ½, to make sure you mark the occasion by sharing some of your nest egg with him.
If you turned 50, the IRS has a gift for you: Permission to pad your tax-preferred retirement savings accounts through 2022! Making what’s called a catch-up contribution can add some serious shine to your golden years. The IRS allows you to sock away an additional $1,000 in an IRA up to the maximum allowable $7,000. If you didn’t max out your contributions to your traditional or Roth IRA, there’s still time to do so for your 2021 taxes. Just make sure you earmark those additional funds for 2021 by April 18. Also remember this for 2022: The IRS lets those age 50-plus contribute an additional $6,500 to an employer-sponsored retirement plan (e.g. a 401(k) or 403(b)) the year you turn 50. The deadline to do that is Dec. 31, 2022. You don’t even have to wait until retirement for the tax payoff: A contribution to a traditional IRA and a regular 401(k) or 403(b) (as opposed to the Roth versions of these accounts) lowers your taxable income for the year and therefore lowers what you owe the IRS.
If you turned 70 ½ in 2021, the IRS will be expecting a little something extra when you file your taxes. Up to this point, Uncle Sam has held off on taxing the investments you squirreled away in your tax-favored retirement accounts. In the calendar year you turn 70 ½, you’re required to start taking RMDs (required minimum distributions) and paying the IRS income taxes. Failure to do so could cost you a punishing 50% penalty tax on every dollar you fail to withdraw. You might as well make this a recurring annual event on your calendar, since RMDs are required each year after you reach age 70 ½. (See the handy IRS RMD table for more.)
FOR THE LATEST ON HERTAXES
Looking for advice on filling out Form W-4, minimizing the bite Uncle Sam takes out of your pay, whether to itemize or not or other taxing issues? Check out HerMoney Tax Central.