Throughout his first six months in office, President Biden has clearly stated his desire to raise taxes on the wealthiest individuals while fortifying the middle class. Though there is no guarantee his tax proposal will pass through Congress as is, it’s still worthwhile to review the proposed tax changes to see how they could potentially affect your tax situation and plan accordingly.
Here are four proposed changes that would have a direct impact on middle-class taxpayers:
Earned Income Tax Credit
Currently, the earned income tax credit (EITC) is only available to low- and moderate-income working parents who can claim a qualifying child.[i] The proposed change would extend the EITC to working individuals who don’t have children living at home—considered “childless workers” for tax purposes. That includes taxpayers aged 65 and older.[ii]
The maximum available credit is based on family size, with larger credits available for larger families, topping out at $3,618 in 2021 for families with one child and $6,728 for families with three or more children. The maximum credit for childless workers is $1,502.[iii]
The EITC is a refundable tax credit, meaning qualifying taxpayers can use the credit to reduce their tax liability. If there is no tax liability, the credit can be paid out as part of the taxpayer’s refund.[iv]
Planning Tip: Check with a tax professional to see if you would qualify under the proposed changes for an EITC and for how much. If you are eligible to receive a credit, you could consider adjusting your exemptions to reduce the amount of taxes withheld from your paycheck.
Child and Dependent Care Tax Credit[v]
The proposed change to the Child and Dependent Care Tax Credit (CDCTC) would significantly increase the amount of the credit and extend eligibility to higher earnings. Currently, the maximum available credit is $3,000 for families with one child and $6,000 for families with two or more children. Under the proposed change, the credit would increase to $8,000 and $16,000, respectively. In addition, the proposed change would increase the maximum reimbursement rate from 35% to 50%. Families with an adjusted gross income (AGI) of $125,000 or less would receive a credit worth 50% of their qualifying expenses.
The reimbursement rate is phased out for taxpayers with higher earnings. The rate for families with an AGI between $125,000 and $185,000 the rate would be gradually reduced from 50% to 20%. The rate would remain at 20% for families with an AGI from $185,000 to $400,000. Between $400,000 and $440,000, the rate would be phased out completely, with no credit available above $440,000.
In addition, the Child Tax Credit, separate from the Child and Dependent Care Credit, would increase to $3,000 from $2,000 per child. The credit would be $3,600 for children older than four. The expanded credit would be available for individuals earning up to $75,000 per year and joint filers earning up to $150,000 per year.
Planning Tip: If you typically file jointly, speak with a tax professional to see if it makes sense to file as heads of household. This would make sense if, under the lower-income spouse, you could qualify for the maximum credit.
The proposed tax law would bring back the popular first-time homebuyer credit. The maximum credit would be available for homebuyers who have not owned or purchased a home within the past three years. There would also be an income limitation of 160% of the area median income. Also, the home’s purchase price cannot be more than 110% of the area median purchase price.[vi]
The credit would be available for homes purchased as primary residences after December 31, 2020. If the home is not used as a primary residence for at least four years, a portion of the credit may be rescinded.[vii]
Planning Tip: If high rental payments are preventing you from saving enough for a down payment, this could be your breakthrough. When combined with a low-down-payment FHA loan, the first-time homebuyers tax credit could get you into an affordable home. As a first-time homebuyer, you could also access up to $10,000 from your traditional or Roth IRA without paying the 10% early withdrawal penalty.
Tax Credit for Retirement Account Contributions[viii]
Under the proposed tax law, the tax deduction for contributions to IRAs, 401(k)s, and other qualified retirement plans would be replaced with a flat 20.5% credit. The new structure would make funding retirement accounts more attractive for lower earners. For example, taxpayers in the 12% tax bracket would get a 20.5% deduction instead of a 12% deduction.
Planning Tip: Taxpayers in the 22% tax bracket or higher would be capped at the 20.5% deduction, so they may find the Roth IRA the more attractive alternative.
How many of these proposed changes make it into law is uncertain. However, if any of them can potentially impact your particular situation, it would be important to review them with your financial advisor and tax professional to position yourself for maximum benefits.
If you are unsure how to handle these changes, the financial advisors at URS Advisory would be happy to discuss it with you. Simply schedule some time on our calendar so we can share our knowledge with you.
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[i] https://www.irs.gov/credits-deductions/individuals/earned-income-tax-credit-eitc 1 July 2021
[ii] https://taxfoundation.org/biden-budget-biden-child-tax-credit/ 1 July 2021
[iv] https://www.cnbc.com/2021/06/11/families-with-children-will-pay-far-less-in-taxes-under-bidens-plans.html 1 July 2021
[v] https://crsreports.congress.gov/product/pdf/IN/IN11645 1 July 2021
[vi] https://www.credible.com/blog/mortgages/first-time-homebuyer-tax-credit/ 1 July 2021
[vii] https://www.credible.com/blog/mortgages/first-time-homebuyer-tax-credit/ 1 July 2021
[viii] https://money.usnews.com/money/retirement/401ks/articles/president-bidens-proposed-changes-to-401-k-plans 1 July 2021