The IRS recently released its 2021 cost-of-living adjustments (COLA) to retirement plan limits and certain tax provisions. Taking the cost of inflation into account, many of the included adjustments were increased though others remain unchanged from 2020 levels.

Going into 2020, the Tax Cuts and Jobs Act (TCJA), made permanent a new method of adjusting annual inflation known as the chained CPI which increases at a slower pace than the traditional CPI measure, previously used. This method pushes taxpayers into higher brackets more quickly as their income rises at the same time that certain tax breaks are reduced, year-over-year.

Woman review the Untracht Early 2021 COLA article as opart of her individual tax planning.

Tax Brackets for Individuals

Tax bracket thresholds for individuals is one of the items most completely impacted by the 2021 COLA. For each filing status, individual tax bracket thresholds have been increased. Those who find themselves in the higher tax brackets will notice the increase is more significant, as those increases are based on percentages. For example, depending on filing status, the top of the 10% bracket increases by a nominal $75 to $150, while the top of the 35% bracket increases more substantially, rising from $3,125 to $6,250.

2021 Ordinary-income Tax Brackets

Tax rate Single Head of household Married filing jointly or surviving spouse Married filing separately
10% $0 – $9,950 $0 – $14,200 $0 – $19,900 $0 – $9,950
12% $9,951 – $40.525 $14,201 – $54,200 $19,901 – $81,050 $9,951 – $40,525
22% $40,526 – $86,375 $54,201 – $86,350 $81,051 – $172,750 $40,526 – $86,375
24% $86,376 – $164,925 $86,351 – $164,900 $172,751 – $329,850 $86,376 – $164,925
32% $164,926 – $209,425 $164,901 – $209,400 $329,851 – $418,850 $164,926 – $209,425
35% $209,426 – $523,600 $209,401 – $523,600 $418,851 – $628,300 $209,426 – $314,150
37% Over $523,600 Over $523,600 Over $628,300 Over $314,150

While the TCJA suspended personal exemptions through 2025, it simultaneously nearly doubled the standard deduction (which is indexed annually for inflation). However, standard deduction amounts will revert to pre-TCJA law amounts, after 2025. For married couples filing jointly in 2021, the standard deduction is $25,100. For heads of households, the standard deduction is $18,800, and for those who are single or married and filing separately, it’s set at $12,550.

Some taxpayers may benefit from the changes to the standard deduction which can help them make up for the loss of personal exemptions, though taxpayers who usually itemize their deductions may not realize a benefit.

Alternative Minimum Tax Brackets

Those subject to the alternative minimum tax (AMT) are allowed certain deductions. However, the AMT allows some deductions while prohibiting others and treats certain income items differently. You are obligated to pay AMT if your AMT liability exceeds the amount of your regular tax liability.

Like the regular individual tax brackets, AMT brackets, exemptions, and phaseouts are annually indexed for inflation. AMT 2021 COLA include threshold increases for the 28% AMT bracket of $2,000 for all filing statuses. The only exception is for those who are married and filing separately, which increased by $1,000.

2021 AMT brackets

Tax rate Single Head of household Married filing jointly or surviving spouse Married filing separately
26% $0 – $199,900 $0 – $199,900 $0 – $199,900  $0 – $99,950
28% Over $199,900 Over $199,900 Over $199,900 Over $99,950

The exemption amounts for 2021 are $73,600 for singles and heads of households (increased by $700 over 2020 rates) and $114,600 for joint filers (increased by $1,200 over 2020 rates). 2021 phaseout ranges are $523,600–$818,000 for singles and heads of households and $1,047,200–$1,505,600 for those filing jointly. For those filing separately, amounts are half of the amounts for joint filers.

Education and Child-related Tax Breaks

Most of the maximum benefits related to tax breaks for education and children remain the same for 2021. It’s important to note, however, that taxpayers will face limitations on these breaks based on their modified adjusted gross income (MAGI). Taxpayers whose MAGIs are within an applicable phaseout range are eligible for a partial break but breaks are eliminated for those whose MAGIs are in excess of the top of the range. Depending on the tax break, phaseout ranges for MAGI either remain the same or are subject to a nominal increase in 2021, including these credits:

  • The American Opportunity Credit is an education credit that carries with it a maximum of $2,500 per eligible student. The phaseout ranges for this credit remain unchanged for 2021 at $160,000–$180,000 (joint filers) and $80,000–$90,000 (all other filers).
  • The Lifetime Learning Credit is another education credit option that carries with it a maximum of $2,000 for each tax return. Phaseout ranges for this credit are $119,000–$139,000 (joint filer) and $59,000–$69,000 (all other filers). For joint filers, this represents an increase of $1,000, though the ranges remain at 2020 amounts for all other filers.
  • The Adoption Credit is a credit afforded to those adopting a child. The phaseout ranges for eligible taxpayers who fall into this category increase for 2021 by $2,140 to $216,660–$256,660 for joint filers, head-of-household filers, and single filers. The maximum credit also increases by $140, to $14,440 for 2021.

In general, married couples filing separately aren’t eligible for these education and child-related credits.

If your MAGI is too high for you to qualify for an education tax break for your child, he or she may be able to claim the credit by filing his or her own tax return.

Taxes for Gifts and Estates

The 2021 COLA also address both the unified gift and estate tax exemption as well as the generation-skipping transfer (GST) tax exemption. Both items, adjusted annually for inflation, have been increased for the new year from the amount of $11.58 million in 2020 to $11.7 million for 2021.

Also for 2021, the annual gift tax exclusion remains at $15,000 as it mainly increases only every few years by $1,000 increments.

Retirement Plan Limits

Because not all limits on retirement plan-related items have been increased for 2021, those who have already been contributing the maximum retirement savings amount allowed may have fewer opportunities to build those savings. Various types of retirement savings plan limitations and their 2020 vs. 2021 limit amounts include:

Retirement Plan-related Limits

Type of limitation 2020 limit 2021 limit
Elective deferrals to 401(k), 403(b), 457(b)(2) and 457(c)(1) plans $19,500 $19,500
Annual benefit for defined benefit plans $230,000 $230,000
Contributions to defined contribution plans $57,000 $58,000
Contributions to SIMPLEs $13,500 $13,000
Contributions to IRAs $6,000 $6,000
Catch-up contributions to 401(k), 403(b), 457(b)(2) and 457(c)(1) plans $6,500 $6,500
Catch-up contributions to SIMPLEs $3,000 $3,000
Catch-up contributions to IRAs $1,000 $1,000
Compensation for benefit purposes for qualified plans and SEPs $285,000 $290,000
Minimum compensation for SEP coverage $600 $650
Highly compensated employee threshold $130,000 $130,000

Additionally, your MAGI may reduce or, in some cases, fully eliminate your ability to take advantage of IRAs. However, Traditional and Roth IRA-related MAGI phaseout range limits have all been increased as part of the 2021 COLA, as follows:

Traditional IRAs

Phaseout ranges for MAGI apply to the deductibility of contributions if a taxpayer or the taxpayer’s spouse participates in an employer-sponsored retirement plan. For married couples filing jointly, the phaseout range is specific to each spouse depending on whether the spouse participates in an employer-sponsored plan. The 2021 phaseout range limits for a participating spouse increase by $1,000, to $105,000–$125,000. For a non-participating spouse, the 2021 phaseout range limits increase by $2,000 to $198,000–$208,000. For taxpayers who are plan participants and who are filing as singles or heads-of-households, the 2021 phaseout range limits increase by $1,000 to $66,000–$76,000.

You can deduct a partial contribution if you’re a taxpayer with MAGI in the applicable range. Taxpayers with MAGI that exceeds the applicable range aren’t permitted to claim any IRA contribution deduction.

However, taxpayers whose deductions are reduced or eliminated are allowed to make nondeductible, traditional IRA contributions. The $6,000 contribution limit (including a $1,000 catch-up contribution, if applicable and reduced by any Roth IRA contributions) still applies. Nondeductible traditional IRA contributions can prove beneficial if your MAGI is also too high for you to contribute, either in full or in part, to a Roth IRA.

Roth IRAs

Your ability to contribute to a Roth IRA is not contingent upon whether you choose to participate in an employer-sponsored plan, although MAGI limits may reduce or eliminate your ability to contribute. For married taxpayers filing jointly, the 2021 phaseout range limits increase by $2,000 to $198,000–$208,000. For single and head-of-household taxpayers, the 2021 phaseout range limits increase by $1,000 to $125,000–$140,000.

If your MAGI falls within the applicable range, you’re allowed to make a partial contribution but aren’t allowed to contribute if your MAGI exceeds the top of the range.

It’s important to note that married taxpayers filing separately are subject to much lower phaseout ranges for both traditional and Roth IRAs.

Annual adjustments for inflation can impact your tax situation. With the amounts for 2021 COLA up slightly over 2020 amounts, it may be helpful to consult with your Untracht Early advisor for additional information on the 2021 changes that could affect you.