American Rescue Plan Act, State Taxes, and You

To lessen the effects of the pandemic, lawmakers passed The American Rescue Plan Act (ARPA) in 2021. The Act contains several changes to tax policies, and some of these changes affect the taxes you are filing now for tax year 2020. Other tax policy changes affect taxes for 2021. Some of the biggest tax changes include waiving federal income taxes on unemployment benefits for 2020 for some taxpayers and increasing the Child Tax Credit for 2021.

Tax-Free Unemployment Benefits

Under Biden’s American Rescue Plan, the first $10,200 in unemployment benefits received in 2020 will be tax-free to most taxpayers. Unfortunately, this tax break only applies to 2020 and does not extend to 2021. To qualify, your modified adjusted gross income must be less than $150,000. If you are married and filing your tax return together, each spouse can deduct up to $10,200 each. However, the income limit of $150,000 stays the same and does not increase if you are filing jointly.

Not all states have changed their tax law to follow the new federal tax changes. This means that although the federal income taxes are waived on the first $10,200 of unemployment benefits, you may still owe state income taxes on your unemployment.

Example. Noah and Evelyn file their tax return together, as married filing jointly. Noah received $5,000 in unemployment benefits in 2020 and earned $15,000 from his employer. Evelyn received $15,000 in unemployment benefits in 2020 and $10,000 from her employer.

Because their combined modified adjusted gross income is below $150,000 in 2020, they qualify for federal income taxes to be waived on the first $10,200 of unemployment benefits they receive. This means Noah will not owe federal income taxes on his $5,000 of unemployment benefits he received. Evelyn will not owe federal income taxes on the first $10,200 of her unemployment benefits. Evelyn will owe taxes on the amount over $10,200 that she received in unemployment or $4,800 ($15,000 - $10,200). Even though Noah did not use his full amount because he only received $5,000 in unemployment benefits, he cannot pass his unused exclusion amount to Evelyn to use.

Unemployment Benefits in Ohio

On March 31, 2021, Governor DeWine signed a law incorporating this federal tax change. This is great news for Ohioans receiving unemployment benefits in 2020. This means if you qualify for your unemployment benefits to be tax free on your federal income tax return, you will qualify for it to be tax free on your Ohio state tax return too. You can read more about how Ohio puts this change in place here. If your Ohio state income tax liability was already $0, you may not qualify for any additional refund. However, if you owed Ohio state income tax, qualified for this tax break, and didn’t receive it, you should see an accountant for the best course of action based on your situation.

How the American Rescue Plan Act Changes the Child Tax Credit

The Child Tax Credit for 2020 remains unchanged. However, for tax year 2021 only, the Child Tax Credit increases to $3,600 for qualifying children 5 years old and under and $3,000 for qualifying children ages 6 to 17. The increased amounts to the Child Tax Credit (amount above $2,000) phases out for taxpayers with incomes over $150,000 for married taxpayers filing a joint return and qualifying widows or widowers, $112,500 for heads of household, and $75,000 for all other taxpayers. These important changes will put more money in the hands of families that need it most both in 2020 and 2021.

Although for 2020, the Child Tax Credit remains at $2,000 for qualifying children under 17 years old, starting in the summer of 2020, many families will receive advance payments of their 2021 Child Tax Credit between July and December. The IRS will base taxpayers’ eligibility off their 2020 tax return, if filed. If you have not filed your 2020 tax return, the IRS will base the amount off your 2019 tax return. With the American Rescue Plan Act, families can qualify for an advance payment up to 50% of their Child Tax Credit.

Example. Logan and Ava have two children, Grace and Ella. Grace just turned 8 years old, and Ella is turning 17 in a few weeks. Logan and Ava make under $150,000, filed their 2020 tax return, and qualify for the Child Tax Credit.

Normally, Logan and Ava would no longer qualify for the Child Tax Credit for Ella for tax year 2021 because she is turning 17. However, due to the American Rescue Plan Act, they would qualify for $3,000 for each Grace and Ella or $6,000 ($3,000 + $3,000). This means starting in July, Logan and Ava could start receiving monthly payments up to $500 (($6,000 * 50%)/6) due to the advance payments the IRS will send. If Logan and Ava receive advance payments of $3,000 during July through December 2021 and their income remains below $150,000, they will still qualify for the remaining balance of their Child Tax Credit or $3,000 on their 2021 tax year, they will file next year.

If you are concerned you will not qualify for the Child Tax Credit for 2021, the IRS will give you an opportunity to decline the advance payments. If you receive the advance payments and end up not qualifying for the Child Tax Credit on your 2021 tax return, you will need to repay the amount received when you file your tax return next year for 2021.

The Bottom Line

Taxes are confusing enough without all the changes that have been happening the last couple of years. Make sure you are filing your taxes correctly and understand how the new tax policies affect your family and you. Do not miss out on these tax breaks, schedule an appointment today with the accounting and tax preparation professionals at Gudorf Tax Group. They will make sure your tax return is filed correctly, and you receive the American Rescue Plan Act tax breaks you qualify to take.