The IRS Releases Inflation Adjustments for Tax Year 2021
Some Tax Provisions Increase Annually
Groceries, housing, and the other fundamental expenditures of life cost more from year to year due to inflation, so paychecks don’t stretch quite as far. The IRS therefore adjusts tax rates, tax credits, and other provisions each year to keep pace with the current value of the U.S. dollar. The government announces the changes each fall.
Here’s what to know about the IRS 2021 inflation adjustments so you can plan your tax situation accordingly.
The IRS made adjustments in more than 60 categories in late 2020, which are in effect for tax year 2021—the return you’ll file in 2022.
The 2021 Tax Brackets
The tax bracket percentage rates don’t change from year to year. They can only be changed by Congress. They remain at 10%, 12%, 22%, 24%, 32%, 35%, and 37%, just where they’ve been since 2018 and the enactment of the Tax Cuts and Jobs Act (TCJA). But the taxable income ranges that each bracket spans do increase. Here’s where they are in 2021:
If you’re filing as single:
- 10%: $0 to $9,950
- 12%: $9,951 to $40,525
- 22%: $40,526 to $86,375
- 24%: $86,376 to $164,925
- 32%: $164,926 to $209,425
- 35%: $209,426 to $523,600
- 37%: Over $523,600
If you’re filing as head of household:
- 10%: $0 to $14,200
- 12%: $14,201 to $54,200
- 22%: $54,201 to $86,350
- 24%: $86,351 to $164,900
- 32%: $164,901 to $209,400
- 35%: $209,401 to $523,600
- 37%: Over $523,600
And if you’re married and filing a joint return:
- 10%: $0 to $19,900
- 12%: $19,901 to $81,050
- 22%: $81,051 to $172,750
- 24%: $172,751 to $329,850
- 32%: $329,851 to $418,850
- 35%: $418,851 to $628,300
- 37%: Over $628,300
Keep in mind that these are marginal rates. You won’t pay 24% on all your taxable income if you’re single and earn $90,000. Only $3,624—the portion you earn in that tax bracket ($86,376 to $164,925)—is taxed at the 24% rate.
The rest of your income is taxed at the applicable rate for those brackets of your income.
2021 Standard Deductions
Tax deductions are amounts you can shave off your gross or overall income so you only pay tax on what’s left. Taxpayers have two options here: They can itemize their deductions, or they can claim the standard deduction for their filing status. The standard deduction amounts are adjusted annually for inflation, too. As of 2021, they are:
- $12,550 for single taxpayers (up from $12,400 in 2020)
- $12,550 for married taxpayers filing separately (up from $12,400 in 2020)
- $18,800 for heads of household (up from $18,650 in 2020)
- $25,100 for married taxpayers filing jointly (up from $24,800 in 2020)
Capital Gains Tax Rates
Capital gains tax rates apply when you sell an asset for more than your basis in it. Your basis is what you paid for it, plus certain allowable costs of maintaining it. You have a short-term gain if you held the asset for one year or less. It may be considered a long-term gain if you owned it for more than one year.
This is a significant distinction, because short-term capital gains are taxed at ordinary income tax rates, topping out at 37% in 2021. Long-term rates are significantly less. The highest long-term rate is 20% as of 2021.
The three long-term capital gains rates of 0%, 15%, and 20% used to be tied to the ordinary income tax brackets, but the TCJA gave them their own tax rates beginning in 2018, and the incomes they cover were indexed for inflation.
As of 2021, single filers will pay 0% on taxable income up to $40,400, head-of-household filers will pay 0% on income up to $54,100, and married couples filing jointly will pay 0% on taxable income up to $80,800.
Single filers will then pay 15% on income between $40,401 and $445,850, and 20% on income of above $445,850. Head-of-household filers will pay 15% on income between $54,101 and $473,750, then 20% on income over $473,750. Married couples filing jointly will pay 15% on income between $80,800 and $501,600, and 20% on income over $501,600.
The Alternative Minimum Tax
The alternative minimum tax (AMT) has been around since 1969, when Congress realized that the wealthiest taxpayers, those with annual incomes in excess of $200,000 at the time, were avoiding paying income tax through the advantageous use of various tax breaks. Congress implemented the AMT, obligating taxpayers with incomes over a certain threshold to add certain claimed deductions back to their taxable incomes.
These thresholds are among the tax provisions that the IRS indexes for inflation. The exemption amounts for 2021 are $73,600 for single taxpayers (phasing out at $523,600, up from $518,400 in 2020) and $114,600 for those who are married and file joint tax returns (phasing out at $1,047,200, up from $1,036,800 in 2020). You don’t have to worry about paying the AMT if you earn less than these amounts.
Tax Credits and Other Increases
Unlike deductions, tax credits don’t reduce your taxable income. They subtract directly from your tax bill so you’ll owe less to the IRS. Several credits are indexed for inflation:
- The maximum Earned Income Tax Credit (EITC) increases to $6,728 in 2021, up from $6,660 in 2020. Qualifying for the maximum credit depends on the number of child dependents you have and your earned income. For 2021, childless taxpayers are also eligible. As the name suggests, you must have earned income in order to qualify.
- You can qualify for the full Lifetime Learning Credit on an adjusted gross income of up to $119,000 if you’re married and filing a joint return. This is up $1,000 from what it was in 2020. The credit applies to qualifying tuition and educational expenses you paid during the tax year for yourself, your spouse, or your dependents, subject to certain rules.
- The maximum Adoption Tax Credit has gone up a little as well, from $14,300 in 2020 to $14,440 in 2021. This credit covers qualified adoption expenses you paid during the year.
The foreign earned income exclusion also increases to $108,700 in 2021, up from $107,600 in 2020.
Additionally, the basic exclusion from estate taxes for decedents who die in 2021 is $11,700,000, up from $11,580,000 in 2020.
Some Things Don’t Change
Several changes to the tax code under the terms of the TCJA will remain in effect until at least December 31, 2025, when the TCJA potentially expires. For example, personal exemptions are still set at $0, and Pease limitations on itemized deductions, which reduced the value of these deductions for high-income taxpayers, are no longer in effect.