FIRE Tax Planning: 2021 Edition

The federal government recently passed another omnibus stimulus bill. This one has a few interesting provisions that people in (or pursuing) FIRE should be aware of for their planning this year.

$1,400 stimulus checks

All the big headlines are on the $1,400 stimulus checks available to income-qualified taxpayers and their dependents. Most people have already received these payments based on the income reported in their most recent tax return. For those whose income was too high in 2019 (or 2020, if they filed their taxes early), but expect to have qualifying income in 2021, the $1,400 will be available as part of their tax refund in 2022.

This stimulus payment has a very narrow phase-out range ($5,000 for single people, $10,000 for married couples). If you didn’t receive a payment because your 2019/2020 income was too high, but you could potentially engineer your income to be below the line this year, that could be a worthwhile thing to do.

Child tax credit

The child tax credit was increased this year. It used to be $2,000 per qualifying child, now it’s $3,000 ($3,600 for kids under 6). More importantly for FIREd families, the credit is now fully refundable, meaning you can get the full amount regardless of how much other income you have.

Previously a portion of the $2,000 was refundable, but only for people who had a certain amount of work income. It was fully non-refundable for FIREd individuals whose income came entirely from investments. As capital gains and dividends have a pretty big range where they’re taxed at 0%, someone getting most of their income from a taxable brokerage account might not have realized any benefit from the child tax credit at all!

For that reason it used to be advantageous to realize some regular income (such as from Roth conversions) to maximize the child tax credit. The tax credit would cancel out the first $2,000 of tax per qualifying kid, creating a pretty big income range with zero net tax liability. This is no longer the case. Now someone with no income starts out with a $3,000 refund per kid, and regular income will start chipping away at this refund beginning with the first dollar above the standard deduction.

This change to the child tax credit currently applies to the year 2021 only, but leading Democrats have stated their intention to extend it to future years as well. Stay tuned.

Earned income credit

The earned income credit has been a long-standing feature of the tax code, giving low-income working families a bit of a financial boost. It is only available at lower incomes, and only to families without much investment income. The investment income limit is a hard cutoff: $1 below the limit and you get the full earned income credit; $1 above and you get nothing. The idea was to target the credit specifically at people without much wealth, to exclude low-income millionaires who aren’t really working for a living anymore.

This investment income limit was previously $3,650 per year. As VTSAX will throw off roughly 2% in dividends alone, a FIREd family with a six-figure balance in taxable brokerage accounts was unlikely to qualify for the credit even if they had a bit of barista-FIRE-style work income. The stimulus bill raises this limit to $10,000 of investment income. There’s no end date attached to this change. This makes the earned income credit much more attainable to those FIREd parents with a bit of income coming in from a part-time job.

ACA premium tax credits

The bill also increases premium tax credits for people buying their health insurance from their local ACA marketplace. The cliff at 400% of the poverty level is eliminated, allowing the tax credit to phase out gradually until premiums hit 8.5% of a person’s income.

At the low end of the scale, the net premium for the second-cheapest silver plan (and any cheaper plan) will be free for people below 150% of the poverty level, and scale up gradually from there. This will create a much smoother transition between expanded Medicaid and the marketplace plans. In 2020, someone moving from 138% of the poverty level to 139% of the poverty level would have been hit with premiums at 3.45% of their income (plus out-of-pocket costs) as they transitioned off Medicaid. In 2021, premiums for the second-cheapest silver plan won’t start until income exceeds 150% of the poverty level, and won’t exceed 2% of income until income passes 200% of the poverty level.

These changes are currently in effect for 2021 and 2022 only. I wrote more about this (and the effect on overall marginal rates for FIREd individuals) in another post.

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