Tax Strategy: What to watch for in a difficult tax season

January 27, 2022 9:00 AM

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Many tax return preparers seem to be hoping that the 2022 tax return preparation season will not be as bad as the 2020 and 2021 seasons, with their delayed filing deadlines, transition to work from home, new COVID-related provisions, and retroactive tax law changes. The IRS has, after all, announced a relatively normal tax filing season, commencing Jan. 24 and ending April 18, 2022.

Yet, for this point in the year, the IRS has probably issued its most dire warning about a tax filing season, predicting delayed return processing, delayed refunds, lack of responses from call centers, and complicated tax returns. These have been problems in the past two years, but now the IRS is predicting a continuation of the same problems ahead of time.

And we may not know the full scope of retroactive tax law changes at this point. Last year they were enacted as late as March, which also is the month being mentioned for another try at the Build Back Better bill, which in the House form includes a change to the state and local tax deduction limit retroactive to 2021. Also, the extensions of the tax filing deadlines in 2020 and 2021 did not come this early in the year.

It should be another challenging tax return filing season as COVID continues to exert its impact on tax legislation and the operations of tax professionals and the IRS.

However, for now, let us focus on what we know will be the complications for this year’s filing season.

Child Tax Credit

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The enhanced Child Tax Credit with the advance payments will be a new problem to deal with on 2021 tax returns. Practitioners will hopefully receive Letter 6419 from the taxpayer to use to calculate the credit on the return. Unlike the Economic Impact Payments associated with the Recovery Rebate Credit, if taxpayers receive too much CTC in advance, they will have to repay it in the tax return calculations, subject to a limited safe harbor provision. There is concern that this could result in some taxpayers being underwithheld for the year. The enhancements to the CTC should primarily benefit taxpayers who were already eligible to claim the credit and not open up the credit to a large category of new taxpayers, although full refundability may make the credit more fully available to lower-income taxpayers.

Earned Income Tax Credit

While many tax professionals may not have to deal too much with the EITC for their clients, the enhancements effective for 2021 do open up the credit to many more taxpayers, particularly childless individuals, individuals with some investment income, separated individuals, and individuals whose children do not have Social Security numbers. As was the case in 2020, taxpayers may still elect to use 2019 income rather than 2021 income if 2019 earned income is larger.

Child and Dependent Care Credit

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The expansion of the Child and Dependent Care Credit for 2021 does potentially make this credit available to many more taxpayers due to the higher phaseout ranges and full refundability; however, some higher-income taxpayers may no longer qualify for the credit since the phasedown now goes to zero, rather than stopping at 20%. Taxpayers not accustomed to qualifying for the credit may not have kept good records of the care providers utilized during the year or have preserved the caregivers’ taxpayer identification numbers.

Premium Tax Credit

Demonstrators outside the Supreme Court in advance of the court's rulling that the ACA was constitutional

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This credit should be available to a larger number of taxpayers in 2021 and also available based on being an unemployment compensation recipient.

Economic Impact Payments and Recovery Rebate Credit

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The issues with the EIPs and the Recovery Rebate Credit for 2021 should be similar to the issues that tax return preparers had to deal with for 2020. Taxpayers could be confused by the fact that the second round of payments came in 2021 but related to 2020 tax returns. Only the third round is taken into account on 2021 tax returns. The third round was also larger than the previous rounds and included amounts for nonchild dependents. Letter 6475 should be obtained from the taxpayer to assist in calculation of the Recovery Rebate Credit. As was the case on 2020 tax returns, if larger payments were received based on 2019 or 2020 income than the taxpayer is entitled to in the credit calculation based on 2021 income, those sums do not have to be repaid.

Charitable deductions

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The enhanced charitable deductions for both individuals and corporations available for 2020 also apply for 2021 tax returns. There are a couple of changes to the charitable deduction for nonitemizers. For 2021 returns it is a below-the-line deduction rather than above-the-line and married filing jointly taxpayers have a maximum deduction of $600 rather than the $300 maximum for 2020.

COBRA continuation coverage

A 100% employee subsidy for COBRA continuation coverage was available from April 1 to Sept. 30, 2021, with the former employer paying the premium and being eligible for a credit on the 2021 tax return. Individuals who paid a COBRA premium during that period should contact their former employer.

COVID expenses

A customer shops for paper towels at a supermarket in Trenton, New Jersey, U.S., on Monday, March 16, 2020. All New Jersey schools must close starting March 18 for at least two weeks as state officials try to slow the spread of the new coronavirus, Governor Murphy said. Photographer: David 'Dee' Delgado/Bloomberg

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Tax law changes clarify that COVID expenses can be allowed for the above-the-line deduction for educator classroom expenses; as medical, flexible spending account and health savings account expenses; and to support penalty-free distributions from retirement plans.

Exclusions

Tax law changes have clarified a number of exclusions from tax, including for student loan forgiveness, financial aid grants to college students, Economic Injury Disaster Loans, Targeted Economic Injury Disaster Loans, and Restaurant Revitalization Grants.

SALT deduction limit

Under current law the state and local tax deduction limit remains at $10,000 for 2021. However, the House version of Build Back Better had proposed to increase the limit to $80,000 retroactive to 2021. The Senate Finance version just included a placeholder pending ongoing negotiations. A retroactive change could make itemizing deductions more attractive for many taxpayers on 2021 returns.

PPP loan expenses

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As was the case for 2020 tax returns (except it had to be applied retroactively for 2020 returns), expenses paid for with PPP loans remain deductible for 2021 tax returns.

Cryptocurrency and non-fungible tokens

Sotheby's 'Natively Digital: A Curated NFT Sale' Exhibition Preview A curated NFT sale at Sotheby's on June 04, 2021 in London, England.The exhibition is on view until 10 June, when the sale closes for bidding. (Photo by Tristan Fewings/Getty Images for Sotheby's)

Tristan Fewings/Photographer: Tristan Fewings/Ge

The infrastructure legislation that passed Congress imposes broad new cryptocurrency reporting requirements for 2023. A cryptocurrency question remains on the 2021 tax return but it is somewhat modified: “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?”

Also, although there is no clear guidance yet from the IRS on non-fungible tokens, many commentators feel, absent other guidance, NFTs should be treated in a similar way to cryptocurrencies.

Business meals deduction

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For 2021 and 2022, the business meals deduction for both food and beverages is increased to 100% if provided by a restaurant. This has been interpreted to include delivery and takeout, not just eating on the premises.

Payroll tax changes

Many of the COVID-related benefits for businesses were focused on payroll taxes. However, these changes could have an impact on the gross income or wages deduction reported on the income tax return.

1. Paid sick and family leave. The credit for paid sick and family leave was eventually extended to Sept. 30, 2021, but with each extension there were also some changes to who was eligible, the dollar limits, and other provisions.

2. Employee Retention Credit. The ERC was gradually extended to Dec. 31, 2021 and then retroactively terminated on Sept. 30, 2021. The IRS provided guidance in Notice 2021-65 for employers that had withheld payroll taxes after Sept. 30, 2021, and before Dec. 20, 2021 as to how to repay those payroll taxes to avoid a penalty. Those taxes had to be repaid with the normal payment due to the IRS with respect to the Dec. 31, 2021 payroll.

3. Employer payroll tax deferral. If businesses took advantage of the employer payroll tax deferral provision, one half of those deferred sums were required to be repaid by Jan. 3, 2022. The other half are due at the end of 2022.

4. Employee payroll tax deferral. If any employers took advantage of the deferral of the employee portion of payroll taxes for the fourth quarter of 2020, those payroll taxes were required to be repaid by Jan. 3, 2022. Many employers did not take advantage of this provision since President Trump’s original executive memorandum authorizing the deferral required repayment in the first quarter of 2021.

Other business tax changes

Many of the COVID relief provisions enacted in the CARES Act for 2020 relaxing some of the changes from the Tax Cuts and Jobs Act with respect to net operating loss carrybacks and deductions, the business interest deduction limitation, and excess business losses of noncorporate taxpayers, expired at the end of 2020 and are not available for 2021 tax returns.

Expiring provisions

Seventeen of the regularly expiring tax provisions expire at the end of 2021. The House Build Back Better bill included extensions of the energy-related provisions but was silent on the others. Among the provisions currently expired as of the end of 2021 are the treatment of qualified mortgage insurance premiums as qualified residence interest, the $500 lifetime credit for qualified nonbusiness energy property, the credit for qualified fuel cell motor vehicles, the 30% credit for alternative fuel vehicle refueling property, the 10% credit for plug-in electric motorcycles and two-wheeled vehicles, the health coverage tax credit, and several business energy provisions.

Reporting forms

Although not directly impacting 2021 tax returns, tax return preparers should alert their business clients to the new reporting threshold with respect to Form 1099-Ks — a $600 threshold starting for reports filed in 2023 and the use of Form 1099-NEC for payments to independent contractors.

Miscellaneous changes

Other tax law changes impact elections for NOL carrybacks for farming activities, restoring the exclusion for contributions in aid of construction for a water or sewer utility, and modification of certain disaster-related deadlines.