The past year was unique in a number of ways that will impact the rapidly approaching filing season. Continued implementation of the Tax Cuts and Jobs Act, plus the pandemic-response legislation such as the CARES Act, and working from home will add complicating factors for tax professionals and taxpayers alike.
There are a number of actions that taxpayers may have taken this year in response to COVID-19 that could affect their individual tax situation, according to Dina Pyron, global TaxChat leader at Big Four firm EY. These include:
- Triggering a new, possibly multi-state filing requirement due to residency changes;
- Taking a retirement plan loan or distribution;
- Receiving unemployment benefits;
- Postponing charitable contributions;
- Having a self-employment loss; and,
- Receiving a stimulus payment.
“Probably the biggest thing that should be on preparers’ and taxpayers’ minds is the state issues,” she said. “This year has been very strange for many, and a lot didn’t work in their customary place of employment for much of the year.”
In fact, according to an Expert Market survey, 74 percent of companies had all their staff currently working remotely, compared with 26 percent before COVID.
“Taxpayers will need to understand how their employer reported withholding, and they will need to file in the state they worked from,” Pyron said. “Most employers will not be able to put together a customized list of where their employees went to work during the shutdowns. When employees get their W-2 in January and they look at state withholding they may be surprised if it doesn’t reflect the state they worked or sheltered in.”
“Many taxpayers will think that if they worked six months in a non-income-tax state like Florida, they won’t owe any state income tax for that period of time,” she cautioned. “They will have to decide if they actually moved their residence to Florida. Relocating from one state to another can get complicated, with different states taking different positions. A handful of states provide a credit offset for taxes paid in another state, but some do not, and there’s a real possibility of double taxation.”
“For taxpayers who postponed charitable contributions because of the larger standard deduction, the CARES Act provides an above-the-line deduction for up to $300,” Pyron noted. “And the self-employed can now carry back a net operating loss to prior years where they had more taxable income.”
Retirement plans are another important area, according to Pyron.
“Contributions to your 401(k) plan will save in taxes while moving taxpayers toward their retirement goals,” she said. “Eligible employees can still contribute up to $19,500 of their pre-tax wages to their 401(k) plan in 2020. Contributions reduce the amount of wages subject to federal income tax, and in most cases, state income tax.”
If a taxpayer took money out of their plan under the CARES Act, they can avoid an early withdrawal penalty for an amount up to $100,000, but will still have to pay the actual tax over three years or pay the money back to the plan over three years. “There hasn’t yet been any clarification from the IRS as to whether they need to pay it back evenly or can pay in more in one year than other years,” she said.
Many taxpayers may have faced unemployment for the first time during the year as a result of the pandemic. “They may be unaware that unemployment benefits are taxable and must be reported on their return. Taxable benefits include any of the special unemployment compensation authorized under the CARES Act,” Pyron noted.
One of the taxpayer-friendly items in the CARES Act gave older taxpayers the ability to skip their required minimum distribution for 2020. The requirement is waived for IRAs and workplace retirement plans, including beneficiaries with inherited accounts.
But there’s a potential surprise in store for some account holders, according to a veteran tax lawyer who himself got “burned” on a small IRA rollover account. “I was led to believe through the account manager’s post-CARES Act online literature that they were not acting on normal RMDs this year because of the CARES Act and that only if requested, would they distribute,” he said. “The catch is that they consider accounts that previously set RMDs as automatic withdrawals as a standing request to distribute irrespective of their advertising the opportunity not to do so. I discovered in early December that they distributed a 2020 RMD to my taxable account, less tax withholding,” he said.
“I normally set up late November for my RMDs, so that those amounts continue to earn as much as possible in the retirement account shell for the year (a bet on an up market but also on the benefit of not having income tax withheld on the distribution until then),” he continued. “I now need to do a 60-day rollover back into the IRA and wait until I file my 2020 return to get the withheld tax back.”
