The past year certainly has been tumultuous in many ways, including for retirement savers trying to keep up with tax planning.
There have been a number of changes to your taxes on the legislative front in regard to the pandemic, of course. Add to the confusion an understaffed IRS and questionable mail service and you have a perfect storm for financial planners.
Let’s start with some timely notices from the IRS itself.
Filing your return: First and foremost, if you can file electronically, do so and choose direct deposit. The IRS warns that getting around to paper returns will take longer this year, as will sending refunds by check.
If you want an update on your refund, the Where’s My Refund? tool at the IRS will show your status 24 hours after you e-file.
Impact payments: If you qualified for previous economic impact payments but did not receive money, chances are you do not have direct deposit set up with the IRS. Filing your return online and asking for direct deposit fixes that problem, but it won’t retroactively send you previous payments.
In that case you will need to claim the Recovery Rebate Credit on your 2020 return. Importantly, your eligibility for those payments will now be based on your 2020 return, which might change your payment amount.
As for the third round of stimulus payments, which became law on Thursday, March 11 as the American Rescue Plan Act of 2021, Congress has restricted income qualifications compared to the previous rounds. That income limit now begins to phase out at $150,000 and reaches zero at $160,000 for married filing jointly (halve these numbers for single filers).
Dependents: Under the new act, people with dependent children will get a larger child tax credit of $3,000 per child ($3,600 for kids under age six), and that money is expected to be paid out monthly starting this summer.
Naturally, having direct deposit will make a big difference once those payments start flowing.
Previously, kids had to be 16 or younger to qualify. Congress decided to add 17-year-olds to the child tax credit calculus for 2021. Your child would have to have been 17 or younger as of December 31.
Working from home: Many people worked from home for the better part of the past year. However, only those with contractor or freelancer relationships can take the home office deduction. If you get a W-2, you’re out of luck.
Charitable giving: The increase in the standard deduction a few years ago quickly made itemizing pointless for many. That has hurt a lot of charities as they fought the impact of Covid, so Congress created a $300 above-the-line deduction for cash contributions made in 2020. If you wrote a check to a food bank or other tax-exempt organization, claim it.
Retirement withdrawals: If you took out a 401(k) or IRA distribution under the first pandemic relief law, the CARES Act, you have a choice to make. The penalty for early withdrawal is waived but you will owe income taxes on that money.
However, you can pay those taxes in three installments over 2020, 2021 and 2022. The form you need, which only recently appeared in online tax filing software, is IRS Form 8915-E. Note that online tax preparers will not allow you to e-file if you use this form, so you will be printing and mailing your return.
Besides lowering the tax hit, the advantage of paying over three years means you can do a bit more planning. For instance, if you took out $30,000, that’s a $10,000 income increase each year.
However, you can repay the money you took out and lower the tax hit at any time in that three-year window. If your income was lower in 2020 but rises this year, it may be worthwhile to go ahead and put money back in order to avoid the extra tax.
Changing IRA limits: Of course, it’s never a bad idea to save more. You can put tax-deductible money in your IRA for 2020 through Tax Day, April 15, 2021 (note on your return that it’s for the year 2020). The limit on total IRA contributions is currently $6,000 plus another $1,000 if you are 50 or older.
If you plan to keep working, you can also keep saving. As of 2020, as long as you are working, the age limit on contributing to an IRA goes away (it used to be 70 ½). Likewise, the age at which required minimum distributions begin rises to 72 from 70 ½.
If you have any questions about financial planning during tax season, please feel free to contact us.