By S. Joseph DiSalvo, ChFC, and Marie L. Madarasz, AIF
Recently a client came in to meet with us. They had experienced a year with less income due to the pandemic with the result that 2020 ended up being a very different tax year for them than in previous years. Their adjusted gross income (AGI) was slightly under $161,000. Now in any other tax year, this amount may not have been cause for concern. But in this tax-filing season, things are far from normal!
The 2021 tax-filing season will be one of the most complicated tax seasons in decades thanks to COVID-19, stimulus payments of 2020 & 2021, and the CARES & SECURE Acts. This and other factors were the reason that the IRS on March 17th extended the deadline for taxpayers to file their 2020 returns to May 17th 2021. While it is beyond the scope of this article to cover all of the strategies and issues to pay less tax and steer clear of tax reporting problems, we will cover what we think will be some of the more common issues where help would benefit the most people.
When it came to our clients, above, the $160,897 AGI would phase them out of both the most recent stimulus payment and they would also lose the ability to have part of the unemployment benefits they received be tax free. However, we could see they were not taking advantage of some opportunities available to them to reduce their income. With the proper advice, they would be eligible to receive both the stimulus and the tax-free unemployment benefits.
Let’s begin with some ideas and strategies on how you (and our clients) can still reduce your 2020 tax bill, and let’s state the not-so-obvious reasons why you want to focus on reducing your tax bill for 2020. The not-so-obvious reasons are provisions under the American Rescue Plan Act of 2021, enacted on 3/11/2021, which is additional stimulus money of $1,400 for single filers, and $2,800 for people married filing jointly, with $1400 of additional stimulus for each dependent. In addition to that, there is the opportunity to qualify for $10,200 worth of tax-free unemployment benefits. Both opportunities are subject to phase-out with different rules.
In the case of the $1400 stimulus payments, eligibility will be determined using your 2019 AGI or your 2020 AGI if you have already filed your return. The phase-out ranges for the stimulus are $150,000 - $160,000 joint filers, $112,500-$120,000 for head of household filers, and $75,000-$80,000 for all other tax payers. You can find your AGI on your 2019 Form 1040 line 8b. If you find that your AGI is above the threshold amounts based on your filing status you can consider the following strategies to reduce your AGI for 2020 in order to qualify for the stimulus:
- Contribute to a traditional IRA for yourself and/or your spouse if you are married, and you qualify based on other IRS rules.
- Consider contributing to a health savings account (HAS) if you have a high deductible health plan, which is the best deal based on the potentially triple tax-free nature of these accounts. There are a myriad of IRS rules around HSAs so getting qualified tax advice is important.
- Under IRS IR-2021-57 you can also return a required minimum distribution (RMD) as a coronavirus-related distribution, but again, getting qualified tax advice is recommended.
- Lastly for those that are self-employed there are opportunities to reduce your AGI by contributing to a SEP or SIMPLE IRA, and/or a Solo 401(k). All of these plans are subject to their own set of rules and deadlines.
Qualifying for the tax-free unemployment payments of $10,200 requires your modified adjusted gross income (MAGI) to be under $150,000, regardless of filing status. The MAGI number is referred to as a “cliff” for purposes of qualifying, meaning that if your MAGI is $150,001 the whole $10,200 of unemployment payment is fully taxable at your marginal tax bracket. We should point out that in the case of taxpayers filing married jointly, the exclusion may double to $20,400, regardless of the taxpayers’ filing status. This is a federal tax break. Each state will have their own rules surrounding this issue. In short, the 2020 filing season is definitely a year in which you will want to get qualified tax advice.
There will also be numerous tax reporting problems to be aware of and avoid this tax reporting season. We will only address some of the more common problems.
The first big issue we see being potentially problematic is for taxpayers who took a coronavirus-related distribution (CRD) in 2020. The issue here is that taxpayers will be required to file Form 8915-E with their 2020 Form 1040. In Form 8915-E one of the more important things to report is how the CRD distribution will be claimed. Will you pay the tax on the distribution in one year or spread the tax liability (technically, spreading the income) equally over a 3-year period? Once made, the election is irrevocable.
While conventional wisdom is to always defer tax payments until tomorrow, we can envision many instances where paying the tax in one year could make sense based on several variables unique to your financial and tax situation. The default option on the 8915-E is the three-year income spread. Taxpayers who took a CRD in 2020 should consider going on extension in order to allow you and your tax professional time to sort this issue out.
Another area of potential tax reporting confusion will be in the case where a taxpayer returned a required minimum distribution under the CARES Act. Those taxpayers will be surprised to see that even though they returned their 2020 RMD, the 1099R issued by the custodian will show it as a taxable distribution, with no indication of the RMD being returned. In this instance it is advisable to include the distribution as a taxable distribution on line 4A of the 1040, and on line 4B write “rollover with $0,” assuming the taxpayer returned the entire RMD as allowed under the CARES Act. Later this year the custodian will issue the taxpayer and the IRS a Form 5498 that will confirm the rollover amount. You do not need a Form 5498 to file the return.
The 2021 tax season promises to be a flurry of confusion where the likelihood of making mistakes, and possibly costly mistakes, is high due to the unprecedented nature of the events of the last 13 months. This is the first tax reporting season following the onset of COVID-19, the CARES and SECURE Acts, so taxpayers should proceed with caution.
About the authors: S. Joseph DiSalvo, ChFC, and Marie L. Madarasz, AIF
S. Joseph DiSalvo, ChFC®, and Marie L. Madarasz, AIF®, authors of Income for Life, a Retiree's Guide to Creating Income from Savings, specialize in coordinating a retiree’s Income, investment and tax planning. They are members of Ed Slott’s Elite IRA Advisor Group, a prestigious study group which enhances their knowledge of IRA distribution planning. Both are strong advocates of financial education, seeking to teach others how to achieve sustained success and lifelong prosperity. www.IncomeForLifeBook.com
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