The upcoming tax filing season is poised to be more confusing and chaotic than normal, with tax professionals predicting Covid-19 relief measures will trigger surprise tax bills and costly filing mistakes.
Among the possible traps for taxpayers are undelivered portions of direct payments to individuals, enhanced unemployment benefits, and forgivable business loans under the Paycheck Protection Program.
Tax return preparers warn, for example, that many people have likely thrown away a key document for claiming the rest of their stimulus checks under the March CARES Act (Public Law 116-136) if they received too little from the IRS this year. Without the document, individuals risk entering incorrect information on their federal tax returns, possibly delaying the processing of those returns and any associated refunds.
“The reckoning’s going to be very painful for a lot of people,” especially for those also struggling to pay what they owe, said Dave Tolleth, president-elect of the National Association of Enrolled Agents.
Direct payments from the CARES Act —$1,200 per individual, plus an extra $500 for each dependent under the age of 17—are advance credits against 2020 taxes. But in many cases, the payments already issued didn’t reflect the amounts taxpayers qualify for.
Because Congress directed the IRS to use information from 2018 and 2019 tax returns to issue the payments quickly, the amounts don’t take into account if someone’s income fell this year or they had a new child.
Those eligible for higher payments can claim extra credit on their 2020 Form 1040.
To calculate what they’re owed, however, individuals must know the exact amount they already received. That can be found on Notice 1444 mailed by the IRS shortly after the checks.
But most people likely didn’t realize the importance of the notice and tossed it, tax professionals said. For that reason, some have asked the IRS to create a portal to look the payments up online so that taxpayers don’t have to sift through bank records or take other actions to track them down.
Putting an incorrect number on the Form 1040 could delay the processing of a return and any associated refunds. For many Americans, those refunds are “the largest payday of the year,” said Mark Steber, chief tax officer at the tax preparation firm Jackson Hewitt.
An IRS official at an event in October said the agency didn’t have any plans for such a search tool but that it would consider it ahead of the filing season. More recently, the IRS told Bloomberg Tax: “We’re continuing to review the situation.”
Individuals who received unemployment benefits, especially for the first time, might not realize that money is taxable, or that they could have opted for some of it to be withheld to cover part or all of their eventual tax liability.
“We’re concerned that some people may get caught by the surprise of owing income tax on their unemployment income,” said Kathy Pickering, the chief tax officer at H&R Block Inc.
Working From Home
Taxpayers who worked remotely in a state or locality different from where they normally work may have to deal with W-2s that don’t reflect their true situation, Pickering said. Employers file Form W-2 to report the wages, tips, and other compensation paid to employees as well as federal, state, and local taxes withheld from their paychecks.
Some individuals may be owed a refund for state and local taxes withheld for the wrong jurisdiction or face new tax liabilities where they moved, Pickering said.
Many newly remote workers might make the mistake of assuming they’re eligible for a home-office deduction. But the tax break doesn’t apply to full-time employees who receive a paycheck or a W-2 exclusively from an employer, Pickering said.
The work-from-home issues are constantly evolving, both on the federal and state levels, she noted, advising taxpayers to stay informed and keep good records.
PPP Loans, Deductions
Loans provided under the new Paycheck Protection Program are likely to be a “bookkeeping nightmare” for businesses and their tax return preparers, said Rhonda Collins, director of tax content and government relations for the National Association of Tax Professionals. Preparers will have to consider how clients accounted for the funds and ensure they didn’t double count expenses in their financial statements before beginning work on returns.
The loans, which are eligible for tax-free forgiveness if used to cover certain expenses, may lead to unplanned tax consequences and difficulty determining certain credits and deductions.
Since businesses aren’t taxed on the forgiven loan amount, they can’t deduct expenses paid by the loans—even if they haven’t yet filed for or received forgiveness, the IRS said in guidance released last month. If they have a “reasonable expectation” that the loan will be forgiven in the future, the deductions have to stop.
Losing those deductions increases a business’s taxable income, which means a higher overall tax bill. But it can also complicate calculations of other credits and deductions, including a new 20% write-off for pass-through businesses, said Annette Nellen, a CPA and director of San Jose State University’s graduate tax program.
Taxpayers and advisers who assumed—prior to the IRS’s latest guidance—that they could continue deducting expenses until their PPP loans were forgiven will have to adjust their positions when filing next year.
But the ground may shift again before year-end, warned Robert Lickwar, a partner at CPA firm UHY LLP in Farmington, Conn.
Democratic and Republican lawmakers have both opposed the IRS’s stance and signaled that they may allow for the expenses to be deducted under a forthcoming stimulus package. A bipartisan proposal unveiled earlier this week would do just that. Preparers, however, can’t base returns on the hope or expectation that the IRS’s policy will be reversed, Lickwar said.
Businesses will likely seek filing extensions if the issue isn’t resolved by the time they have to submit a return next year, he said. Extensions, though, don’t apply to the actual payment of tax—an estimate of which will still be due by the original deadline.
“It’s kind of a mess, for sure,” he said.
—With assistance from Sony Kassam.