Here are some tax issues that may impact your 2020 returns, due next April.
— Teleworking. Typically, you pay taxes on income earned in the state where you permanently reside and the state where you work. But with so many companies sending employees home to work to prevent the spread of the novel coronavirus, it’s possible many workers may end up paying taxes to two jurisdictions. This could happen if you’ve moved, even temporarily, but your income is still derived from work done for a company located elsewhere.
Unless you instruct your employer to withhold taxes for the appropriate states, you could get an unexpected tax bill, says Eileen Sherr, senior manager for tax policy and advocacy for the American Institute of Certified Public Accountants (AICPA).
Working even one day in another state could trigger taxation, Sherr said.
The AICPA says 16 states have reciprocity agreements with neighboring jurisdictions that exempt residents of a reciprocity state from income tax withholding. Most states will allow a taxpayer to apply for a credit for income taxes paid to another state. On its website, the AICPA has a state tax guidance chart for the pandemic.
The Mobile Workforce Coalition has a useful website (mobileworkforcecoalition.org/problem) on the requirements to file personal income tax returns when traveling to a nonresident state to work.
It’s important that you know what your state income tax responsibility will be, Sherr said.
— Payroll tax. What the government giveth, it can take away. In the first few months of 2021, millions of workers could see a significant pay cut as companies recoup the coronavirus-related tax break Trump authorized in an executive order signed Aug. 8.
Starting this month, employers can temporarily stop withholding the payroll tax they impose on employees, according to guidance issued last week by the Treasury Department and IRS. The deferral lasts until the end of the year. Employees are taxed 6.2 percent of their income toward Social Security, which pays for retirement, survivor and disability benefits.
The payroll tax deferral will only affect employees who earn up to $4,000 every two weeks and less than $104,000 annually.
Unless Congress acts to forgive the deferred tax, the break could become a burden for a lot of people. From January through April, employers will have to recover the payroll money they didn’t withhold.
“Workers would owe the money, so it would be prudent to think through how they would pay it back and when,” said Edward Karl, the AICPA’s vice president of taxation. “Setting the money aside is one option.”
Voisin recommends employees tell their employers to keep withholding the payroll tax. “People are going to have to be proactive,” she said. “They’ve really got to be thinking that this [tax] is going to be due again at some point.”
— Home office deduction. Yes, you’re working from your bedroom, but no, you can’t take a home office deduction. Employees are not eligible to claim the home office deduction, even if an employer requires remote work because of covid-19. The Tax Cuts and Jobs Act passed in 2017 eliminated employee business expenses on Schedule A. Independent contractors and the self-employed can still take a home office deduction.
“Will people try to take the deduction this year because of what’s going on? I’m sure,” Voisin says. “But you increase your audit risk if you do.”
— Refund of 529 funds. Concerned about the spread of the coronavirus, colleges have reversed housing decisions and have sent students home. But if you used money from a 529 college savings plan to cover the cost of housing and food, you’ll need to put the money back to avoid paying income tax and a 10 percent penalty on the earnings.
A 529 plan allows contributions to grow tax-free. Here’s the issue for fall education expenses: You can’t keep the money; otherwise, it’s considered a non-qualified distribution. You also can’t hold on to the money you took out this year to cover 2021 expenses. Distributions from a 529 plan need to match up with qualified expenses incurred during the same tax year. An account holder has just 60 days from the date of the refund to return the money to the 529 account without incurring taxes and the 10 percent penalty on earnings.
If you are returning the money to a 529 plan, be sure it’s characterized as a “recontribution” of a previous-qualified distribution. Also make sure that the amount you are recontributing is the exact amount of the refund.
“With all of the changes that 2020 has brought, we anticipate that come tax season for 2020, it will be a bit of a mess,” Voisin said.