This storm has been brewing for a long time and has been made worse by the coronavirus pandemic, says Erin M. Collins of the independent Taxpayer Advocate Service, an organization within the IRS that helps taxpayers resolve issues with the agency.
“The covid-19 pandemic has presented frustrations and challenges,” Collins, the national taxpayer advocate, wrote last month in an annual report to Congress. “It also has pulled back the curtain on the significant limitations the IRS faces with technology and with its workforce.”
Despite the IRS’s overall success in managing the 2020 filing season and accurately distributing the vast majority of the 160 million stimulus payments included in the first round of coronavirus relief, some taxpayers experienced major problems — and the agency was not always fully transparent about its struggles, Collins wrote.
Now that the 2021 filing season has opened, people should be prepared for a tempest of tax issues, Collins said.
“I feel like a broken record, but it gets back to resources, both employees and IT,” she said. “I’m hoping the taxpayers who have the ability to file electronically can do that. And so those people hopefully will be facing minimal problems. I do think there are going to be challenges when there’s an inconsistency between taxpayers’ economic-impact numbers and the IRS records. But there are going to be challenges.”
The swirling debris of issues in the tax-season tornado this year include the following:
There have been two rounds of stimulus payments, and a proposal for a third is working its way through Congress.
The Coronavirus Aid, Relief and Economic Security Act, or Cares Act, which passed in the spring, authorized payments of up to $1,200 for individuals and $2,400 for couples filing jointly, based on their 2018 or 2019 federal tax returns. There was an extra $500 payment for eligible children under 17. The Cares Act required the IRS to deliver the first round of stimulus payments by Dec. 31.
The Coronavirus Response and Relief Supplemental Appropriations Act, which passed at the end of December, called for additional stimulus payments of up to $600 per adult ($1,200 for couples). Parents could receive $600 for children under 17. But the IRS had a very short window — until Jan. 15 — to get out the $600 payments.
A glitch that sent stimulus payments to the wrong bank accounts meant that the deadline was extended for certain affected taxpayers. But for the most part, if payments weren’t direct-deposited or mailed by then, people have to wait to get their money until after they file their 2020 tax return.
The Biden administration is negotiating another stimulus payment for coronavirus-related relief. The latest stimulus measure under discussion would send $1,400 payments to individuals and $2,800 to married couples.
Technically, the stimulus payments were an advance of a credit referred to on Forms 1040 and 1040-SR as the “Recovery Rebate Credit” — on the second page, Line 30.
If you received all the money you were eligible for under the stimulus packages for yourself or any children, you should not include anything on Line 30.
You may claim the credit on your 2020 federal return if you didn’t get a payment for which you were eligible, or if you didn’t get the full amount you were due for yourself or for any eligible children.
Eligibility for the Recovery Rebate Credit is based on your adjusted gross income on your 2020 tax return. So, if you earned too much and didn’t get stimulus payments but your income dropped last year, you may still be eligible to claim the credit when you file your return.
If you received a partial payment or didn’t get all the money designated for a dependent child under 17, you can claim the balance on your 2020 return.
Worried that you still haven’t received your stimulus payment? When filling out your 2020 return, make sure to include the amount you are due on Line 30.
If you received your stimulus payment on a prepaid debit card and haven’t activated it, you can’t claim the credit on your tax return, the IRS says. The IRS considers that money paid. The debit card doesn’t expire until 2023. “The funds will remain valid on the card and accessible once you activate the card,” the IRS says.
If your card is lost or was tossed out by mistake, you can request a replacement by contacting MetaBank at (800) 240-8100. When you call, ignore the instructions to press Option 1 to reach customer service. Instead, choose Option 2 for a lost or stolen card. Then select Option 1 to input the last six digits of your Social Security number as well as your Zip code. From there, you should be transferred to a person in customer service. Then you have to answer some security questions before a replacement card is mailed.
Many taxpayers will be shocked to find that because they owe back taxes or student loans or have other state or federal liabilities, they won’t get a stimulus payment.
The IRS can offset or take a person’s refund to satisfy those debts. This issue has created a group of haves and have-nots. People who received the first stimulus payments didn’t have to contend with offsets unless they owed back child support. For the second round of stimulus payments, there were no offsets — even for child support. However, because of delays in processing returns from last year or other glitches, people who won’t get their stimulus payments until they file their 2020 return will be subject to offsets if they owe the IRS or other government entities or have past-due student loans.
Meanwhile, some offsets might be incorrectly attributed to unpaid federal tax liabilities. As of Jan. 29, the IRS estimated it still had 6.7 million individual returns in the processing pipeline.
“As a result, the tax accounts of millions of taxpayers may not be properly adjusted,” Collins said. “They may be owed refunds or have challenged a tax liability. As a result, the IRS may end up offsetting refunds to satisfy federal tax debts that no longer exist.”
And, no, the stimulus payments will not be taxed. Nor will you have to pay back any stimulus money that you received if, based on your 2020 income, you would not be eligible for the Recovery Rebate Credit. There is no clawback, unless someone fraudulently obtained a payment.
Stimulus payments to young adults
There’s been some confusion over whether young adults can claim a stimulus payment. If they are self-supporting and eligible for a payment, they can claim the credit. But they can’t if, for example, parents are providing more than 50 percent of their expenses. However, college students who graduated in 2020 and are now living on their own may not realize they are eligible for a stimulus payment up to a total of $1,800 from the first two rounds of stimulus payments.
Claiming an incorrect Recovery Rebate Credit amount
The IRS won’t calculate the Recovery Rebate Credit amount for you — unless you make a mistake in filling in Line 30 on your 1040 form. If this happens, the agency said, it will calculate the correct amount of the credit, make the correction to your tax return and continue processing your return. But the IRS said that could cause a “slight” delay in processing your return. You would get a notice explaining any change that was made.
Overall, 10 million people in the United States are currently unemployed, and about 40 percent of these people have been out of work for more than six months. Many people unemployed for the first time may have not fully understood that their unemployment is taxed.
“I’m concerned that a lot of people who received it didn’t understand the taxability of it, or it wasn’t of the utmost importance when they were cashing a check, and now they’re going to be stuck with filing a tax return and have taxes due,” Collins said.
If you received unemployment benefits, you should get Form 1099-G, Certain Government Payments, indicating the amount of unemployment compensation you received.
If you end up with a tax bill but can’t pay it, you should still file your return on time.
“I would encourage those people to file and then figure out the payment schedule later, because if you don’t timely file it’s potentially a 25 percent penalty of the tax owed,” Collins said. “I’m concerned that a lot of people will just not want to do anything if they’re going to owe taxes.”
If you can, file electronically. But if you can’t, be prepared for a long wait for any refund. The IRS received roughly 16 million individual paper returns last year and is still working its way through a huge backlog of mailed returns and correspondence. Mail is handled as it comes in. So new mail gets placed at the back of the line.
“It’s more important than ever to file electronically and choose direct deposit for your refund,” Ken Corbin, the IRS’s wage and investment commissioner and its new chief taxpayer experience officer, said during a press call this month.
About 10 percent of taxpayers file a paper return, Corbin said.
“The IRS will do everything it can to move quickly,” he said. “But realistically, those filing on paper and expecting a refund need to be prepared for a potential lengthy wait. This is due to the impact of the pandemic, ranging from potentially lengthy mail times to the need to social-distance our employees at our processing sites.”
Because the IRS is still processing millions of 2019 federal returns, many people are unsure what to put down for their adjusted gross income, according to Brette Gollihare, a lawyer and the director of Legal Aid Services of Oklahoma’s Low Income Tax Clinic. “One of the verification questions is what is your adjusted gross income, or AGI, from last year,” she said.
If you are filing electronically, you must sign and validate your electronic tax return by entering your prior-year AGI or your prior-year Self-Select PIN. The IRS has issued the following instructions on how to answer the validation questions:
If you used the non-filers tool the IRS created for people who don’t typically have to file a tax return, you should enter “$1” as the prior-year AGI verification.
If you did not use the non-filers tool or you didn’t file a 2019 return, you should enter “$0” as the prior-year AGI verification.
The IRS says that if you filed an electronic or paper 2019 Form 1040 or Form 1040-SR, enter the AGI amount from Line 8b of the submitted form as the prior-year AGI verification. But people may still have a problem if their return is one of the ones still in the pipeline and hasn’t been processed.
Taxpayers will face more frustration because the IRS workforce is beleaguered. In addition to the regular workload and normal issues that come with the tax season, staff members are dealing with coronavirus-related slowdowns as they contend with social distancing mandates. There’s also the added responsibility of dealing with stimulus-payment problems.
So far this year, the accounts-management phone lines are handling only 14 percent of calls, down from 61 percent for the same period last year, according to Collins. This means taxpayers will have to wait a long time to get a person on the line or may never reach a live representative.
“We are having our customer service representatives work extraordinary hours to make sure that we can get to as many calls as possible,” Corbin said.
In the 2020 fiscal year, the IRS received more than 100 million calls on its toll-free phone lines. Employees answered only about 24 million. And things won’t get better during the 2021 season. “Unfortunately, I think this filing season you’re not going to see a huge improvement,” Collins said.
Some of the people processing paper returns are also responsible for the phone lines, she said. “So, again, they’re leveraging similar people. So that’s what makes it difficult.”
Earned-income tax credit
The earned-income tax credit helps low-to-moderate-income workers and families reduce their taxes and can result in a refund. To claim the credit, you have to have earned income.
Here’s the problem for people who would typically qualify to claim the credit: You can’t count unemployment benefits toward qualifying for the EITC. So, to address the high number of people who lost their jobs because of the pandemic, the Taxpayer Certainty and Disaster Tax Relief Act of 2020 expanded eligibility for the EITC, allowing people to use their 2019 earned income.
Many people have struggled to make ends meet during the pandemic and dipped into their retirement accounts. Some of them will now have to reckon with paying taxes on the money they withdrew from their workplace retirement plan.
If you are younger than 59½, you are ordinarily subject to a 10 percent early-withdrawal penalty on top of the income tax owed on your withdrawal. But — if you experienced financial hardship related to the pandemic — the Cares Act waived the 10 percent penalty on withdrawals from individual retirement accounts and defined contribution plans, such as a 401(k) or 403(b).
The Cares Act also gave people three years to pay the income tax due on the withdrawal. Here’s how that would work, according to an example provided by the IRS: If you took a $9,000 coronavirus-related distribution in 2020, you would report the first $3,000 in income on your federal income-tax return for 2020. You would then report $3,000 each for 2021 and 2022. Taxpayers could also elect to include the entire distribution on their 2020 return.
Yes, you’re working at your kitchen table pushing dishes away to finish a report for work. But, no, you can’t deduct the cost of working from home if you work for an employer — even if the employer requires remote work because of the coronavirus. The Tax Cuts and Jobs Act passed in 2017 eliminated employee business expenses.
You can take a home-office deduction only if you’re self-employed, an independent contractor or a gig worker.
You might be tempted to try to take the deduction anyway, but if you do you could increase the likelihood of being audited, warned Erin Voisin, director of financial planning at California-based EP Wealth Advisors.
Refund of 529 funds
Concerned about the spread of the coronavirus, many colleges sent students home. This resulted in refunds for housing and in some cases reduced tuition payments.
Here’s where some people may run into an issue. If the returned money taken from a 529 plan wasn’t used for qualified expenses for the rest of the calendar year — tuition, room and board, as well as required textbooks, computers, related equipment, software and Internet access — the account holder may have to pay income taxes on the earnings and be subject to an additional 10 percent penalty for a non-qualified distribution.
Typically, 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. Because of the pandemic, the IRS has issued guidance that gave 529-plan account holders a longer window to return refunded college expenses. If the 60-day period ended on or after April 1 of last year, account holders had until the July 15 tax deadline to replace the money without incurring taxes or the 10 percent penalty.
The availability of free in-person tax preparation services will again be limited this year because of the coronavirus. And although people can get virtual help, this service may be difficult for filers who don’t have Internet access.
“We kind of hobbled through it last year,” Collins said. “But I’m wondering if lots of low-income people, even though there’s Free File, can’t do stuff electronically. You’ve still got to get your documents to people.”
The IRS’s Volunteer Income Tax Assistance (VITA) and Tax Counseling for the Elderly (TCE) programs offer free tax help for people who generally make $57,000 or less. To find a VITA or TCE site near you, go to irs.treasury.gov/freetaxprep or call (800) 906-9887.
Predatory companies will no doubt be aggressively going after people who owe the IRS and have trouble paying their tax bills.
The pitches are enticing, often falsely claiming “skilled” agents (or even lawyers) can make a deal with the IRS so that you pay less than what you owe.
But don’t make that call. You’ll more likely end up deeper in debt or scammed with no relief forthcoming.
If your financial situation is really bad — you’ve lost your job and are barely putting food on the table — you can request that your account be placed in “Currently Not Collectible” status. If the IRS agrees, it will delay collection until your financial condition improves. However, interest and penalties still accrue. To discuss your payment options or request a temporary delay of the collection process, contact the IRS at (800) 829-1040, or call the phone number on your bill or notice.
If you can’t pay your tax bill, your first contact should be to the IRS. Don’t pay for services you can get free.
Note: Please join me for an online tax chat at noon Eastern time Thursday, Feb. 18. I will be taking your questions on the 2021 tax season, along with guest expert Eric Bronnenkant, head of tax at Betterment. His 15 years of experience include working for Ernst & Young and Fidelity and as an adjunct tax professor at Seton Hall University.