- What to Expect During the 2021 Tax Season
- Economic Impact Payments
- Unemployment Insurance Benefits
- Refundable Tax Credits
- Tax Refunds
- Many Americans Are Shocked By Their Tax Returns in 2019. Here’s What You Should Know
- What changed with the tax code from last year?
- Who is most affected by tax changes this year?
- Why do these tax changes feel so significant?
- What can you do about the change this tax season and next?
What to Expect During the 2021 Tax Season
Since February 12th, the Internal Revenue Service (IRS) has been processing federal tax returns for the 2020 tax year, complicated for taxpayers and the IRS by the coronavirus pandemic and multiple pandemic-related relief packages passed last year.
That’s why on Wednesday, the IRS announced the extension of tax filing and payment deadlines from April 15th to May 17th to help taxpayers navigating the many tax changes and give the IRS opportunity to clear its backlog of tax returns and correspondence.
Because of tax policy changes introduced through the CARES Act (passed in March 2020), the coronavirus relief package in the Consolidated Appropriations Act, 2021 (passed in December), and the American Rescue Plan Act (ARPA, signed just a week ago), the tax filing season has several unique features to keep in mind:
- the adjustment of economic impact payments on individual income tax returns;
- a tax exclusion for the first $10,200 in unemployment insurance (UI) benefits; and
- changes to individual tax refunds.
With these changes, outlined below, the IRS is urging taxpayers to file their returns electronically to expedite the processing of tax returns.
Economic Impact Payments
The IRS and Treasury Department sent two rounds of economic impact payments to individuals in 2020 as part of broader coronavirus relief packages.
The payments, sometimes called stimulus payments, were sent through direct deposit, paper check, or prepaid debit cards. Technically, the payments are tax credits advanced to individuals their 2018 or 2019 adjusted gross income (AGI).
For the filing season now underway, the IRS updated the 2020 Form 1040 to finalize payments in case individuals are eligible for an additional amount.
Individuals may receive an additional payment (in the form of a refundable tax credit on their 2020 individual income tax return) in one of two ways. First, filers who did not receive either of the payments due to processing delays or errors may claim it on their return.
Second, filers ly will benefit by using 2020 AGI when calculating any credit they are owed.
If a filer received a partial payment (or no payment at all) because of a 2018 or 2019 AGI above the phaseout threshold, using a lower 2020 AGI would make them eligible for an additional payment.
Filers who did not receive a payment for an eligible dependent may also receive the credit on their tax return. (Additionally, filers who originally were not eligible for a CARES Act payment because they lacked a Social Security number may be eligible if they are part of an eligible mixed-status family.)
Adjustments are only made in the taxpayers’ favor, so taxpayers will not see any increase in their tax liability related to the payments. Because the payments are tax credits, they are not taxable income.
Adjustments for the latest round of $1,400 economic impact payments through the ARPA will be made in the 2022 tax filing season.
Unemployment Insurance Benefits
Lawmakers responded to the unprecedented increase in unemployment in 2020 with large increases in the payment of unemployment insurance (UI) benefits. The UI benefits helped support American incomes through the year and are considered taxable income.
To avoid an unexpected tax bill when filing their taxes, taxpayers would have needed to correctly withhold taxes from their UI benefits. For federal income taxes, a taxpayer can opt into a 10 percent withholding rate, but it is not required.
Taxpayers may additionally remit quarterly estimated taxes throughout the year. Many taxpayers ly have not properly withheld or saved tax owed on UI benefits, which may create an unexpected tax liability when they file for the 2020 tax year.
To provide tax relief for unemployed workers, the ARPA excluded the first $10,200 in unemployment benefits for filers earning less than $150,000 per year.
The IRS will provide guidance on this exclusion for filers who have already filed their tax return and received unemployment benefits; they may not need to submit an amended return if the IRS automatically calculates the proper tax owed and sends out a tax refund if necessary.
According to the U.S. Department of Labor, about $6.4 billion in unemployment insurance benefits were paid in the fourth quarter of 2019. By the second quarter of 2020, this jumped to $64.2 billion, and the third quarter of 2020 saw $48.
7 billion in UI benefits paid. The higher UI benefit payments follow the rise in unemployment from 3.5 percent in February 2020 to a peak of 14.8 percent in April 2020. The unemployment rate remains elevated, at about 6.7 percent in December.
Refundable Tax Credits
The December coronavirus relief package included an adjustment to the way the Earned Income Tax Credit (EITC) and the Child Tax Credit (CTC) are calculated for the 2020 tax year.
Normally, both credit amounts are calculated earned income and phase in over time for lower-income earners.
The phase-in with earned income means that an economic downturn can lower the value of credits for people who may have lost their incomes due to the pandemic.
Filers can use 2019 earnings in lieu of 2020 to determine credit eligibility for tax filing. The “lookback” provision will raise the total amount of refundable credits provided to lower-income earners.
It will be important for filers to compare earned income for both tax years to see what is best for their tax situation.
The Joint Committee on Taxation (JCT) estimates that the lookback will reduce federal revenue by about $4.1 billion in 2021.
Many filers are concerned about tax refunds heading into tax season. The combination of unique economic and tax policy circumstances may affect refunds both for individual taxpayers and in the aggregate.
Economic recessions tend to impact refunds because taxpayers have lower incomes and tax policy tends to provide stimulus that flows into refund amounts.
During the Great Recession, for example, total refunds rose above trend from about $250 billion in 2007 to $335 billion in 2009 before remaining flat for the next several years (see the following Figure).
The share of returns with a tax refund, however, remained stable at between 75 percent and 80 percent of returns filed in those years. The average tax refund also rose, from about $2,200 in 2007 to about $2,600 in 2009, before dropping to about $2,200 in 2016.
Where tax refunds will end up for the 2020 tax year is uncertain, though the trends tend to point toward higher refund levels compared to recent tax seasons. Many taxpayers have yet to claim their economic impact payment. Up to nine million individuals eligible for a payment had not received one as of mid-September 2020.
Additionally, individuals who have not received a second-round stimulus payment must indicate it on their tax return to receive this credit. Filers will have to watch that they do not double claim these payments if the second-round payment arrives after filing a return, which may require an amendment to the tax return.
The payments will tend to increase refunds, all else equal, though it’s unclear how many people who typically do not file a tax return will do so this year to claim a payment.
The lookback adjustment for tax credits may also help sustain refund levels for lower-income taxpayers. The estimated $4 billion cost of the adjustment is about 1 percent of 2019 tax refunds processed, though the revenue loss is unly to translate to a direct dollar-for-dollar increase in tax refunds.
The increase in unemployment insurance claims means some filers may have additional tax owed if they have not properly withheld tax over the tax year.
The same problem, however, was not so large during the Great Recession to offset the other trends pushing tax refunds up overall.
The recent exclusion of the first $10,200 in unemployment benefits for those earning less than $150,000 will limit unexpected tax bills and makes it more ly that refunds will be higher than prior years.
While tax refunds are an area of focus for taxpayers, it’s important to remember that tax refunds are not an accurate way of looking at tax liability or evaluating how tax changes impact taxpayers’ after-tax incomes.
The 2021 tax season is a messy one for taxpayers, the IRS, and state tax authorities because of the tax changes made over the past year and the logistical challenges due to the ongoing pandemic.
The IRS should provide flexibility for individuals and businesses seeking to comply with and understand their tax obligations for the year while looking forward to ways that would simplify tax compliance and the filing process.
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Many Americans Are Shocked By Their Tax Returns in 2019. Here’s What You Should Know
As tax season starts to heat up, people with big plans for their tax refunds may be surprised to find they are receiving less money than in years past.
The initial batch of tax refunds in the first two weeks of the season declined an average of 8.7% from last year as of Feb. 8, according to a report from the Internal Revenue Service.
The average refund around the same time in 2018 was $2,135; this year, the number stands at $1,949. The changes ly stem from the Tax Cuts and Jobs Act law that passed in December 2017, significantly overhauling the tax code in the U.S.
Among the changes were new tax brackets, standard deductions and expanded credits for families with children.
Changes in the new tax law could lead to confusion as people try to figure out how much they will receive in their refunds, or if they owe money to the IRS. Here’s what you should know about what’s different this year.
What changed with the tax code from last year?
Because so many pieces of the tax code shifted, it’s difficult to tell why certain people are affected differently than others, according to tax specialists and financial experts.
But one place where people are ly to feel an impact comes from changes to withholding tables, which are guides that employers follow to deduct the proper amount from each employee’s paycheck for income tax.
Under the new law, many people saw less money taken their paychecks, which has led to smaller tax refunds.
Other changes to the tax law include the implementation of higher standard deduction for single filers at $12,000 and married couples filing jointly at $24,000 and a higher child tax credit, doubling to $2,000 per child from $1,000 per child last year. The law also meant the elimination of personal exemptions and limits to itemized deductions, such as a newly introduced $10,000 cap on deductions at the state and local levels.
Those most ly to feel the impact are people who did not change how much they wanted withheld from their paychecks in their W-4 forms. Further, it’s emerged as people get ready for tax season that about half of Americans don’t understand how the new law affects their tax bracket and about 28% are unsure about what exactly shifted under the code, according NerdWallet’s 2019 Tax Study.
That lack of awareness on part of taxpayers over what to do with their forms is probably driving the lower tax refund average, says Andrea Coombes, a tax specialist and writer at NerdWallet.
“Because employers have to change their withholding tables the IRS’s new rules, people ly would have been enjoying more money in their paychecks over the course of the year,” she says. “That, in turn, could mean a smaller refund now.”
Who is most affected by tax changes this year?
Those most at risk for receiving less money in their tax refunds are taxpayers who itemize their deductions and have no dependents, homeowners in high tax states and employees who have unreimbursed business expenses, according to Lynn Ebel, the director of the Tax Institute at H&R Block. Families with children under the age of 17 will ly get a higher refund, she says, because the child tax credit jumped in size under the law, to $2,000 per qualifying child plus a new $500 credit for other qualifying dependents.
That the number of people who will receive lower-than-usual tax refunds will grow is quite ly, says Mark Jaeger, the director of tax development at the tax preparation firm TaxAct.
“It’s a short window [the IRS] is reporting on, but it does seem this is going to continue for at least this year,” he says. “Not everybody is going to see a tax decrease this year, but a majority should. It comes back to withholdings calculations.”
Why do these tax changes feel so significant?
The confusion over what people may or may not receive in their tax refunds contributes to a stressful climate, according to financial psychologist Brad Klontz.
Money itself is already a significant stressor for Americans, according to the American Psychological Association, which found in a 2015 survey that money is the top cause of stress in the country.
That pressure gets “exacerbated around tax season,” Klontz says.
It’s still too early in the tax season to determine how many taxpayers are expected to receive a refund this year. The 2018 tax season saw about 70% of taxpayers receive a refund, according to the IRS. The average tax refund around the end of the second week of February was around $2,000 in 2017 and 2018.
“It’s the one time of year where you’re forced to look at your financial life in great detail,” Klontz says. “People have a tendency to not think about it — one way to deal with stress is to be in denial about it.”
This year could be a lot harder to deal with that stress, particularly if people receive notice that they owe taxes instead of a tax refund. Ashley Alt, an Illinois woman, told the New York Times she received a tax bill of $4,800 — far higher than the small amount she had expected to owe the IRS. Klontz says such people will feel the impact of tax season in a much more emotional way.
What can you do about the change this tax season and next?
The W-4 form allows taxpayers to tell their employers how much to take each paycheck for taxes. People can claim a number of allowances on the form, and the more they claim, the fewer taxes will be withheld, Coombes says.
“If you got a big tax bill this year and you don’t want another one that, you would use form W-4 to reduce your allowances,” she says. “Instead of five, claim one or two [allowances]. That will increase your withholdings over the year, and that will help you owe less next April.”
People vary in terms of how they prefer to pay taxes and receive refunds. Some prefer to get a large chunk of money in their tax refunds, while others plan to receive $0 after having the right amount withheld all year from their paychecks, says Ebel.
Others have said they prefer to owe small amounts to the IRS because they don’t want to give what they see as an interest-free loan to the government.
No matter what outcome taxpayers desire, they have take steps to prepare themselves properly, according to Ebel.
Ebel says that instead of preparing, many people took the “wait and see approach” this year due to confusion over how the new tax law would affect them.
At H&R Block, which helps people prepare their taxes, the company tried to educate their clients on the changes to the tax rules starting last year.
There are several tools taxpayers can use to figure out what they’re paying, such as withholding calculators, or taking a deep look at what you paid in taxes in previous years.
“Taxes can be a source of panic for people,” she says. “It’s not the most fun or sexy thing to talk about or to have a good understanding of. Relying on the withholding tables was kind of a wake up call for people to be a little more proactive.”
For those who get less in their tax refunds than in years prior, Klontz suggests shifting the mindset around what the refund even means.
Receiving a couple thousand dollars can feel a bonus — many people use that money to pay off debts, add a lump sum to savings or go on vacation.
But it would help if people saw their refunds as just another paycheck, and not as extra money, according to Klontz.
“It helps to understand that it’s not actually a bonus from the IRS,” he says. “It’s a return of your money because you were overpaying your taxes. You need a level of consciousness around it.”
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