Employer Open Enrollment: Make Benefit Choices That Work for You
Open enrollment is the time when employers may change their benefit offerings for the upcoming plan year. If you’re employed, this is your once-a-year chance to make important decisions that will affect your health-care choices and your finances.
Even if you are satisfied with your current health plan, it may no longer be the most cost-effective option. Before you make any benefit elections, take plenty of time to review the information provided by your employer. You should also consider how your life has changed over the last year and any plans or potential developments for 2022.
Decipher Your Health Plan Options
The details matter when it comes to selecting a suitable health plan. One of your options could be a better fit for you (or your family) and might even help reduce your overall health-care costs. But you will have to look beyond the monthly premiums. Policies with lower premiums tend to have more restrictions or higher out-of-pocket costs (such as copays, coinsurance, and deductibles) when you do seek care for a health issue.
To help you weigh the tradeoffs, here is a comparison of the five main types of health plans. It should also help demystify some of the terminology and acronyms used so often across the health insurance landscape.
Health maintenance organization (HMO). Coverage is limited to care from physicians, other medical providers, and facilities within the HMO network (except in an emergency). You choose a primary-care physician (PCP) who will decide whether to approve or deny any request for a referral to a specialist.
Point of service (POS) plan. Out-of-network care is available, but you will pay more than you would for in-network services. As with an HMO, you must have a referral from a PCP to see a specialist. POS premiums tend to be a little bit higher than HMO premiums.
Exclusive provider organization (EPO). Services are covered only if you use medical providers and facilities in the plan’s network, but you do not need a referral to see a specialist. Premiums are typically higher than an HMO, but lower than a PPO.
Preferred provider organization (PPO). You have the freedom to see any health providers you choose without a referral, but there are financial incentives to seek care from PPO physicians and hospitals (a larger percentage of the cost will be covered by the plan). A PPO usually has a higher premium than an HMO, EPO, or POS plan and often has a deductible.
A deductible is the amount you must pay before insurance payments kick in. Preventive care (such as annual visits and recommended screenings) is typically covered free of charge, regardless of whether the deductible has been met.
High-deductible health plan (HDHP). In return for significantly lower premiums, you’ll pay more out-of-pocket for medical services until you reach the annual deductible. HDHP deductibles start at $1,400 for an individual and $2,800 for family coverage in 2022 and can be much higher. Care will be less expensive if you use providers in the plan’s network, and your upfront cost could be reduced through the insurer’s negotiated rate.
An HDHP is designed to be paired with a health savings account (HSA), to which your employer may contribute funds toward the deductible. You can also elect to contribute to your HSA through pre-tax payroll deductions or make tax-deductible contributions directly to the HSA provider, up to the annual limit ($3,650 for an individual or $7,300 for family coverage in 2022, plus $1,000 for those 55+).
HSA funds, including any earnings if the account has an investment option, can be withdrawn free of federal income tax and penalties if the money is spent on qualified health-care expenses. (Some states do not follow federal tax rules on HSAs.) Unspent balances can be retained in the account indefinitely and used to pay future medical expenses, whether you are enrolled in an HDHP or not. Be sure to save receipts if you decide to delay using the funds in the HAS in the future. Delaying using the funds allow the earnings and growth of the funds invested free of income tax. If you change employers or retire, the funds can be rolled over to a new HSA.
Three Steps to a Sound Decision
Start by adding up your total expenses (premiums, copays, coinsurance, deductibles) under each plan offered by your employer, based on last year’s usage. Your employer’s benefit materials may include an online calculator to help you compare plans by taking factors such as your chronic health conditions and regular medications into account.
If you are married, you may need to coordinate two sets of workplace benefits. Many companies apply a surcharge to encourage a worker’s spouse to use other available coverage, so look at the costs and benefits of having both of you on the same plan versus individual coverage from each employer. If you have children, compare what it would cost to cover them under each spouse’s plan.
Before enrolling in a plan, check to see if your preferred health-care providers are included in the network.
Tame Taxes with a Flexible Spending Account
If you elect to open an employer-provided health and/or dependent-care flexible spending account (FSA), the money you contribute via payroll deduction is not subject to federal income and Social Security taxes (nor generally to state and local income taxes). Using these tax-free dollars to pay for health-care costs not covered by insurance or for dependent-care expenses could save you about 30% or more, depending on your tax bracket.
The federal limit for contributions to a health FSA was $2,750 in 2021 and should be similar for 2022. Some employers set lower limits. (The official limit has not been announced by the IRS). You can use the funds for a broad range of qualified medical, dental, and vision expenses.
With a dependent-care FSA, you can set aside up to $5,000 a year (per household) to cover eligible child-care costs for qualifying children aged 12 or younger. The tax savings could help offset some of the costs paid for a nanny, babysitter, day care, preschool, or day camp, but only if the services are used so you (or a spouse) can work.
One drawback of health and dependent-care FSAs is that they are typically subject to the use-it-or-lose-it rule, which requires you to spend everything in your account by the end of the calendar year or risk losing the money. Some employers allow certain amounts (up to $550) to be carried over to the following plan year or offer a grace period up to 2½ months. Still, you must estimate your expenses in advance, and your predictions could turn out to be way off base.
Legislation passed during the pandemic allows workers to carry over any unused FSA funds from 2021 into 2022, if the employer opts into this temporary change. If you have leftover money in an FSA, you should consider your account balance and your employer’s carryover policies when deciding on your contribution election for 2022.
Take Advantage of Valuable Perks
A change in the tax code enacted at the end of 2020 made it possible for employers to offer student debt assistance as a tax-free employee benefit through 2025, spurring more companies to add it to their menu of benefit options. A 2021 survey found that 17% of employers now offer student debt assistance, and 31% are planning to do so in the future. Many employers target a student debt assistance benefit of $100 per month, which doesn’t sound like much, but it adds up.1 For example, an employee with $31,000 in student loans who is paying them off over 10 years at a 6% interest rate would save about $3,000 in interest and get out of debt 2½ years faster.
Many employers provide access to voluntary benefits such as dental coverage, vision coverage, disability insurance, life insurance, and long-term care insurance. Even if your employer doesn’t contribute toward the premium cost, you may be able to pay premiums conveniently through payroll deduction. Your employer may also offer discounts on health-related products and services, such as fitness equipment or gym memberships, and other wellness incentives, like a monetary reward for completing a health assessment.
1) CNBC, September 28, 2021
Is the Back-Door Roth IRA Going Away for Good?
Among the many provisions in the multi-trillion-dollar legislative package being debated in Congress is a provision that would eliminate a strategy that allows high-income investors to pursue tax-free retirement income: the so-called back-door Roth IRA. The next few months may present the last chance to take advantage of this opportunity.
Roth IRA Background
Since its introduction in 1997, the Roth IRA has become an attractive investment vehicle due to the potential to build a sizable, tax-free nest egg. Although contributions to a Roth IRA are not tax deductible, any earnings in the account grow tax-free if future distributions are qualified. A qualified distribution is one made after the Roth account has been held for five years and after the account holder reaches age 59½, becomes disabled, dies, or uses the funds for the purchase of a first home ($10,000 lifetime limit).
Unlike other retirement savings accounts, original owners of Roth IRAs are not subject to required minimum distributions at age 72 — another potentially tax-beneficial benefit that makes Roth IRAs appealing in estate planning strategies. (Beneficiaries are subject to distribution rules.)
However, as initially passed, the 1997 legislation rendered it impossible for high-income taxpayers to enjoy Roth IRAs. Individuals and married taxpayers whose income exceeded certain thresholds could neither contribute to a Roth IRA nor convert traditional IRA assets to a Roth IRA.
A Loophole Emerges
Nearly 10 years after the Roth’s introduction, the Tax Increase Prevention and Reconciliation Act of 2005 ushered in a change that relaxed the conversion rules beginning in 2010; that is, as of that year, the income limits for a Roth conversion were eliminated, which meant that anyone could convert traditional IRA assets to a Roth IRA. (Of course, a conversion results in a tax obligation on deductible contributions and earnings that have previously accrued in the traditional IRA.)
One perhaps unintended consequence of this change was the emergence of a new strategy that has been utilized ever since: High-income individuals could make full, annual, nondeductible contributions to a traditional IRA and convert those contribution dollars to a Roth. If the account holders had no other IRAs (see note below) and the conversion was executed quickly enough so that no earnings were able to accrue, the transaction could potentially be a tax-free way for otherwise ineligible taxpayers to fund a Roth IRA. This move became known as the back-door Roth IRA.
(Note: When calculating a tax obligation on a Roth conversion, investors must aggregate all their IRAs, including SEP and SIMPLE IRAs, before determining the amount. For example, say an investor has $100,000 in several different traditional IRAs, 80% of which is attributed to deductible contributions and earnings. If that investor chose to convert any traditional IRA assets — even recent after-tax contributions — to a Roth IRA, 80% of the converted funds would be taxable. This is known as the “pro-rata rule.”)
Current Roth IRA Income Limits
For 2021, you can generally contribute up to $6,000 to an IRA (traditional, Roth, or a combination of both); $7,000 if you’ll be age 50 or older by December 31. However, your ability to make contributions to a Roth IRA is limited or eliminated if your modified adjusted gross income, or MAGI, falls within or exceeds the parameters shown below.
| If your federal filing status is: | Your 2021 Roth IRA contribution is reduced if your MAGI is: | You can’t contribute to a Roth IRA for 2021 if your MAGI is: |
| Single or head of household | More than $125,000 but less than $140,000 | $140,000 or more |
| Married filing jointly or qualifying widow(er) | More than $198,000 but less than $208,000 | $208,000 or more |
| Married filing separately | Less than $10,000 | $10,000 or more |
Note that your contributions generally can’t exceed your earned income for the year (special rules apply to spousal Roth IRAs).
Now or Never … Maybe
While no one knows for sure what may come of the legislative debates, the current proposal would prohibit the conversion of nondeductible contributions from a traditional IRA after December 31, 2021. If you expect your MAGI to exceed this year’s thresholds and you’d like to fund a Roth IRA for 2021, the next few months may be your last chance to use the back-door strategy. Contact your financial and tax professionals for more information.
There is no assurance that working with a financial professional will improve investment results.
You can make 2021 IRA contributions up until April 15, 2022, but if the legislation is enacted, a Roth conversion involving nondeductible contributions would have to be conducted by December 31, 2021.
Keep in mind that a separate five-year rule applies to the principal amount of each Roth IRA conversion you make unless an exception applies.
Advancing Tax Proposals Put Corporations and High-Income Individuals in Spotlight
The House Budget Committee voted Saturday, September 25, 2021, to advance a $3.5 trillion spending package to the House floor for debate. Summaries of proposed tax changes intended to help fund the spending package was previously released by The House Ways and Means Committee and the Joint Committee on Taxation. Many of these provisions focus specifically on businesses and high-income households. There is a high probability that changes will be made as the process continues.
Below are some highlights from the proposed provisions.
Corporate Income Tax Rate Increase
Corporations would be subject to a graduated tax rate structure, with a higher top rate.
Currently, a flat 21% rate applies to corporate taxable income. The proposed legislation would impose a top tax rate of 26.5% on corporate taxable income above $5 million. Specifically:
- A 16% rate would apply to the first $400,000 of corporate taxable income
- A 21% rate on remaining taxable income up to $5 million
- The 26.5% rate would apply to taxable income over $5 million, and corporations making more than $10 million in taxable income would have the benefit of the lower tax rates phased out.
Personal service corporations would pay tax on their entire taxable income at 26.5%.
Tax Increases for High-Income Individuals
Top individual income tax rate. The proposed legislation would increase the existing top marginal income tax rate of 37% to 39.6% effective in tax years starting on or after January 1, 2022 and apply it to taxable income over $450,000 for married individuals filing jointly, $425,000 for heads of households, $400,000 for single taxpayers, and $225,000 for married individuals filing separate returns. (These income thresholds are lower than the current top rate thresholds.)
Top capital gains tax rate. The top long-term capital gains tax rate would be raised from 20% to 25% under the proposed legislation; this increased tax rate would generally be effective for sales after September 13, 2021. In addition, the taxable income thresholds for the 25% capital gains tax bracket would be made the same as for the 39.6% regular income tax bracket (see above) starting in 2022.
New 3% surtax on income. A new 3% surtax is proposed on modified adjusted gross income over $5 million ($2.5 million for a married individual filing separately).
3.8% net investment income tax expanded. Currently, there is a 3.8% net investment income tax on high-income individuals. This tax would be expanded to cover certain other income derived in the ordinary course of a trade or business for single taxpayers with taxable income greater than $400,000 ($500,000 for joint filers). This would generally affect certain income of S corporation shareholders, partners, and limited liability company (LLC) members that is currently not subject to the net investment income tax.
New qualified business income deduction limit. A deduction is currently available for up to 20% of qualified business income from a partnership, S corporation, or sole proprietorship, as well as 20% of aggregate qualified real estate investment trust dividends and qualified publicly traded partnership income. The proposed legislation would limit the maximum allowable deduction at $500,000 for a joint return, $400,000 for a single return, and $250,000 for a separate return.
Retirement Plans Provisions Affecting High-Income Individuals
New limit on contributions to Roth and traditional IRAs. The proposed legislation would prohibit those with total IRA and defined contribution retirement plan accounts exceeding $10 million from making any additional contributions to Roth and traditional IRAs. The limit would apply to single taxpayers and married taxpayers filing separately with taxable income over $400,000, $450,000 for married taxpayers filing jointly, and $425,000 for heads of household.
New required minimum distributions for large aggregate retirement accounts.
- These rules would apply to high-income individuals (same income limits as described above), regardless of age.
- The proposed legislation would require that individuals with total retirement account balances (traditional IRAs, Roth IRAs, employer-sponsored retirement plans) exceeding $20 million distribute funds from Roth accounts (100% of Roth retirement funds or, if less, by the amount total retirement account balances exceed $20 million).
- To the extent that the combined balance in traditional IRAs, Roth IRAs, and defined contribution plans exceeds $10 million, distributions equal to 50% of the excess must be made.
- The 10% early-distribution penalty tax would not apply to distributions required because of the $10 million or $20 million limits.
Roth conversions limited. In general, taxpayers can currently convert all or a portion of a non-Roth IRA or defined contribution plan account into a Roth IRA or account without regard to the amount of their taxable income. The proposed legislation would prohibit Roth conversions for single taxpayers and married taxpayers filing separately with taxable income over $400,000, $450,000 for married taxpayers filing jointly, and $425,000 for heads of household. [It appears that this proposal would not be effective until 2032.]
Roth conversions not allowed for distributions that include nondeductible contributions. Taxpayers who are unable to make contributions to a Roth IRA can currently make “back-door” contributions by making nondeductible contributions to a traditional IRA and then shortly afterward convert the nondeductible contribution from the traditional IRA to a Roth IRA. It is proposed that amounts held in a non-Roth IRA or defined contribution account cannot be converted to a Roth IRA or designated Roth account if any portion of the distribution being converted consists of after-tax or nondeductible contributions.
Estates and Trusts
- For estate and gift taxes (and the generation-skipping transfer tax), the current basic exclusion amount (and GST tax exemption) of $11.7 million would be cut by about one-half under the proposal.
- The proposal would generally include grantor trusts in the grantor’s estate for estate tax purposes; tax rules relating to the sale of appreciated property to a grantor trust would also be modified to provide for taxation of gain.
- Current valuation rules that generally allow substantial discounts for transfer tax purposes for an interest in a closely held business entity, such as an interest in a family limited partnership, would be modified to disallow any such discount for transfers of nonbusiness assets.
IRS Releases 2022 Key Numbers for Health Savings Accounts
The IRS has released the 2022 contribution limits for health savings accounts (HSAs), as well as the 2022 minimum deductible and maximum out-of-pocket amounts for high-deductible health plans (HDHPs). An HSA is a tax-advantaged account that’s paired with an HDHP. An HSA offers several valuable tax benefits:
- You may be able to make pre-tax contributions via payroll deduction through your employer, reducing your current income tax.
- If you make contributions on your own using after-tax dollars, they’re deductible from your federal income tax (and perhaps from your state income tax) whether you itemize or not.
- Contributions to your HSA, and any interest or earnings, grow tax deferred.
- Contributions and any earnings you withdraw will be tax-free if used to pay qualified medical expenses.
Health Savings Accounts
Annual contributions:
2022 Self-only coverage $3,650, $50 increase from 2021
2022 Family coverage $7,300, $100 increase from 2021
High-deductible health plan: self-only coverage:
2022 Annual deductible: minimum $1,400, the same as 2021
2022 Annual out-of-pocket expenses required to be paid (other than premiums) can’t exceed $7,050,
$50 increase from 2021
High-deductible health plan: family coverage:
2022 Annual deductible: $2,800, the same as 2021
2022 Annual out-of-pocket expenses required to be paid (other than premiums) can’t exceed $14,000,
$100 increase from 2021
Catch-up contributions:
2022 Annual catch-up contributions limit for individuals age 55 or older $1,000, the same as 2021
Mid-Year Is a Good Time for a Financial Checkup
The first half of 2021 is behind us. As life emerges from the pandemic to a “new normal,” a mid-year financial checkup may be more important than ever this year. Here are some ways to make sure that your financial situation is continuing the right path.
Reassess your financial goals
At the beginning of the year, you may have set financial goals geared toward improving your financial situation. Perhaps you wanted to save more, spend less, or reduce your debt. How much progress have you made? If your income, expenses, and life circumstances have changed, you may need to rethink your priorities. Review your financial statements and account balances to determine whether you need to make any changes to keep your financial plan on track.
Look at your taxes
Completing a mid-year estimate of your tax liability may reveal new tax planning opportunities. You can use last year’s tax return as a basis, then factor in any anticipated adjustments to your income and deductions for this year. Check your withholding, especially if you owed taxes or received a large refund. Doing that now, rather than waiting until the end of the year, may help you avoid owing a big tax bill next year or overpaying taxes and giving Uncle Sam an interest-free loan. You can check your withholding by using the IRS Tax Withholding Estimator https://www.irs.gov/individuals/tax-withholding-estimator . If necessary, adjust the amount of federal or state income tax withheld from your paycheck by filing a new Form W-4 with your employer. Be sure to factor any Advance Child Tax Credit Payments if you are receiving or expect to receive any. https://www.irs.gov/credits-deductions/advance-child-tax-credit-payments-in-2021
Check your retirement savings
If you’re still working, look for ways to increase retirement plan contributions. For example, if you receive a pay increase this year, you could contribute a higher percentage of your salary to your employer-sponsored retirement plan, if available. For 2021, the contribution limit is $19,500, or $26,000 if you’re age 50 or older. If you are close to retirement or already retired, take another look at your retirement income needs and whether your current investment and distribution strategy will provide the income you will need.
Evaluate your insurance coverage
What are the deductibles and coverage limits of your homeowners/renter’s insurance policies? How much disability or life insurance coverage do you have? Your insurance needs can change over time. As a result, you’ll want to make sure your coverage has kept pace with your income and family/personal circumstances. The cost and availability of life insurance depend on factors such as age, health, and the type and amount of insurance purchased.
Ask questions
Some questions you should also ask yourself as part of your mid-year financial checkup:
• Do you have enough money set aside to cover unexpected expenses?
• Do you have money left in your flexible spending account?
• Are your beneficiary designations up to date?
• Have you checked your credit score recently?
• Do you need to create or update your will?
• When you review your portfolio, is your asset allocation still in line with your financial goals, time horizon, and tolerance for risk? Are any changes warranted?
Asset allocation is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss. All investing involves risk, including the possible loss of principal, and there is no guarantee that any investment strategy will be successful.
American Families Plan Would Provide Benefits for Some, More Taxes for Others
On April 28, 2021, the White House released a fact sheet for President Biden’s American Families Plan (AFP), which proposes about $1 trillion in investments and $800 billion in tax cuts. There would also be tax increases for those making more than $400,000 per year. Major provisions proposed in the plan are summarized here, including some tax provisions.
Education
The AFP proposes the following:
- Free universal pre-school for all three- and four-year olds.
- Two years of free community college.
- Increased assistance to low-income students by raising the maximum Pell Grant award that pays for college education by about $1,400.
Child care
Low- and middle-income families would pay no more than 7% of their income on child care.
Nutrition
Summer and school meal programs would be expanded for low-income families.
Unemployment insurance
Funds would be provided for unemployment system modernization, equitable access, and fraud prevention. The plan proposes to automatically adjust the length and amount of unemployment insurance benefits depending on economic conditions.
Paid leave
A national comprehensive paid family and medical leave program would be created and scaled in over a 10-year period.
Health insurance
- The American Rescue Plan Act of 2021 (ARPA 2021), enacted in March 2021, provided that persons who bought their own health insurance through a government exchange might qualify for a lower cost through December 31, 2022. The AFP would make that provision permanent.
- The AFP would also lower prescription drug prices by letting Medicare negotiate prices.
- In addition, the AFP would create a public option and the option for people to enroll in Medicare at age 60.
Child tax credit
ARPA 2021 made the following temporary changes to the child tax credit. For 2021, the credit amount increased from $2,000 to $3,000 per qualifying child ($3,600 for qualifying children under age 6), subject to phaseout based on modified adjusted gross income. The legislation also made 17-year-olds eligible as qualifying children in 2021. For most taxpayers, the credit is fully refundable for 2021 if it exceeds tax liability. The Treasury Department is expected to send out periodic advance payments (to be worked out by the Treasury) for up to one-half of the refundable credit during 2021.
The AFP would make permanent the full refundability of the child tax credit, and extend the other child tax credit provisions through 2025. Longer term, the plan would seek to make all these provisions permanent.
Child and dependent care tax credit
ARPA 2021 made the following temporary changes to the child and dependent care tax credit. For 2021, the legislation increased the maximum credit up to $4,000 for one qualifying individual and up to $8,000 for two or more (based on an increased applicable percentage of 50% of costs paid and increased dollar limits). Most taxpayers will not have the applicable percentage reduced (can be reduced from 50% to 20% if AGI exceeds a substantially increased $125,000) in 2021. However, the applicable percentage can now also be reduced from 20% down to 0% if the taxpayer’s AGI exceeds $400,000 in 2021. For most individuals, the credit is fully refundable for 2021 if it exceeds tax liability.
The AFP would make these provisions permanent.
Earned income tax credit
In addition to some other changes to the earned income tax credit (some temporary, some permanent), ARPA 2021 made the following temporary changes to the earned income tax credit for 2021. The legislation generally increased the credit available for individuals with no qualifying children (bringing it closer to the amounts for individuals with one, two, or three or more children which were already much higher). For individuals with no qualifying children, the minimum age at which the credit can be claimed was generally lowered from 25 to 19 (24 for certain full-time students) and the maximum age limit of 64 was eliminated (there are no similar age limits for individuals with qualifying children).
The AFP would make these provisions permanent for individuals with no qualifying children.
Increase in top tax rate on wealthiest taxpayers
The AFP would raise the top income tax rate on individuals back up to 39.6%, applying only to the top one percent. The 39.6% rate would also apply to the capital gains and dividends of households making over $1 million (the top 0.3 percent).
Stepped-up basis
The tax basis of most property is stepped-up (or down) to fair market value when an individual dies. The AFP would eliminate this step-up in basis for gains in excess of $1 million ($2.5 million per couple when combined with existing real estate exemptions). There would be provisions designed with protections for family-owned businesses and farms.
Like-kind exchanges
Current tax law allows real estate investors to defer taxes when they exchange property. The AFP would eliminate the tax deferral on like-kind exchanges for gains greater than $500,000.
Due Date for Federal Income Tax Returns and Payments Postponed to May 17
Due to the unusual conditions related to the coronavirus pandemic, the due date for individuals to file 2020 federal income tax returns and make tax payments has been postponed by the IRS from Thursday, April 15, 2021, to Monday, May 17, 2021. No interest, penalties, or additions to tax will be incurred by taxpayers during this approximately one-month relief period for any return or payment postponed under this relief provision.
The relief applies automatically to all taxpayers and no additional forms need to be filed to qualify for the relief. The new deadline applies to federal income tax payments for taxable year 2020, including payments of tax on self-employment income. It does not apply to estimated tax payments for 2021 that are due on April 15, 2021. There is no limit on the amount of tax that can be deferred.
Note: Under this relief provision, no extension is provided for the payment or deposit of any other type of federal tax, or for the filing of any federal information return. The IRS urges taxpayers to check with their state tax agencies regarding state tax filing and payment deadlines.
Note: Earlier this year, the IRS announced that victims of the February winter storms in Texas, Oklahoma, and Louisiana have until Tuesday, June 15, 2021, to file various individual and business tax returns and make tax payments.
Need more time?
If you’re not able to file your federal income tax return by the May due date, you can file for an extension by the May due date using IRS Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return. Filing this extension gives you an additional five months (until October 15, 2021) to file your federal income tax return. You can also file for an automatic five-month extension electronically (details on how to do so can be found in the Form 4868 instructions). There may be penalties for failing to file or for filing late.
Filing for an extension using Form 4868 does not provide any additional time to pay your tax. When you file for an extension, you have to estimate the amount of tax you will owe and pay this amount by the May filing due date. If you don’t pay the amount you’ve estimated, you may owe interest and penalties. In fact, if the IRS believes that your estimate was not reasonable, it may void your extension.
Tax refunds
The IRS encourages taxpayers seeking a tax refund to file their tax return as soon as possible, and to file electronically with direct deposit. The IRS issues most tax refunds within 21 days of the IRS receiving a tax return. However, the IRS has experienced delays in processing paper tax returns due to limited staffing during the coronavirus pandemic.
IRA contributions
Contributions to an individual retirement account (IRA) for 2020 can be made up to the due date (without regard to extensions) for filing the 2020 federal income tax return. The postponement of the 2020 tax filing due date by the IRS also generally extends the time to make IRA contributions for 2020 to May 17, 2021.
American Rescue Plan Act Provides Relief to Individuals and Businesses
On Thursday, March 11, 2021, the American Rescue Plan Act of 2021 (ARPA 2021) was signed into law. This is a $1.9 trillion emergency relief package that includes payments to individuals and funding for federal programs, vaccines and testing, state and local governments, and schools. It is intended to assist individuals and businesses during the ongoing coronavirus pandemic and accompanying economic crisis. Major relief provisions are summarized here, including some tax provisions.
Recovery rebates (stimulus checks)
Many individuals will receive another direct payment from the federal government. Technically a 2021 refundable income tax credit, the rebate amount will be calculated based on 2019 tax returns filed (or on 2020 tax returns if filed and processed by the IRS at the time of determination) and sent automatically via check, direct deposit, or debit card to qualifying individuals. To qualify for a payment, individuals generally must have a Social Security number and must not qualify as the dependent of another individual.
The amount of the recovery rebate is $1,400 ($2,800 if married filing a joint return) plus $1,400 for each dependent. Recovery rebates start to phase out for those with an adjusted gross income (AGI) exceeding $75,000 ($150,000 if married filing a joint return, $112,500 for those filing as head of household). Recovery rebates are completely phased out for those with an AGI of $80,000 ($160,000 if married filing a joint return, $120,000 for those filing as head of household).
Unemployment provisions
The legislation extends unemployment benefit assistance:
- An additional $300 weekly benefit to those collecting unemployment benefits, through September 6, 2021.
- An additional 29-week extension of federally funded unemployment benefits for individuals who exhaust their state unemployment benefits.
- Targeted federal reimbursement of state unemployment compensation designed to eliminate state one-week delays in providing benefits (allowing individuals to receive a maximum 79 weeks of benefits)
- Unemployment benefits through September 6, 2021, for many who would not otherwise qualify, including independent contractors and part-time workers.
For 2020, the legislation also makes the first $10,200 (per spouse for joint returns) of unemployment benefits nontaxable if the taxpayer’s modified adjusted gross income is less than $150,000. If a 2020 tax return has already been filed, an amended return may be needed.
Business relief
- The employee retention tax credit has been extended through December 31, 2021. It is available to employers that were significantly impacted by the crisis and is applied to offset Social Security payroll taxes. As in the previous extension, the credit is increased to 70% of qualified wages, up to a certain maximum per quarter.
- The employer tax credits for providing emergency sick and family leave have been extended through September 30, 2021.
- Eligible small businesses can receive targeted economic injury disaster loan advances from the Small Business Administration. The advances are not included in taxable income. Furthermore, no deduction or basis increase is denied, and no tax attribute is reduced by reason of the exclusion from income.
- Eligible restaurants can receive restaurant revitalization grants from the Small Business Administration. The grants are not included in taxable income. Furthermore, no deduction or basis increase is denied, and no tax attribute is reduced by reason of the exclusion from income.
Housing relief
- The legislation allocates additional funds to state and local governments to provide emergency rental and utility assistance through December 31, 2021.
- The legislation allocates funds to help homeowners with mortgage payments and utility bills.
- The legislation also allocates funds to help the homeless.
Health insurance relief
- For those who lost a job and qualify for health insurance under the federal COBRA continuation coverage program, the federal government will generally pay the entire COBRA premium for health insurance from April 1, 2021, through September 30, 2021.
- For 2021, if a taxpayer receives unemployment compensation, the taxpayer is treated as an applicable taxpayer for purposes of the premium tax credit, and the household income of the taxpayer is favorably treated for purposes of determining the amount of the credit.
- Persons who bought their own health insurance through a government exchange may qualify for a lower cost through December 31, 2022.
Student loan tax relief
For student loans forgiven or cancelled between January 1, 2021, and December 31, 2025, discharged amounts are not included in taxable income.
Child tax credit
- For 2021, the credit amount increases from $2,000 to $3,000 per qualifying child ($3,600 for qualifying children under age 6), subject to phaseout based on modified adjusted gross income. The legislation also makes 17-year-olds eligible as qualifying children in 2021.
- For most individuals, the credit is fully refundable for 2021 if it exceeds tax liability.
- The Treasury Department is expected to send out periodic advance payments (to be worked out by the Treasury) for up to one-half of the credit during 2021.
Child and dependent care tax credit
- For 2021, the legislation increases the maximum credit up to $4,000 for one qualifying individual and up to $8,000 for two or more (based on an increased applicable percentage of 50% of costs paid and increased dollar limits).
- Most taxpayers will not have the applicable percentage reduced (can be reduced from 50% to 20% if AGI exceeds a substantially increased $125,000) in 2021. However, the applicable percentage can now also be reduced from 20% down to 0% if the taxpayer’s AGI exceeds $400,000 in 2021.
- For most individuals, the credit is fully refundable for 2021 if it exceeds tax liability.
Earned income tax credit
For 2021 only:
- The legislation generally increases the credit available for individuals with no qualifying children (bringing it closer to the amounts for individuals with one, two, or three or more children which were already much higher).
- For individuals with no qualifying children, the minimum age at which the credit can be claimed is generally lowered from 25 to 19 (24 for certain full-time students) and the maximum age limit of 64 is eliminated (there are no similar age limits for individuals with qualifying children).
- To determine the credit amount, taxpayers can elect to use their 2019 earned income if it is more than their 2021 earned income.
For 2021 and later years:
- Taxpayers otherwise eligible for the credit except that their children do not have Social Security numbers (and were previously prohibited from claiming any credit) can now claim the credit for individuals with no qualifying children.
- The credit is now available to certain separated spouses who do not file a joint tax return.
- The level of investment income at which a taxpayer is disqualified from claiming the credit is increased from $3,650 (as previously indexed for 2021) to $10,000 in 2021 (indexed for inflation in future years).
Pandemic Relief Measures and Your Tax Return
Two emergency relief bills passed in 2020 in response to the COVID-19 pandemic will make this an unusual tax season for many taxpayers. The Coronavirus Aid, Relief, and Economic Security (CARES) Act was passed in March, and a second relief package was attached to the Consolidated Appropriations Act, 2021, in December.
The federal government relied on the tax system to deliver financial lifelines to struggling households, boost consumer spending, and help speed the economic recovery.
The following provisions may affect many households when they file their personal tax returns for 2020. You might consult a tax professional who can further explain the relevant changes and recommend strategies to help reduce your tax liability for 2021.
Recovery Rebate Credit
Most U.S. households received two Economic Impact Payments (EIPs) from the federal government in 2020. They are not taxable because technically they are advances on a refundable credit against 2020 income taxes.
The CARES Act provided a Recovery Rebate Credit of $1,200 ($2,400 for married joint filers) plus $500 for each qualifying child under age 17. The second bill provided another $600 per eligible family member.
Any individual who has a Social Security number and is not a dependent generally qualifies for the payments, up to certain income limits. The amounts are reduced for those with adjusted gross incomes (AGIs) exceeding $75,000 ($150,000 for joint filers and $112,500 for heads of household) and phase out completely at AGIs of $99,000 ($198,000 for joint filers and $112,500 for heads of household).
In order for the money to be delivered quickly, eligibility was based on 2019 income tax returns (or 2018 if a 2019 return had not been filed). Eligible taxpayers who did not receive two full payments, possibly due to errors or processing delays, may claim the money as a Recovery Rebate Credit on their 2020 tax return. Households that reported a lower AGI in 2020 (or added a dependent) might be eligible for additional funds. To calculate the credit, filers will need to know the amounts of any payments they already received. The credit amount will increase the refund or decrease the tax owed, dollar for dollar.
Taxpayers who received two full payments don’t need to fill out any additional information on their tax returns. The IRS began accepting 2020 tax returns on February 12, 2021; filing electronically usually results in a faster refund.
Coronavirus-related distributions
Another measure in the CARES Act allowed IRA owners and employer-plan participants who were adversely affected by COVID-19 to withdraw up to $100,000 of their vested account balance in 2020 without having to pay the 10% tax penalty (25% for SIMPLE IRAs) that normally applies prior to age 59½.
Still, withdrawals from tax-deferred retirement accounts are typically taxed as ordinary income in the year of the distribution. To help manage the tax liability, qualified individuals can choose to spread the income from a coronavirus-related distribution (CRD) equally over three years or report it in full for the 2020 tax year, with up to three years to reinvest the money in an eligible employer plan or an IRA.
Taxpayers who elect to report income over three years and then recontribute amounts greater than the amount reported in a given year may “carry forward” the excess contributions to next year’s tax return. Taxpayers who recontribute amounts after paying taxes on reported CRD income can file amended returns to recoup the payments.
Qualified individuals whose plans did not adopt CRD provisions may choose to categorize other types of distributions — including those normally considered required minimum distributions — as CRDs on their tax returns (up to the $100,000 limit).
Other notable changes
The special rules for charitable gift deductions enacted for 2020 have been extended through 2021. For those who itemize deductions, the limit on the charitable gift deduction increased to 100% of AGI for direct cash gifts to public charities. For nonitemizers, a new $300 charitable deduction for 2020 and 2021 direct cash gifts to public charities is available. For joint filers, this deduction increases to $600 for 2021 cash gifts to charitable organizations.
The floor for deducting medical expenses has been permanently lowered to 7.5% of AGI. (It was scheduled to increase to 10% in 2021.) And starting in 2021, there is no deduction for qualified tuition and related expenses. Instead, the modified adjusted gross income (MAGI) phaseout range for the Lifetime Learning credit was increased to be the same as the phaseout range for the American Opportunity credit ($80,000 to $90,000 for single filers; $160,000 to 180,000 for joint filers).
A temporary provision that allows taxpayers to exclude discharged debt for a qualified principal residence from gross income was extended through 2025, though the limit has been reduced from $2 million to $750,000. Also, through 2025, employers can pay up to $5,250 annually toward employees’ student loans as a tax-free employee benefit.
Yes, unemployment aid is taxable!
The number of unemployed workers spiked above 22 million in March 2020, and more than 9 million people were still out of work at the end of the year.1 Both relief bills expanded unemployment benefits and provided them to many workers who normally are not eligible (including the self-employed, independent contractors, and part-time workers).
Unemployment benefits, which sustained many families impacted by the pandemic, are considered taxable income, and many recipients may not have correctly withheld taxes from their 2020 payments. Avoiding a surprise tax bill typically requires opting into a 10% withholding rate and, in some cases, paying additional quarterly taxes during the year.
Last year was unpredictable, and your financial situation may have been far from normal. You should file your 2020 tax return by the April 15 deadline, even if you are worried that it’s going to show a balance due. Being up-to-date on filing is generally required to pursue a payment agreement with the IRS. If you owe $50,000 or less, you may even be able to apply online for a short-term extension (up to 120 days) or a longer payment agreement. Paying as much as you can afford can help limit penalties and interest that accrue on unpaid amounts.
1) U.S. Bureau of Labor Statistics, 2021
2020 Year-End Tax Tips
Here are some things to consider as you weigh potential tax moves between now and the end of the year.
1. Defer income to next year
Consider opportunities to defer income to 2021, particularly if you think you may be in a lower tax bracket then. For example, you may be able to defer a year-end bonus or delay the collection of business debts, rents, and payments for services. Doing so may enable you to postpone payment of tax on the income until next year.
If your expected 2020 income to be lower than 2021 income, you should consider accelerating income before year-end. See 6. Below relating to the waiver of 2020 required minimum distributions. Depending on individual circumstances, a Roth Conversion may be appropriate in 2020. There are many considerations and unknowns to be considered in evaluating if a Roth Conversion applies to your situation.
2. Accelerate deductions
You might also look for opportunities to accelerate deductions into the current tax year. If you itemize deductions, making payments for deductible expenses such as medical expenses, qualifying interest, and state taxes before the end of the year (instead of paying them in early 2021) could make a difference on your 2020 return.
3. Make deductible charitable contributions
If you itemize deductions on your federal income tax return, you can generally deduct charitable contributions, but the deduction is limited to 60%, 30%, or 20% of your adjusted gross income (AGI), depending on the type of property you give and the type of organization to which you contribute. (Excess amounts can be carried over for up to five years.)
For 2020 charitable gifts, the normal rules have been enhanced: The limit is increased to 100% of AGI for direct cash gifts to public charities. And even if you don’t itemize deductions, you can receive a $300 charitable deduction for direct cash gifts to public charities (in addition to the standard deduction).
Qualified Charitable Distributions (QCD) may be beneficial if you have an Individual Retirement Account (IRA) and are 70½ or older. QCD are limited to $100,000 and must be paid directly from pre-tax funds in an IRA to the charity. A QCD is not taxable.
4. Bump up withholding to cover a tax shortfall
If it looks as though you will owe federal income tax for the year, consider increasing your withholding on Form W-4 for the remainder of the year to cover the shortfall. There may not be much time for employees to request a Form W-4 change and for their employers to implement it in time for 2020. The biggest advantage in doing so is that withholding is considered as having been paid evenly throughout the year instead of when the dollars are taken from your paycheck. This strategy can be used to make up for low or missing quarterly estimated tax payments.
5. Maximize retirement savings
Deductible contributions to a traditional IRA and pre-tax contributions to an employer-sponsored retirement plan such as a 401(k) can reduce your 2020 taxable income. If you haven’t already contributed up to the maximum amount allowed, consider doing so. For 2020, you can contribute up to $19,500 to a 401(k) plan ($26,000 if you’re age 50 or older) and up to $6,000 to traditional and Roth IRAs combined ($7,000 if you’re age 50 or older). * The window to make 2020 contributions to an employer plan generally closes at the end of the year, while you have until April 15, 2021, to make 2020 IRA contributions.
*Roth contributions are not deductible, but Roth qualified distributions are not taxable.
6. Avoid RMDs in 2020
Normally, once you reach age 70½ (age 72 if you reach age 70½ after 2019), you generally must start taking required minimum distributions (RMDs) from traditional IRAs and employer-sponsored retirement plans. Beneficiaries of retirement plans are also generally required to take distributions after the death of the IRA owner or plan participant. However, recent legislation waived RMDs from IRAs and most employer retirement plans for 2020 and you don’t have to take such distributions.
If you have already taken a distribution for 2020 that is not required, you may be able to roll it over to an eligible retirement plan. The IRS provided a safe-harbor date (August 31, 2020) to roll over a distribution that was not required because RMDs were suspended for 2020 and that date has passed.
There are other provisions that could allow for a rollover. For example, amounts that are distributed can generally be rolled over if the rollover is completed within 60 days. Only one rollover is permitted in a 12-month period regardless of the number of IRAs you have. So, for example, if an amount is distributed on November 1, 2020, it may be possible to roll it over during 2020. Also, for someone who takes a coronavirus-related distribution in 2020, it may be possible to roll it over to an eligible retirement plan within three years of the day after the distribution was received.
7. Weigh year-end investment moves
You shouldn’t let tax considerations drive your investment decisions. However, it’s worth considering the tax implications of any year-end investment moves that you make. For example, if you have realized net capital gains from selling securities at a profit, you might avoid being taxed on some or all those gains by selling losing positions. Any losses over and above the amount of your gains can be used to offset up to $3,000 of ordinary income ($1,500 if your filing status is married filing separately) or carried forward to reduce your taxes in future years.
Check with tour custodian or broker for cutoff dates to complete transactions by year-end.
The foregoing is provided for information purposes only. It is not intended or designed to provide legal, accounting, tax, investment, or other professional advice. Such advice requires consideration of individual circumstances. Individuals have different situations and preferences. Before any action is taken based upon this information, it is essential that competent individual professional advice be obtained. JAS Financial Services, LLC is not responsible for any modifications made to this material, or for the accuracy of information provided by other sources.
