For most clients who needed more time to prepare their 2020 individual income tax return, a Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, should have been filed by May 17, 2021. Due to the tough times many people were experiencing, the IRS postponed the 2020 individual tax year due date from April 15, 2021, to May 17, 2021. The extension allows individuals additional time to file a tax return. It does not, however, grant them an extension of time to pay taxes for the 2020 tax year. To avoid possible penalties, an estimate of taxes owed should have been paid by the extended deadline. Special rules apply for those:
- Serving in a combat zone or a qualified hazardous duty area
- Living outside the United States
Many clients still need to file their individual returns. Some individuals may be slow in giving their tax preparer their information for several reasons. Fear of owing tax may be one of them. Due to the unique nature of the past year, we thought it would be helpful to remind practitioners of some of the atypical items you might encounter with the 2020 extended returns.
Due to COVID, many clients may have received a coronavirus-related distribution and could be thinking they will have a big tax bill as a result. Coronavirus-related distributions, up to $100,000, from eligible retirement plans receive favorable tax treatment.
Tax professionals can share the good news with these clients by telling them that qualified distributions are taken into the taxpayer’s gross income ratably over three years, beginning with the year the distribution is received. Unless the taxpayer elects out of the three-year spread or rolls the money back into an account tax-free, the three-year averaging rule applies automatically.
Also, qualified distributions are exempt from the §72(t) premature tax. Qualified distributions may be recontributed to eligible retirement plans or IRAs, tax –free, any time during the three-year period beginning on the day after the date of the distribution.
Planning opportunities may exist for professionals with clients regarding these distributions. For some, it may make sense to report the distribution in 2020; for others it may make sense to spread over three years. Also, don’t forget about those who may have the money to recontribute as their financial situation has improved.
Up to $10,200 of unemployment compensation may be excludable from income for 2020. If a couple is filing a joint return, each spouse is entitled to a separate $10,200 exclusion. The taxpayer’s modified gross income (modified AGI, also MAGI) must be less than $150,000 to qualify. MAGI is determined after the application of:
- Social Security income limitations
- Exclusion of U.S. savings bond interest used to pay higher education tuition and fees
- Exclusion for adoption assistance programs
- IRA deductions
- Student loan interest deductions
- Tuition and fees deductions
- Passive loss limitations
It should be noted, MAGI is also determined without regard to unemployment compensation.
This exclusion is reported separately from the total unemployment compensation received. Schedule 1 (Form 1040), Line 7, is used to report the total unemployment compensation. Schedule 1 (Form 1040), Line 8, is used to report the exclusion. The IRS has a worksheet to calculate the taxpayer’s modified AGI and exclusion amount, however most software will also have the worksheet.
Because the modified AGI limitation is per return, not individual, in some cases it may make sense for a married couple to file separately instead of jointly.
Repaying excess advance payments of the premium tax credit (excess APTC)
For 2020, any excess APTC is not required to be repaid. There is no requirement to report excess APTC on the 2020 return or file Form 8962, Premium Tax Credit. If a taxpayer is claiming a net premium tax credit (PTC) for 2020, Form 8962 is required. If the taxpayer’s PTC computed on the return is more than the APTC paid on the taxpayer’s behalf during the year, the difference is a net PTC.
Claiming a net PTC will increase the taxpayer’s refund or lower the amount of tax they owe. Net PTC is reported on Schedule 3 (Form 1040), Line 8. Taxpayers claiming a net PTC must file Form 8962 and report an amount on Line 26 of the form when filing their 2020 tax return.
Principal residence debt
Taxpayers can now exclude the discharge of indebtedness on principal residence debt from taxable income through Dec. 31, 2025. The forgiven debt is retroactive to the beginning of 2018. For discharges of indebtedness after Dec. 31, 2020, the maximum amount that may be excluded is $750,000 ($375,000 MFS). Previously up to $2 million of qualified principal residence debt could be excluded.
Amended returns may be needed for some to take advantage of this exclusion – especially those whose 2018 tax return included forgiven mortgage debt – as existing law protected discharges prior to Jan. 1, 2018. For most individuals, April 15, 2022, is the deadline to file a 2018 return, so these returns should be filed as soon as possible.
This past year has been trying for some Schedule C businesses, while other businesses have thrived. According to the U.S. Chamber of Commerce, “businesses that help people socially distance themselves from others, retailers that enable people to eat and drink at home and health care services are primary examples of businesses creatively learning to adopt to coronavirus.”
An issue one may see in practice is regarding the PPP loans. Taxpayers whose PPP loans are forgiven may still deduct the otherwise allowable deductible expenses paid with the PPP loan proceeds, and for federal purposes, will not be required to include in gross income the PPP loan forgiveness amount.
The pandemic has created issues with many rental properties. Clients may have been advertising their rentals for rent but have had no luck renting them. If a taxpayer held property for rental purposes, they may be able to deduct their ordinary and necessary expenses for managing, conserving, or maintaining the property while the property is vacant. No deduction is available for the loss of rental income.
The IRS announced that victims of Hurricane Ida have until Jan. 3, 2022, to file various individual and business tax returns and make tax payments. This means taxpayers who have extensions to file their 2020 tax returns by Oct. 15, 2021, now will have until Jan. 3, 2022, to file their tax returns.
Keep in mind any payments of tax were still due May 17, 2021, so any tax due is not covered by this postponement.
There is no need for taxpayers to contact the IRS to get this relief. The IRS automatically uses a taxpayer address of record to identify affected taxpayers. If a taxpayer in a relief area gets a notice for late filing, the taxpayer should contact the IRS about penalty abatement. Also, taxpayers who live outside of the federal disaster area should call the IRS at 866-562-5227 to request relief.