Taxpayers got good news last month when the Internal Revenue Service announced that the deadline for filing their 2020 returns would be pushed back a month, to May 17. While estimated taxes are still due on April 15, the later filing deadline gives taxpayers more time to adjust to the disruptions of the pandemic–as well as consider the impact of changes in the tax laws. What should they be thinking about? For some tax tips, From Day One consulted with Moses Balian, HR Consulting Manager for Justworks, the payroll and benefits platform. His suggestions:
What’s the situation with unemployment benefits, based on the $1.9 trillion pandemic-relief legislation?
The first big chunk of unemployment benefits, $10,200, will be excluded from taxation by the federal government. So a lot of money that folks might have been budgeting for their tax bill will be relieved, which is fantastic. This could apply to plenty of employees who were unemployed for parts of 2020 and later went back to the same employer when they were rehired.
Millions of people who worked from home might be thinking for the first time about taking the deduction for home-office expenses. What should they know?
The home-office deduction is probably the No. 1 most misused tax deduction by individuals–and has the least impact on your overall tax burden for how much trouble it can cause. My general guidance would be not to attempt to take the home office deduction for people who have remained in an employment relationship. If you got laid off and started your own business and started doing freelance work, then by all means, you could write that off on your Schedule C. But for those who remain in a traditional employment relationship, the deduction might not be appropriate and you probably won't have enough deductions across the board to file an itemized return anyway. Unless you’ve been directed by your tax advisor to take the deduction, in the event of an audit, you might be unhappy that you tried to take it.
OK, that one’s tricky, but what are some key deductions that individuals might miss or shrug off?
A big one is the special charitable deduction. There's an above-the-line, $300 tax deduction that applies at the federal and state level for donations to qualifying charities, even for taxpayers who don’t itemize their deductions and are taking the standard deduction. There's an exhaustive list of tax-exempt organizations on IRS.gov if they want to look. This applies to cash donations made before the end of 2020.
What other ones should they keep in mind?
There's the perennial option for lowering your tax burden: contributions to a traditional IRA. If your income is low enough, you can qualify for a deductible IRA contribution. That’s always worth consideration. The irony is that folks might not have as much extra money in their bank accounts to save for retirement after the difficult year that they experienced. But if at all possible, any contributions that you can make to your 2020 deductible IRA will lower your tax burden.
Looking ahead to taxes for 2021, what can people think about doing now?
One consideration is the Flexible Spending Account (FSA) for health-care costs, if your employer provides access to one. In some cases, existing balances in FSAs from 2020 can be rolled over into the next year. So you might have some money in your FSA this year that you didn't know was there, that maybe you forgot about. As for open enrollment in 2021, FSAs would normally have been closed already. But the IRS changed that rule because of the pandemic. Workers can make midyear changes in their FSAs, as long as their employer allows it. So if you're looking ahead and your budget allows you to increase your contributions up to the maximum of $2,750 for an individual, that's extra special because, unlike a 401(k) or IRA, the FSA is not subject to taxes for Social Security and Medicare. So that is really a tremendous above-the-line savings if you can swing it. If you don’t think you’ll spend your whole balance on regular check-ups, FSAs can also be used to cover the costs of talk or text therapy, a range of over-the-counter products that can be purchased at a pharmacy or online, and elective eyeware like contact lenses or a new pair of glasses.
Let’s talk about tax prep. What should you consider when choosing an accountant or tax firm?
I’d say look for value. In my experience, a lot of the independent offices will be more affordable than the higher-tier individualized services that an H&R Block offers. I've had great experiences with independent shops. If you have only W-2 income, you can file yourself and use a self-service, online version of TurboTax or H&R Block, and you'll be in good shape. But a lot of people might have sold investments in 2020, and some services will upcharge you $50 or more for your federal and state return if you have a Form 1099-B, for example. Or if you have rental income. If you have sources of nonwage income or do freelance work, I'd say look for an independent, small shop.
In the new era of remote work, it is worth moving to a lower-tax state?
If you have a remote-work arrangement that's been extended indefinitely, you should consider moving to an income-tax-free state like Washington, Tennessee and Florida, or even some of the more rural ones, like Wyoming and South Dakota. If you have the freedom of movement, and your employer will support a remote-work arrangement in the state you hope to move to, you can get upwards of a 10% raise just for relocating across state lines.
If you’re an employee who gets hired by a company that uses a Professional Employer Organization (PEO) like Justworks, how will your conversation with your accountant be different this year, especially if you make the switch midyear?
From a tax-filing perspective, it shouldn’t be different from any other time you’ve changed employers midyear. You’ll still get two W-2s: one from your prior employer, and one from your new employer. The difference is, the W-2 from your new employer will give the name of the PEO as the employer of record as well as the PEO’s EIN. This has to do with the co-employment relationship between PEOs and their customers. Rest assured, it doesn’t change how you, as an employee, are taxed in any way. Just don’t wait to file your taxes because you’re still waiting for your employer to send you your W-2! If they use a PEO, it’ll come from the PEO. (Fun fact: Employees who move from one employer to another that both use the same PEO will only get one W-2!)
Let’s talk about benefits for a moment. What are some corporate benefits that people should consider taking advantage of, especially now?
The first is short-term disability insurance (STD). A lot of employers provide employer-paid coverage, but if they don’t, they usually will offer the opportunity for employees to enroll. It's not free, but it is not expensive–usually anywhere between $20 and $40 a month. But it's just such an incredible safety net. (A few states do have statutory disability coverage, like in California, that’s on par with most private policies. But for most American workers, STD is well worth it!) As Covid reminds us, you can be a perfectly healthy individual and you just don't know when you might be afflicted by something you never could have anticipated. So having a short-term disability insurance in the event you're unable to work due to illness or injury is really crucial, especially for anyone who has a family.
Another one is the Health Savings Account (HSA), which is very similar to an FSA in that contributions are exempt from income tax as well as Social Security and Medicare. However, the HSA is only compatible with a High Deductible Health Plan (HDHP), so employees usually look at them and say, ‘Oh my god, a $5,000 deductible. No way!’” And they don't give it a second thought, but what they often don't realize is that these plans are very special, because they are the only ones that can be paired with an HSA, which have very high contribution limits–almost $4,000 for individuals. And when the deductible is higher, the premiums are typically going to be much, much lower. When you take advantage of an HDHP, the money you would have been spending on premiums for a lower-deductible plan can be contributed to your HSA and invested like a retirement account. Investment gains are tax-free, as long as the funds are used on qualifying medical expenses. And HSA balances roll over indefinitely. Don’t worry about accruing too high of a balance, because funds can be withdrawn penalty-free for any reason once you turn 65.
Any other kinds of insurance to keep in mind?
Life insurance isn’t fun to talk about, but it’s one of the surest investments you can make in your family’s financial security. If you're young, basic coverage will be a negligible expense. For young parents, especially, it’s a no-brainer. Premiums tend to increase with age, but so might the importance of the cash benefit being available to your family in the event of your untimely passing. We've all probably thought a lot more about death in 2020 than we were used to. To effectively navigate some of these more emotionally triggering ideas, it helps to think pragmatically. We’ve seen how a health crisis can sweep the country. You can be healthy and careful, but that doesn't necessarily protect you. Life insurance is as good of an idea in 2021 as it was in 2019, but maybe people now can be more receptive to just how wise an investment it might be.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, legal or tax advice. If you have any legal or tax questions regarding this content or related issues, then you should consult with your professional legal or tax advisor.