February 2022
Six New Tax Return Items
Key changes on 2021 returns
There are usually some new twists and turns to the current tax return rules for individuals, but this year is especially tricky due to recent legislation. Following are six potential items to watch out for on 2021 returns.
1. Charitable donations: Normally, you can deduct monetary contributions made to qualified charitable organizations only if you itemize on your return. However, under rules that went into effect in 2018, more taxpayers are claiming the standard deduction instead of itemizing.
Initially, Congress approved a maximum deduction of up to $300 for monetary contributions made by non-itemizing filers in 2020. The maximum is doubled to $600 for joint filers in 2021.
2. Child Tax Credit: For many taxpayers, the Child Tax Credit (CTC) is “bigger and better” on their 2021 returns. Under the latest legislation, the credit amount is increased from $2,000 per qualified child to $3,000 ($3,600 for children under age six), although the phase-out levels are adjusted downward, and the credit is made fully refundable. Also, parents may have benefitted from advance CTC payments in 2021. These payments are not considered taxable income.
The IRS is mailing Letter 6419 to taxpayers who received advance CTC payments. It shows the amount that should be reflected on your 2021 return.
3. Economic Impact Payments: The government handed out a third round of Economic Impact Payments (EIPs) in 2021. The maximum payment was $1,400 for each qualified individual—$2,800 for a married couple—plus another $1,400 for a qualified dependent. But EIPs may be phased out based on adjusted gross income (AGI).
If you did not receive the full EIP you were entitled to, you may claim a recovery rebate credit on your 2021 return.
4. Dependent care credit: Parents who pay costs of caring for children under age 13 while they work may be eligible for a dependent care credit. Legislation generally enhances the credit for 2021.
Significantly, the limit on qualified expenses is increased from $3,000 to $8,000 for one child; from $6,000 to $16,000 for two or more children. Also, the maximum credit percentage is increased from 35% to 50%, subject to certain phase-outs, and the credit is refundable for 2021.
5. Higher education credits: Generally, parents can claim either the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Credit (LLC) for qualified higher education expenses, subject to phase-outs based on modified adjusted gross income (MAGI). But the alternative tuition-and-fees deduction has been repealed and is not available on 2021 returns.
The maximum AOTC is $2,500 per student as opposed to the maximum LLC of $2,000 per filer. But the MAGI phase-out ranges, which previously favored the AOTC, have been equalized, beginning in 2021.
6. Required minimum distributions: After you reach age 72 (age 70½ before 2020), you must take annual required minimum distributions (RMDs) from traditional IRAs and qualified plans like 401(k)s. The amount depends on life expectancy tables and your account balance at the end of the prior year.
RMDs were suspended for 2020, but the rules were revived in 2021, so you must report RMDs on this year’s return.
Do not leave matters to chance. Obtain the guidance you need from your professional tax advisors
Four Options for 401(k) Payouts
Weigh the financial factors
Are you looking to change jobs? The current marketplace may offer some intriguing opportunities. If you are participating in a 401(k) plan at your current workplace, you will have to decide what to do with the vested funds in your account. Essentially, there are four basic options when you “separate from service.”
1. Take cash distributions. Of course, you are free to take the money out of your account in a lump-sum or through a series of payments. Just be aware of the potential tax implications for a sizeable withdrawal. Generally, the full amount of the distribution is taxable at ordinary income rates reaching as high as 37%. In addition, the distributions may result in other tax complications. One prime consideration is the 3.8% tax on “net investment income” (NII). Another is potential state income tax liability.
Note also that withdrawals made prior to age 59½ are subject to a 10% tax penalty, unless a special exception applies. If you arrange for a series of substantially equal periodic payments (SEPPs), you can avoid the 10% penalty, but the payouts are still taxable.
2. Leave the money where it is. Assuming the plan permits it, and many do, you can leave the funds in the account, even though you no longer work for the employer. The account may continue to grow on a tax-deferred basis until amounts are withdrawn. At that time, the distributions are taxed as ordinary income.
This may be appealing to you from an investment standpoint. For instance, if you have invested in target funds that have produced a steady return over time, you might want to stick with them.
3. Roll over to a new qualified plan. If you will be changing jobs and your employer provides a qualified retirement plan, such as a 401(k), you can roll over the funds into your new 401(k) account without any tax liability. The rollover must be completed within 60 days. If you do not meet the 60-day deadline, the transfer is treated as a taxable distribution, plus the 10% penalty tax may apply.
Usually, it makes sense to use a trustee-to-trustee transfer. In this case, the money never touches your hands. Otherwise, the rollover is subject to income tax withholding, even if you intend to meet the 60-day deadline.
4. Roll over to an IRA. Whether you are retiring or switching jobs, you have the option of rolling over the funds into a traditional IRA in your name. The basic rules are the same as they are for rollovers to another qualified plan. Thus, you must complete the rollover within 60 days to avoid tax liability and a trustee-to-trustee transfer may be preferred.
The rollover to an IRA generally provides an account holder with the greatest flexibility. You can choose the financial institution to be custodian and make your own investment choices.
Do not jump to any quick conclusions. Have your situation analyzed to determine the optimal approach.
The Tax ABCs of Scholarships
Answers to common questions
If your child will be attending college or graduate school next year, you probably do not have to be told about the sky high cost of higher education. You already know all about it from personal experience.
“At least my child has qualified for a scholarship to a prestigious university. That should take some of the sting out of the situation.”
For those students who are fortunate to receive such an award, this can definitely help defray the cost of attending school. However, some or all of the amount your child receives as a scholarship or a fellowship may be subject to federal income tax.
“I thought that scholarships and fellowships were completely tax free.”
Not exactly. This special tax exclusion is limited to amounts used by degree candidates for “qualified education expenses” at an educational institution that meets certain basic requirements (e.g., it has a regular faculty and student body).
“Exactly what sort of expenses are we talking about?”
The tax exclusion specifically covers (1) tuition and fees for enrollment and (2) fees, books, supplies and equipment that are required for study. However, the exclusion does not apply to amounts that are used for room and board.
“Can you show how the current rules work in an example?”
Suppose your daughter is awarded a $20,000 scholarship to attend the school of her choice. For simplicity, say that her tuition, books and supplies for the school year comes to $15,000, while room and board for the year is $10,000. Because your daughter can show that $15,000 is spent on qualified tuition and related expenses, only $5,000 of the scholarship is taxable.
“What if the scholarship is specifically earmarked for room and board?”
This designation controls for federal income tax purposes. For instance, if your daughter’s $20,000 scholarship specifically provides that $10,000 is to be used for room and board, then $10,000 is subject to tax. Keep this in mind when your child applies for scholarships.
“My son will be receiving a fellowship from his graduate school in return for providing teaching and research services. What are the tax ramifications?”
Any part of a grant that represents payment for past, future or present services is taxable. However, the special tax exclusion may apply to a qualified reduction in tuition received by an employee of the educational institution.
“Does the kiddie tax ever come into play?”
It might. With the kiddie tax, unearned income above an annual threshold received by a dependent child under age 19 or a full-time student under age 24 is taxed at the parents’ top tax rate. This includes certain taxable scholarships not treated as wages. The kiddie tax threshold for 2021 returns is $2,200 (going up to $2,300 in 2022).
Make sure you have a good understanding of the tax rules for scholarships and fellowships. You do not want to learn a tax lesson the hard way.
Watch Out for Grandparent Scams
Con artists target the elderly
Besides the pandemic and disruptions to the supply chain, there is another growing concern for families today: The proliferation of “grandparent scams” targeted at senior citizens. But being forewarned is being forearmed.
How it works: There are numerous variations on the theme, but the basic premise is as follows. An elderly person receives a frantic call from someone posing as their grandchild. This person, who is clearly emotional, claims to be in trouble while traveling in another country. For example, the caller may say that they are being arrested, were injured in an accident or that their car has been damaged.
Then the “grandchild” asks the grandparent to immediately send money—it might be a few thousand dollars—to post bail, pay emergency medical fees or lay out cash for repairs. And the caller will plead with the grandparent to keep the matter “a secret” from their parents.
In a version of this scam, a second caller pretends to be a law enforcement officer who instructs the grandparent to pay up. Alternatively, one of the scammers may impersonate a family friend or neighbor.
Finally, in the latest variation of these scams, the caller will play on a grandparent’s COVID-19 fears, creating an even greater sense of urgency.
Typically, the grandparent is asked to wire the money or to provide bank account routing numbers. Thus, the scam artists steal the funds or sensitive financial information—or both. The information may be used for other illegal means.
How do scammers find their victims? There is a treasure trove of free information available online and via social media sites like Facebook, LinkedIn and Instagram. As a result, scammers may find out when people are away from home or otherwise out of touch.
Also, some scammers make random calls until they reach a prime candidate. Unfortunately, a retiree might even fill in some of the blanks for the caller. For instance, if a caller says, “Hi Grandpa, it’s your oldest grandchild,” the retiree may respond with the grandchild’s name.
To avoid loss of money or sensitive information, grandparents and others should be reminded of the following steps recommended by the Federal Trade Commission (FTC).
• If you receive a call that sounds suspicious, the worst thing you can do is to help out the caller by referring to other confidential information, such as the names and addresses of family members.
• Resist the temptation to act immediately no matter how dramatic the caller’s plight appears to be.
• Verify the person’s identity by asking questions a stranger could not possibly answer.
• Call the grandchild’s phone number that you know to be legitimate.
• Check out the story within your trusted family or friends even if you have been told it is a secret.
• Do not wire money or send a check or money order or use an overnight delivery service or courier for this purpose.
What to do: The FTC advises consumers to report the incident at ftc.gov/complaint. Alternatively, you can call 877-FTC-HELP.
Feast on Business Meal Deductions
Take advantage of a unique tax break for small businesses on 2021 returns if you “dined in” or “dined out” this past year,
Generally, a business can deduct 50% of the cost of qualified business meals, including food and beverages invoiced separately from entertainment. However, under recent legislation you can deduct 100% of the cost of qualified expenses for food and beverages provided by restaurants. This applies to most eating and drinking establishments but not convenience or grocery stores.
Caveat: Do not get too used to this tax break. It only lasts for two tax years—2021 and 2022.
Facts and Figures
Timely points of particular interest
Tax Day Coming—The IRS has announced that “Tax Day” in 2022—the deadline for filing 2021 federal income tax returns—is Monday, April 18. The due date is extended from Friday, April 15 because of the Emancipation Day holiday in our nation’s capital. This also generally postpones to April 18 other tax deadlines scheduled for April 15. Note: For taxpayers residing in Maine and Massachusetts, Tax Day is Tuesday, April 19 due to the Patriots’ Day holiday in those states.
Outside Influence—-It often helps to take a new look at an old problem that has been troubling your company. A business may even bring in a manager from a different field that will have a fresh outlook on the situation. For example, you might hire an executive who turned around a manufacturing company to do the same for your retail outfit. But be careful: Consider all the implications for your industry before you make any drastic moves.