The 8 Most Important Questions Federal Employees Need to Ask Before Preparing Their 2021 Federal Tax Returns
Edward A. Zurndorfer
As federal employees organize their 2021 tax documents and tax-related information in order to prepare their 2021 federal income tax returns, there are a number of tax-related questions they need to be asking themselves. These questions have been generated mainly as a result of some major tax law changes and COVID-related economic events that occurred during 2021. If employees are using a professional tax preparer to get their 2021 federal tax returns prepared, then they are advised to bring up these questions with their preparers. These eight questions are presented in this column.
Question 1. Advanced Child Tax Credit (ACTC).
This expanded tax credit (expanded and enhanced from prior years) was legislated as part of the American Rescue Plan Act of 2021. These tax credits were paid to qualifying parents in the form of monthly direct bank payments from July through December. The monthly payments are intended as prepayments of 50 percent of the additional child tax credit which will appear on the 2021 federal income tax return. The IRS will be mailing Letter 6419 to all recipients of the ACTC during January or February 2022 notifying ACTC recipients of the amount of ACTC they received during the last 6 months of 2021. This amount appearing on Letter 6419 must be included on line 15e of Schedule 8812 (Credits for Qualifying Children and Other Dependents) which is to be included as part of their 2021 federal income tax return?.
The question for employees who received direct bank deposits of the ACTC during the period July through December 2021: Have they received Letter 6419? If they have not received the letter, can they instead check their bank statements for the period July 1 through December 31, 2021, in order to verify deposits of monthly ACTC checks and their amounts?
Question 2. Cryptocurrency.
Cryptocurrencies are taxed as ordinary property. Purchasing cryptocurrencies is not in itself is not a taxable event. But here are some possible taxable events associated with cryptocurrency: (1) Trading cryptocurrency with resulting capital gains or losses; (2) gifting cryptocurrency, treated as any other gift; (3) receiving cryptocurrency as payment for services or products, treated as such;(4) “forks” with cryptocurrency provided to owner, treated as other income. The question is: Was an individual or any family member including children involved in cryptocurrency during 2021? With respect to dependent children, a Coinbase survey found that 18 percent of college students were involved in cryptocurrency during 2021 and many parents were not aware of it. There is a question prominently placed near the top of IRS Form 1040 asking the individual filer whether there was any cryptocurrency involvement during 2021 among the filer and family members. The question must be answered by the filer.
Question 3. Economic Impact Payment – Recovery Rebate Credit.
While the second economic impact payment (EIP) (paid to qualifying individuals in January 2021) was included on the 2020 federal income tax return, the third EIP (generally paid in March and early April 2021) will be included on the 2021 federal income tax return. As happened on the 2020 federal income tax returns, line 30 of Form 1040 allows individuals to claim any unpaid or underpaid EIP through the Recovery Rebate Credit (RRC). The IRS is treating errors in reporting EIP as “math errors”. Errors on this line could substantially slow the refund process. During January 2022, the IRS is sending Letter 6475 notifying recipients of the third EIP. This letter will make it easier to compute and verify the RRC when they prepare their 2021 return. The question for individuals: Did they receive IRS Letter 6475 and if so, can they verify the accuracy of the third EIP by checking their bank records to see if a direct deposit of the payment was made in March or early April 2021, or perhaps sometime later in 2021?
Question 4. Refinancing of Mortgages.
As a result of low-interest rates, the years 2020 and 2021 were busy years for individuals to refinance home mortgages. The Tax Cuts and Jobs Act (TCJA) somewhat changed rules regarding deducting mortgage interest. Only the interest on paid borrowed money used for acquisition and to make capital improvements of the home can be deducted. Before the passage of TCJA, individuals could deduct the interest on an additional $100,000 borrowed against the home.
Unfortunately, when some individuals refinance, they “cash out”, taking out (borrowing) additional money to cover the closing costs or extra to buy a car or pay for a semester of college. If the purpose of the extra amount borrowed is for capital improvements, then the interest on the additional amount borrowed is deductible as mortgage on their principal residence. It is important to know the difference between how much they used to pay off the old mortgage and how much was borrowed for the new mortgage. The interest paid on the excess funds borrowed, the difference between the new mortgage and the amount left on the old mortgage, is not deductible if the excess funds are used to pay for anything other than home improvements. The question for individuals regarding the mortgage interest deductions: Did they refinance their principal residence mortgage during 2021? If so, do they have a record of the payoff amount of the old mortgage, the amount of the new mortgage, and how any excess borrowed funds are being spent?
Question 5. Charitable donations.
For 2020 federal income tax returns, Congress allowed individuals who do not itemize an “above the line” (adjustment to income) deduction of up to $300 per tax return. The $300 deduction applied to both single and married filing joint tax returns for cash/check charitable contributions. For 2021 federal income tax returns, the $300 is a “below the line” (deduction from taxable income) and up to $300 per filer; that is, $300 for a single/head of household filers and $600 for a married couple filing jointly.
There is an increased penalty for errors made in this deduction. The charitable contribution must be made in cash, check, or credit card to a qualifying charitable organization. As with all donation deductions, receipts for amounts of $250 or more are required. Receipts, canceled checks, or credit card statements should be available for donations under $250 in case of an IRS audit. Questions for individuals: Do they intend to take the standard deduction on their 2021 federal income tax return and if so, did they make during 2021 cash or credit card charitable contributions of $300 or more? Do they have receipts, canceled checks, or credit card statements in order to verify their donations?
Question 6. The Coronavirus Aid, Relief and Economic Security (CARES) Act.
The CARES Act allowed individuals to take distributions of their qualified retirement funds (including the Thrift Savings Plan) of up to $100,000 and subject to federal and state income taxes on the amount withdrawn. Individuals who made these withdrawals had the option of paying the income tax due on these withdrawals over three years or complete their payback within three years. Paying back the funds within three years allows individuals to amend their 2020 federal tax return. The question for some federal employees who withdraw funds from their TSP accounts during 2020 and intended to pay back the withdrawn funds: Have they completed their and if so, will they amend their 2020 federal and state tax returns?
Question 7. Unemployment benefits.
The COVID pandemic resulted in some dependents of federal employees (mostly college students and high school students) receiving unemployment benefits. The questions for employees who are parents of college students or high school students: Did their children receive any unemployment benefits during 2021? If so, then a federal (and perhaps state) income tax return may have to be filed for 2021.
Question 8. Hobby income.
Many individuals picked up hobbies or side jobs during the COVID-19 pandemic. While these individuals may consider these jobs to be “inconsequential”, the income from these hobbies or side jobs has to be reported as “other income”. Question for employees: Have they accounted for all of their (and their family’s) income received during 2021?
Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street – Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.