Unemployment Recipients May Want To Wait To File Their 2020 Tax Returns

Congress just put another twist in the never-ending saga that is the 2021 filing season. Democrats are considering a deal to reduce the federal supplemental unemployment benefits in the next Covid relief bill from $400 to $300 per week in return for a slightly longer benefit period (benefits will end in October rather than August) and, of more immediate significance, making the first $10,200 in 2020 unemployment benefits tax free at the federal level. That high-pitched sound you are hearing is the collective screaming of thousands of tax professionals.

Tax professionals have been watching and worrying over this issue coming to pass ever since Senator Dick Durbin (D-Illinois) and Representative Cindy Axne (D-Iowa) introduced a bill to make the first $10,200 in unemployment exempt from federal income tax. Many tax professionals decided to recommend that clients wait to file their 2020 tax returns while Congress decided whether or when to take up their bill. When the provision did not get included in the House version of the current Covid relief package, many decided that if unemployment benefits did eventually end up being excluded it would be 2021 benefits, thus kicking the tax reporting can into the 2022 filing season. Many tax professionals decided that the costs of waiting outweighed the benefits for their offices and their clients and went ahead and filed returns as usual.

For other tax professionals holding returns was not an option due to in office return volume or because their clients needed their refund money and could not afford to wait. Helen O’Planick, an enrolled agent who owns HELJAN Associates in Manchester, PA, has already seen more than 200 clients who have received unemployment benefits. All but two of those clients were expecting refunds. It was simply not feasible for her to delay processing of hundreds of returns on a maybe. Other tax professionals, many of whom are seasonal and are not quite so plugged into pending legislation, may not have even been aware of the possibility that some unemployment benefits could potentially be non taxable and just proceeded as usual with their 2021 filing season.

Unfortunately, legislation that was a maybe when this shortened filing season opened on February 12 is now looking like a reality. Taxpayers who received unemployment benefits during the year should wait to file until the current bill becomes law. At a 10% marginal tax rate the savings will be a little over $1,000 in tax. Taxpayers who are unwilling to wait should recognize that they may have to correct their return to take advantage of the new law. Taxpayers should also remember that most paid professionals do not file amended returns for free and it is unlikely that many will be willing to prepare an amended return until after the 2021 filing season ends (assuming it ever does end, the jury is still out on when the 2020 filing season “ended”). If your tax professional is asking or recommending that you wait, do yourself and your taxpro a favor and wait. One excellent reason not to wait to file is if your 2020 income is low enough to qualify you for the next round of stimulus payments when your 2019 income was not. Get that return filed now! Especially if there is more than one person in your household who is eligible for the stimulus money.

What if your return has already been filed? The most obvious answer is that you may have to file an amended return either on paper or electronically using Form 1040-X. It’s an answer that begs the question of how can the IRS, which is currently in the middle of the 2021 filing season and still has a large backlog of unprocessed 2019 tax returns, process potentially hundreds of thousands or maybe over a million amended 2020 returns. Electronic submission does not guarantee electronic processing. For example, even though authorization forms such as Forms 2848 and 8821 (which allow tax practitioners to access client information) can now be submitted electronically, for processing they go into a first-in, first-out pile of the same types of forms that have been submitted by mail or by fax. If that is what happens with electronically submitted amended returns, the processing delays will be staggering.

It is possible that (after filing season ends) the IRS could use the algorithms it uses to detect math errors on returns to solve this problem more automatically. It could, for example, find a way to identify returns with information in Forms 1099-G, Box 1 and automatically reverse up to $10,200 of income, make the adjustments, and issue a notice and a refund to affected taxpayers. It’s possible. I don’t know if it’s likely.

Also unlikely is the possibility that the IRS could make this programming change and push the changes out to tax software providers in the middle of an already challenging filing season. The possibility of a mid-season programming change is even more unlikely, given IRS Commissioner Rettig’s continued assertions that the April 15 filing deadline will not be extended. By the time this bill is finally signed into law there will only be four or five weeks left in the current filing season. No matter what happens, this tax season is already one bumpy ride. Be as patient as possible and wait to file if you can.