This pandemic tax filing season is ‘dumpster fire 2.0’

By: Emily Nolan | January 12, 2022

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By  Lynnley Browning January 11, 2022, 10:20 a.m. EST6 Min Read

Millions of mass affluent Americans face yet another turbulent tax season this year, as special payments sent out during the COVID pandemic scramble their federal returns — and potentially their refunds.

With Jan. 24 the first day to file a return for last year, according to a Treasury Department announcement on Jan. 10, financial advisors with moderately wealthy clients who have young children or student loans (or both) have a lot to handle. Two multibillion-dollar pandemic-related relief provisions over the last two years — the advance child tax credit and a pause on student loan payments — can cause a return filed this year to show a smaller-than-anticipated refund. Or a larger one.

The third pandemic filing season comes as the IRS is backlogged and understaffed.
The third pandemic filing season comes as the IRS is backlogged and understaffed.

Either way, the result can impact the dollars a client is budgeting to add to her retirement savings. Many Americans typically consider their refund — the average last year was more than $2,800, according to the IRS — a windfall, and most advisors urge them to shove it into their investment and retirement accounts, not spend it on discretionary stuff.

Dan Herron, an accountant, certified financial planner and the founder of Elemental Wealth Advisors, a fee-only advisory firm in San Luis Obispo, California, said that the current filing season “is going to be very similar to how it was last year. You could call it dumpster fire 2.0.”

Last year’s season was delayed to Feb. 12 amid pandemic-fueled staffing shortages at the IRS and tax law changes that the agency had to program into its systems. As of last December, the agency had around 6 million returns that it had still not processed; it’s not clear what the figure is now.

With the IRS now in its third filing season under the pandemic and expecting more than 160 million individual returns, IRS Commissioner Chuck Rettig warned of tangles in a statement on Jan. 10.

Advisors predict a 'disaster' filing season for many taxpayers.
Advisors predict a ‘disaster’ filing season for many taxpayers.

“Having an accurate tax return can avoid processing delays, refund delays and later IRS notices,” his statement said. “This is especially important for people who received advance Child Tax Credit payments or Economic Impact Payments (American Rescue Plan stimulus payments) in 2021; they will need the amounts of these payments when preparing their tax return.”

The agency said that it anticipates most taxpayers will receive a refund within 21 days of filing electronically, if they choose direct deposit and there are no issues with their returns. For some taxpayers, that’s a big if. It’s all but impossible to speak to an agency representative, which means that the filing season is already not looking pretty.

“In many areas, we are unable to deliver the amount of service and enforcement that our taxpayers and tax system deserves and needs,” Rettig’s statement said. “This is frustrating for taxpayers, for IRS employees and for me.” Still, it said to carry on: “Taxpayers generally will not need to wait for their 2020 return to be fully processed to file their 2021 tax returns and can file when they are ready.”

Those darn kids
The complicated child tax credit, and its spawn, the advance child tax credit, are causing some of the biggest tangles.

The 2017 tax code overhaul doubled the child tax credit to $2,000 and boosted the income levels at which it phases out, to $400,000 for married couples and $200,000 for everyone else.

In response to the pandemic’s emergence in early 2020, the federal government temporarily increased the credit to $3,600 for children up to age 5 and $3,000 for those aged 6-17, including 17-year olds for the first time. And it made the credits fully “refundable,” meaning that low-income taxpayers got cash back from the government even if their taxable income wasn’t high enough to zero out their tax bill. The credit reverts back to a maximum $2,000 this year.

Do not enter

The Biden Administration advanced monthly payments of chunks of the credits to 39 million Americans over last July through December. Taxpayers could opt out of receiving them if they anticipated getting a raise, switching to a higher-paying job or selling their home, events that could reduce the amount of credit they’re eligible for, as the benefit gets smaller as income rises.

But some taxpayers who didn’t opt out could end up having to pay some of the money back — a flow that could show up as a lower refund on their returns this year or a check written to the IRS. Meanwhile, taxpayers who had a baby after last March could see bigger refunds, while those who got divorced and saw a child’s primary residence go to the former spouse could see a smaller or no refund.

The $1.9 trillion American Rescue Plan that authorized the child tax credit boost last March also introduced a woolly method for calculating who gets how much. It’s that method that’s going to cause headaches for many taxpayers when they file their returns come Monday, April 18, three days after the normal deadline due to a holiday in Washington, D.C.

“It’s one of the biggest problems of the filing season,” said Sheryl Rowling, the founder of Rowling & Associates, a fee-only investment advisory firm in San Diego and a columnist for Morningstar. “Most taxpayers will estimate what they got, and then it will be up to the IRS to figure out if they’re owed money.”

The IRS has two complicated filters that reduce the child tax credit, depending on how much money you make. The first filter phases out $3,000 to $2,000 once you start making $150,000 if married (half that amount for single filers, and $112,500 for heads of household). For such earners, each $1,000 of income above those thresholds reduces the credit by $50.

The second filter hits higher earners and governs when a taxpayer can receive less $2,000. Once couples make more than $400,000 (more than $200,000 for all other filers), the $2,000 credit falls by $50 for each $1,000 chunk of income over those thresholds. Whip out your calculator.

You’ve got (IRS) mail
Taxpayers also need to make sure they’ve received all three of their economic stimulus payments, known as “stimmie” checks. Two went out in 2020 and a third last year. The last one was $1,400 for individuals and $2,800 for married couples, plus an additional $1,400 for each dependent. People making up to $80,000 (at least $160,000 for couples) get some or all of the full amount, with higher earners getting less. Taxpayers whose incomes changed or who added a child to the family may be owed a bigger or smaller stimmie check. Those who didn’t get a check claim it on their returns as a “Recovery Rebate Credit.

Deparment of justice DOJ IAG

Snail mail from the IRS typically terrifies the recipient, but taxpayers should pay attention if they receive one or both of the following letters. Letter 6419 details the child tax credits you’ve gotten, and letter 6475 details whether you got the third stimulus payment. Both can help your accountant determine whether you are owed more or were paid too much and might have to give money back to Uncle Sam.

“Watch for IRS letters about advance Child Tax Credit payments and third Economic Impact Payments,” the agency said on Jan. 10. But Herron said that many clients hadn’t yet received the letters. “How are you going to have a filing season when those letters haven’t even gone out?” he said. “It’s going to be a huge headache for taxpayers.”

Another variable that can throw a wrench into a return is the federal government’s pause on payments for federal student loans from March 2020 through May 1, 2022. That means no deduction for student loan interest on returns filed for those years. The deduction, taken by nearly 13 million taxpayers in 2019, according to IRS data, is typically worth up to $2,500. Not having it can potentially result in a larger tax bill, even with the out-of-pocket savings that come from the pause in repayments.

“The problem is that when there are complications and people get confused, they’re not going to get through to the IRS,” Rowling, an accountant and certified financial planner, said. “If you have to do anything at all with the IRS, it’s going to be a disaster.”

Lynnley Browning Wealth Editor, Financial Planning