Tax time can be intimidating, especially with so many new changes to the tax code when you're filing in 2021. But take heart. You can ace filing your tax return with this overview of what’s involved in the process.
Making use of a tax calculator before you get started can give you a heads-up estimate as to what you might owe the Internal Revenue Service, and it can be invaluable if you end up asking the IRS for an extension of time to file your return.
Making use of a tax calculator before you get started can give you a heads-up estimate as to what you might owe the Internal Revenue Service
You’ll need to send in a payment with your request for an extension to avoid fines and penalties, but you’ll want an idea of how much you’ll owe, if anything, before that. Think of a tax calculator as an estimator of your tax liability or potential refund after the whole preparation/filing process is completed.
E-Filing and IRS E-Services
The IRS offers a whole slew of e-services on its website, but all providers are approved to e-file your return for you if you use tax preparation software. The IRS also offers Free File services online if you qualify, guiding you to software providers who will take care of the whole filing business for you free of charge if your income is $72,000 or less in tax season 2021 when you'll file your 2020 tax return.
You do have to officially authorize your tax preparer to electronically file your return if you use a professional rather than commercial software. This is where IRS Form 8879 comes in. Complete and sign it and give it to your tax preparer. Don’t file it with the IRS.
Tax Return Preparation, Services and Tax Attorneys
You can sharpen your pencil and tackle your Form 1040 tax return yourself, but why do that when tax services abound all over the country and many charge very reasonable fees, if anything at all?
AARP normally provides a free tax service, Tax-Aide, that’s manned by volunteers, but you must meet certain income and age requirements to qualify. Tax-Aide is temporarily closed in 2020 due to the coronavirus pandemic, but it's expected to reopen in 2021. The IRS Volunteer Income Tax Assistance program is free if you have limited income, are disabled or have a limited ability with speaking the English language.
You might want to consider a certified public accountant or an enrolled agent if you have investments, a side business or want to do a little tax planning. Yes, this will cost you, but these professionals have passed rigorous testing and training, and you get what you pay for.
Hopefully, you’ll never need a tax attorney. These are the professionals who can appear in tax court for you if you ever have a serious problem with the IRS. As with all lawyers, your conversations with a tax attorney are privileged and confidential communications.
Tax Preparation Software
Then, of course, there are all those software programs and apps. Most work by walking you through a series of questions and prompting you to enter your information. They can handle simple to more complex tax situations, but prices tend to increase for more complicated returns.
This is where tax preparation actually begins, well before you decide how you’re actually going to prepare your return. You’ll be asked to complete a Form W-4 for your employer whenever you start a new job. You can submit a new one at any time if your situation changes, maybe because you’ve gotten married or you’ve taken on a second job.
This is the form where you provide all the information your employer needs to calculate withholding from your paychecks. The goal is to get your withholding just right so you don’t owe the IRS anything at the end of the year, or pay in too much so the IRS gets to use your money until you file your return and request a refund.
Assuming you work for someone else for your living, you'll receive a Form W-2 from your employer after the tax year ends, usually sometime in late January or early February. We’re talking more than 20 boxes and innumerable codes on this form, all of them detailing aspects of your earnings. Form W-2 chronicles everything you’ll need to know to cite your income on your 1040 tax return.
Tax Form 1040
OK, about Form 1040. The IRS issued a new one for the 2018 tax year, the return you would have filed in 2019. Then it turned right around and revised that form for the 2019 tax year, and a few changes have been made to the 2020 version as well. All these years' forms are roughly half the size of the old one, but they include many more schedules for entering information that used to appear directly on the 1040.
You have no choice but to use the new forms because they officially replace the old Form 1040, Form 1040-A and Form 1040-EZ – it’s one size fits all. Forms 1040-A and 1040-EZ are obsolete.
Choosing a Filing Status
Your next challenge involves figuring out your filing status. There are five options: single, married filing jointly, married filing separately, head of household and qualifying widow(er).
The rules for each are somewhat complex because they depend on whether you’re “considered” married or unmarried according to the tax code, and that’s not always black and white. If you have a divorce decree, you’re not married, but you might still be "considered unmarried" even if you don't.
Itemizing Deductions on Schedule A
You can still itemize after all the tax changes that took effect in 2018 if you complete and file Schedule A with your return, but you might not want to because the tax law implemented numerous new rules for itemizing, some of them favorable and some of them not.
The limit for deductible cash charitable contributions increased to 60 percent of your adjusted gross income or AGI, up from the 50 percent limit in 2017, but this change has been temporarily suspended due to the coronavirus pandemic. Individual taxpayers can deduct up to 100 percent of their AGIs in the 2020 tax year.
The itemized medical expense deduction is subject to an AGI threshold of 7.5 percent. You can only deduct the portion of your medical expenses that exceed this amount as of the 2020 tax year. And here’s a bit of bad news: That 7.5 percent threshold is scheduled to increase to 10 percent in the 2021 tax year.
The itemized deduction for state and local taxes has been tweaked, too. It’s now capped at $10,000 cumulatively for state and local income and property taxes or sales taxes – you can’t claim all three. This drops to $5,000 if you’re married and file a separate return. So if you pay $3,000 in state income tax and $8,000 on property taxes, you’ll have to leave that extra $1,000 on the table.
You used to be able to claim an interest deduction for up to $1 million in mortgage indebtedness, but that was slashed to $750,000 beginning with the 2018 tax year. And here’s another big change: You can only claim a deduction for home equity loans now if you use the proceeds to “substantially improve” your property. Gone are the days when you could use the loan proceeds to pay for your child’s college education and claim a tax deduction for it.
The Standard Deduction
Taxpayers are given a choice between itemizing or claiming the standard deduction for their filing status. It's an either/or decision – you can't claim both – so you're usually better off claiming the option that results in the greatest amount taken off your taxable income.
The standard deductions for the 2020 tax year, the return you’ll file in 2021, are $12,400 if you’re single, $24,800 if you’re married and filing a joint return, or $18,650 if you qualify as head of household. These deductions go up even more in the 2021 tax year, to $12,550 if you’re single, to $25,100 if you’re married filing jointly, and to $18,800 for heads of household filers. These figures are tweaked regularly to keep pace with inflation.
If the total of all your itemized deductions doesn't exceed the standard deduction you're entitled to, you're probably better off not itemizing.
Above the Line Adjustments to Income
You can take some tax deductions without itemizing or claiming the standard deduction. These are called “above the line” adjustments to income.
You can claim certain contributions you made to a health savings account this way if you file Form 8889 with your return, and distributions you take from such accounts are reported on Form 1099-SA and issued to you and the IRS. Other above the line adjustments to income include retirement fund contributions, student loan interest you pay and educator expenses if you’re a teacher.
All these above-the-line deductions result in your adjusted gross income after you take them, that all-important AGI that so many other tax breaks depend upon. Some tax breaks also depend on your modified adjusted gross income. Many taxpayers will find that this is the same as their AGI. Your MAGI is your AGI with certain deductions added back in for purposes of qualifying for a particular tax break.
Your dependents won’t save you quite as many tax dollars as they did before the 2018 tax reform because personal exemptions have been eliminated from the tax code. But having them can still qualify you for some valuable tax credits and deductions. Dependents include your children and some qualifying adults. The rules are extensive and complicated, but it can be worth it to determine which of your relatives qualify, if any.
Available Tax Credits
Tax credits don’t work the same way as tax deductions do – they’re actually better. Credits act as payments, just as if you wrote the IRS a check toward any balance you owe. They eliminate your tax debt dollar for dollar.
The Child and Dependent Care Credit is equal to 20 to 35 percent of child care expenses you incur for your children under age 13 or disabled dependents so you can work, look for work, or go to school. Complete IRS Form 2441 to find out if you qualify, and for how much, and submit it with your tax return.
The Earned Income Tax Credit or EITC is designed to put money back into the pockets of lower income taxpayers and it’s refundable. The IRS will send you any balance of the credit that’s left over after it erases your tax bill. This makes it very popular, so the tax code is pretty strict about qualifications. Submit Form 8862 if you’ve been denied the credit but you think you are entitled to claim it.
The Child Tax Credit has been increased to $2,000 under the new tax law for each of your qualifying children who have not yet turned 17 as of the last day of the tax year. It, too, is at least partially refundable beginning in tax year 2020. You must submit Schedule 8812 with your return to claim the “additional” part of the child tax credit, the refundable portion for taxpayers who qualify.
The tax code offers two educational credits: The Lifetime Learning Credit and the American Opportunity Credit. They have slightly different qualifying rules, but both are based on educational expenses you pay for yourself, your spouse or your dependents. You should receive a Form 1098-T from the learning institution, detailing how much you spent on qualifying costs so you can claim one of these credits.
The Retirement Savings Contributions Credit, sometimes called the Saver’s Credit, rewards you for contributing to an individual retirement arrangement or an employer-sponsored retirement plan. It can be worth up to 50 percent of your contributions or a total of $2,000. Complete IRS Form 8880 to find out how much you qualify for, and submit the form with your tax return.
The Premium Tax Credit is designed to help out with those health insurance premiums you’re required to pay under the ACA. It, too, is refundable – sort of. The money is sent to your insurer to help defray your costs for coverage.
Tax Filing Deadlines and Extensions
Now that you know how to deal with your tax return, when is it due? This can change from year to year, but only by a day or so. Technically, it’s April 15, but it’s bumped to the next business day if this date falls on a weekend or a holiday. That doesn't happen in 2021, so the official filing date is April 15.
You can file Form 4868 with the IRS to get an automatic six-month extension to Oct. 15 if you're running out of time.
What Happens If You Don’t File?
It’s true that not everyone has to file. You’re off the hook if you have very negligible income, but you might still want to file to collect a tax credit like the EITC if you qualify for it, or to get back any taxes you paid through withholding. Otherwise, you’ll be hit with some nasty penalties based on a percentage of how much you would owe.
Paying the IRS
File your return anyway if you owe taxes and you absolutely cannot pay them in one lump sum. The IRS offers several payment options and it’s often just a matter of reaching out to them for help, although penalties and interest apply.
You can request either a short-term or long-term installment agreement by filing Form 433-D, either on paper or online. You might be required to complete and file Form 433-F as well, providing details of your financial situation.
An offer in compromise allows you to pay less than the full amount you owe. The IRS will sometimes agree to this under one of three circumstances: There’s some doubt that you really owe what the IRS says you owe, it’s highly unlikely that you can pay the whole debt or doing so would cause you considerable economic hardship.
You’ll be subject to garnishment, levies and possibly tax liens if you can’t work something out with the government, but the IRS does want to help you. It launched its Fresh Start Initiative in 2011 for just this reason.
Read More: What Happens If You Can't Make Federal Tax Payments?
If you’re lucky, you won’t owe the IRS anything – the IRS will owe you. You have several options for getting your hands on that refund. Many banks, lenders and tax filing services offer “refund anticipation loans” if you just can’t wait, but you’ll owe fees and interest, just as you would with any other loan. Your refund will go directly to the lender for repayment, not to you, when the IRS issues it.
You don’t have to deal with paper refund checks these days, either. Submit Form 8888 with your tax return and the IRS will direct deposit your money in up to three accounts. You can even use Form 8888 to use some or all of your refund to purchase U.S. savings bonds.
A lot of the stress associated with tax time is the fear of something going wrong and landing you in the middle of a tax audit.
It might help to know that the vast majority of IRS audits are “correspondence audits.” You’ll receive a snail-mailed notice from the IRS (not an email!) asking for further documentation or proof of information that you stated on your return.
You can expect one of three outcomes if you’re subject to a full-blown audit: The IRS will agree that your return is okay after all, it will determine that you did make a mistake and you agree to pay any additional taxes or you won’t agree that you goofed, in which case you can request mediation or appeal.
- IRS: e-Services
- Consumer Reports: Where to Get Professional Tax Preparation Help
- IRS: Charitable Contribution Deductions
- HealthCare.gov: Health Savings Account (HSA)
- IRS: Earned Income Tax Credit (EITC)
- IRS: Education Credits - AOTC and LLC
- IRS: The Premium Tax Credit - The Basics
- IRS: Additional Information on Payment Plans
- IRS: File Your Federal Taxes Online for Free
- AARP: Due to Coronavirus Concerns, AARP Foundation Tax-Aide Suspends Service Through 2020
- Benefits.gov: Volunteer Income Tax Assistance (VITA)
- IRS: IRS Provides Tax Inflation Adjustments for Tax Year 2021
- IRS: Retirement Savings Contributions Credit (Saver’s Credit)
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.