- Most filers expect a refund so they should consider filing as soon as possible.
- You can make contributions for 2020 to certain retirement plans up until the federal tax deadline.
- If you worked from a different state than usual during 2020, you may need to take a careful look at your state taxes.
- You can use your 2020 taxes as a guide for financial planning for the current year and the future.
When you stay at a hotel, are you one of those people who get halfway to the elevator on the way to check out, and you double back for one last sweep of the room, looking under the bed for lost socks? Even if you are the most conscientious and organized tax filer, your annual return could use the same kind of second look before you send it off to the Internal Revenue Service.
People tend to think they are doing their taxes wrong, no matter if they use tax software, hire a professional, or do it themselves. "It's such a mysterious process, and uncertainty often breeds anxiety—will I get audited, fined, or even go to jail? Worst-case scenarios are rare, but we tend to overestimate their likelihood because they're so emotionally vivid," says Andy Reed, PhD, Fidelity's vice president for behavioral economics.
The reality is that IRS statistics show that around 75% of taxpayers got a refund last year, rather than owing, with the average refund running $2,550.* Most never hear from the IRS again, or at most get a letter asking to furnish additional information. Note, if the IRS wants something from you, they will write, not call, which is the hallmark of many IRS scams. The risk of getting audited is generally very low for most Americans, and even lower to get criminally investigated or eventually go to jail.
Nevertheless, it’s still wise to be careful and always double-check your return. Here are some questions to consider.
1. Have you made all the contributions that you can?
You can make contributions to traditional IRAs, Roth IRAs, and health savings accounts (HSAs) up until the federal tax filing deadline, which is now May 17, 2021, for most 2020 returns. And if you are self-employed or freelance, you can open and contribute to a Simplified Employee Pension plan—more commonly known as a SEP IRA—even if you also have a full-time job as an employee.
One strategy many people use is to fund these accounts with a lump sum at this time of year with their expected tax refund. It's important to remember that putting the money in the account is just the first step.
"Unless you are set up to auto-invest all new contributions, which is a good step, you will want to designate how you want that money invested rather than just leave it in cash, as you are likely not earning a very high rate of return on savings right now," says Ann Dowd, CFP®, a vice president at Fidelity.
TIP: For more information, visit Fidelity's Learning Center.
2. Did you file your state taxes correctly?
The COVID-19 pandemic wreaked havoc on people's work lives, and may impact your state taxes, especially if you moved to another state for a significant amount of time. One of the most frequent questions the tax software provider TurboTax® is getting already this tax season is from people who say they worked a state different than in their home state, says Lisa Greene-Lewis, a certified public accountant and tax expert for TurboTax.
State taxes are notoriously difficult to understand, which is further complicated by the fact that many states changed their laws recently. Many states have differences with federal law and some states don't have income taxes at all. Arizona, for instance, recently increased their income tax brackets, while Tennessee eliminated its state individual income tax. There are no shortcuts to finding out this information, unfortunately, so you just have to pay attention to the rules where you file.
"State taxes play a critical role in your overall financial plans, so it can help you to be educated on the impact state tax laws can have," says David Peterson, head of Wealth Planning at Fidelity.
You can consult state tax websites for specific information about taxes where you live or talk to a tax advisor who knows about the specifics in your state.
3. Are you owed any stimulus money?
TurboTax says many people are asking if they have to count any stimulus money they received from the government as income and if they must pay tax on it. You don't.
Stimulus payments are actually advance tax credits for 2020, and there is a worksheet with the 2020 tax forms to reconcile your income for the year with the requirements of the program. Your tax return will be where you finalize what you are due, because the initial payments were estimates based on your 2018 or 2019 tax returns. If you are owed money you did not receive, it will offset any tax due or be included in any refund you get when you file.
The IRS says if your income went up in 2020 and you no longer qualify, you will not be asked to return any payments you might have received up to that point. Note: Subsequent stimulus packages will likely have similar rules, but the limits may change. You may want to consult a tax advisor to see your best filing timing for your 2020 return.
4. Have you accounted for all your income and deductions?
It's always good to do a last-minute check on the details before you file your tax return. Here are just a few: Are you missing any 1099 forms? Did you account for any taxes due on unemployment? If you are claiming the standard deduction, did you claim up to $300 in charitable donations on your return? Do you have to reconcile any tuition rebates you received if you took qualified 529 withdrawals?
One item many people may miss is claiming a home office deduction if they are self-employed. While the Tax Cuts & Jobs Act eliminated this deduction for full-time employees, those who count as freelance or sole proprietors, like many lawyers, can still claim it. "It's probably something worth revisiting. People like lawyers may not have qualified for a home office before because they had a primary office available, but now most people don't," says Christopher Williams, Principal at EY Private Client Services.
5. Have you filed for an extension if you aren't going to file in time?
The IRS moved the main tax deadline to May 17, but if you're not ready to file by that deadline, it's important to remember to follow the rules when filing an extension. The key one: Pay what you owe by the tax filing deadline or you could face penalties and fees.
But also remember that there are key benefits to filing as soon as you are ready, namely reducing your exposure to tax-related identity theft and getting your refund earlier. There's no reason to let the government hold onto that money for you. Another benefit: Once you figure out your 2020 taxes, you can plan your finances better for 2021.
Those changes can be as simple as updating the tax withholding on your paycheck to long-range planning about your state residency. "You can use your tax return as a guide and make adjustments," says EY's Williams.