Thanks to the IRS, tax return season has gone from bad to worse, and it has begun to impact our high-net-worth clients who are avid, affluent investors in unpleasant ways. A large backlog of unprocessed returns is creating anxiety for many clients who take their tax obligations seriously. This “dumpster fire” of a filing season was confirmed by the Washington Post which recently reported the IRS was bogged down with nearly 24 million unprocessed returns filed for last year and earlier — more than twice the amount that was publicly known. The IRS is grappling with a pandemic-fueled manpower shortage, aging technology, funding shortfalls and two multibillion-dollar pandemic-related relief provisions: the advance child tax credit and a pause on student loan payments. But it’s not just average earners, who benefit the most from those one-off measures, who may see their refunds delayed.
Now many high net worth taxpayers are stuck, or about to get caught, in limbo. Why? Because they tend to have a lot of losses they use to offset, or reduce, the taxes they paid in past years or owe in future years. If a prior federal return with a loss is still unprocessed, it can cause a current return that uses a leftover portion of that loss to be flagged as incorrect. If a current return applies a loss to prior years but is stuck in a processing backlog, it can delay a refund.
Under IRS rules, an investment loss of up to $3,000 can reduce income on which taxes are owed each year. Any leftover losses can be “carried forward” to offset income in a future year. The rules for business losses are more generous. Before 2017, net operating losses were fully deductible. Taxpayers could use “excess” losses for which they didn’t have enough taxable income in a given year to offset taxes owed during the prior two years or in the next 20 years. Then the 2017 tax law eliminated the ability to deduct such losses from prior returns and limited their use to 80% for future returns. So from 2018 until 2026, taxpayers can deduct up to $250,000 (twice that for married couples) of business losses from non-business income, such as investment gains and dividends.
But in 2020, to help pandemic-plagued businesses retain more cash, Congress changed the rules again, suspending those limits for net operating losses from business that are carried back or applied to 2018, 2019 and 2020. A net loss, which can be in the past or in the future, produces either a lower tax bill or a tax refund. In 2020, a then-record number of Americans started new businesses in the pandemic, a surge that means many people who ventured out then and are now filing returns may face an IRS-induced financial squeeze.
For example, what if you are a client with a $90,000 business loss in 2020 that was reported on a return that was still stuck in the backlog. You had a $100,000 profit last year, which means you owe tax on only $10,000 of the gain. If by the time you file your 2021 return this year, the previous year’s return hasn’t been processed, the IRS will show you as owing federal income tax on the full $100,000. You can hold off on filing as long as possible. The IRS delays are affecting client’s business planning, if it’s a significant amount but you are not sure when you are going to get it, you can’t count on it or plan with it.
Trusts, too, have issues. Some wealthy clients who file trust returns are also worried. Those returns impact estate taxes, which kick in at a top 40% once a deceased taxpayer’s estate transfers more than $1 million to beneficiaries. For 2021, the transfers are exempt from the levy until the estate reaches $11.7 million (twice that for couples). If you received an IRS letters saying that trust returns from 2019 and 2020 hadn’t been filed, but they were, it is because the agency only recently redeployed workers to its Ogden, Utah, center.
IRS computers don’t know which returns are in the backlog when it sends out the automatic notice that a return hasn’t been received. There have been additional delays of up to six months in receiving a refund for overpaid taxes, especially on the sale of a business. Adding to the problem is that the agency’s backlogs and confusing and errant mailings make it difficult to resolve things. It’s not clear if IRS employees who work remotely have access to the agency’s full systems or paper returns.
CONTACT US: Corporate deadlines were March 15th, many business clients went on extension for the reasons mentioned above. The due date for individual tax filings this year is April 18th, three days after the normal deadline. Taxpayers can file for a six-month extension to mid-October. The nation’s tax collector continues to insist it will issue most refunds in 21 days or less, however some are taking 21 weeks or many months more. Please contact our tax team with your questions at CPA@fuoco.com or call toll free 855-542-7537.
