Tax tricks to navigate problems with Child Tax Credit, retirement withdrawals, and Rental Property Sales

New or unexpected life events tend to cause the most problems for people filing their taxes every year. Explore three tax-filing problem areas and how to overcome them in the 2022 tax season.

In many cases, the problem can be avoided or mitigated by advance planning. Since April 15 is the filing deadline, this may provide you with several months to come up with a plan to deal with any financial hardship if you find yourself to be negatively affected by one of these problem areas. 

1) Child Tax Credit changes

For the most part, the 2021 tax year Child Tax Credit changes are helpful, but there are circumstances in which the advance Child Tax Payments may cause a problem.

  • Unless the taxpayer opted out of the payments, the taxpayer may actually receive less Child Tax Credit when filing their 2021 tax return than they would have with the old Child Tax Credit. 
  • Before 2021, the credit available was $2,000. Now it is $3,000 for kids ages 6 to 17 and $3,600 below age 6, but half may have been received in advance payments. 
  • For a child aged 6 to 17, this leaves $1,500 of the remaining credit to be received in the 2021 tax return instead of $2,000. 

Therefore, many taxpayers may receive smaller refunds than they previously expected, especially if they have several qualifying children. In some cases, this may cause some taxpayers to owe when they file their 2021 tax returns instead of getting a refund. 

Consider using a tax calculator to estimate what your result will be ahead of tax filing. This way you’ll know as soon as possible whether you may have to pay the US Treasury instead of getting a refund. 

But it can be worse for some taxpayers. Since the advance Child Tax Credit payments are based on a previous tax return (2020 or 2019), there are taxpayers who will not be claiming the child for which they received advance payments. 

Also, some taxpayers may have earned so much more money that they are no longer eligible for the full, or any, expanded Child Tax Credit. In these two cases, the taxpayers may have to pay the advance Child Tax Credit payments back. 

This is done when filing your 2021 tax return and may result in a significantly lower refund or owing the US Treasury some money. The taxpayers owing could request a payment plan. 

There is a safe harbor provision for taxpayers who received the advance Child Tax Credit payments based on a previous tax return and are not claiming the child for 2021. This provision permits taxpayers to not pay back some or all of the advance payments if they have low to moderate-income. If the safe harbor provision doesn’t apply, the advance payments must be paid back in full.

2) COVID-19 retirement plan withdrawals

In 2020, the CARES Act permitted a COVID-19 related distribution of up to $100,000 from qualified retirement plans without the 10% tax penalty normally applied to early distributions. This provision was designed to help people who lost jobs and needed to tap into their retirement accounts to make up for the lost income. 

What does that have to do with 2021?

Those who took a COVID-19 related distribution had the option to spread the income over three years – 2020, 2021, and 2022- instead of having all that income counted in 2020. 

This allowed them to have a lower tax liability for tax year 2020. However, any tax withholding for the distribution was only counted for 2020. 

Those taxpayers who chose to spread the income over the three years will show an increased income in 2021 due to counting one-third of the 2020 distribution in 2021, but without any taxes being paid for that distribution in 2021. 

If the taxpayers didn’t make sure that their tax liability would be covered with their 2021 tax refund or with any other tax withholding, perhaps by increasing their W-2 withholding or by making an estimated tax payment, then they may find they owe a substantial amount of taxes when they file their 2021 tax return. 

3) Rental house sales

The 2021 housing market has been an incredible opportunity for sellers. A large number of landlords saw 2021 as a good time to sell and a whole lot of houses have been sold. 

Many landlords are not wealthy or big corporations. Some everyday taxpayers use or attempt to use, rental property to better their finances and build wealth. It can be wildly successful, or it can be a disappointment. 

Investing in rental houses has quite a bit of risk, and often people go into it without fully understanding the risk or doing adequate investment analysis. When this is the case, and even sometimes when it is not, the sale of rental property can be an expensive tax experience. 

Most people don’t have to pay taxes when they sell the home they have been living in for at least two years due to a capital gains exclusion for the sale of a primary home. 

However, rental houses are usually different. 

For a landlord with one or two rental properties, the sale of that rental property may be the highest income year and therefore the highest tax year they experience in their lifetime. 

The tax code for the sale of rental property is more complicated than what most taxpayers normally experience. It isn’t as simple as taking the amount you sell the property for and subtracting what you paid for the property. 

Errors are more common in the sale of rental property than in many other areas of taxes, particularly for those who only have one or a few rental properties. And some taxpayers who sell rental property don’t pay enough estimated taxes when they sell the property, which can create financial hardship when they file their tax return. 

Publication 523 is a good place to start in order to gain an understanding of taxes on the sale of a rental property. However, selling a rental property is a good time to consider consulting a tax professional. 

These three tricky tax challenges are examples of why tax season isn’t just about filing tax returns. Tax season is about preparation and planning. Visit our one-stop guide to get more tax time planning and preparation tips.