[This article has been updated for tax filing in 2021 from an earlier version posted last year.]
It's tax season. Employees are looking over their W-2 earned-income forms, which should have been delivered to them by Jan. 31, and preparing to file income taxes by April 15.
Now is a good time for HR departments to advise them to review their paycheck withholding and consider increasing their contributions to tax-advantaged retirement accounts, tax advisors say. As they share other pertinent tax-time tips, employers can also direct eligible employees to the IRS Free File program.
As they prepare their income tax returns, many employees will find that their withholding is not enough to offset taxes owed this year, while others will find they've withheld too much. They can adjust their paycheck withholding amount by submitting Form W-4, Employee's Withholding Certificate, to their HR or finance staff. with major revisions designed to make accurate income-tax withholding easier for employees.
Starting in 2020, the updated Form W-4 replaced complicated worksheets with more straightforward questions. The primary goals of the new design was "to provide simplicity, accuracy and privacy for employees while minimizing burden for employers and payroll processors," the IRS said.
According to Eric Bronnenkant, head of tax at Betterment, which provides retirement plan services, "Few Americans actually withhold the right amount from their paycheck to cover their taxes." That's why reminding employees to evaluate paycheck withholding and review Form W-4 elections can be so helpful.
Along with the new Form W-4, the IRS has updated its online tax withholding estimator. Employees can see if they've withheld the correct amount of income tax from their paychecks for 2020 and what adjustments they may want to consider through 2021. If an adjustment is needed, the estimator gives specific recommendations on how to fill out their employer's online Form W-4 or provides the form as a PDF with key parts filled out.
Although it's too late for employees to adjust their withholding for 2020, there's still time to get their withholding amount correct for 2021 "so that they're not caught by surprise, again, come April 15 next year," said Tom DiLorenzo, senior manager at consultancy EY's employee financial services.
Help for Low- and Middle-Income Earners
Tax-time communications should also inform employees about programs and tax credits available to moderate- and low-income workers.
The IRS Free File service, which lets anyone who earned less than $72,000 in 2020—and that's most taxpayers—prepare and electronically file a federal return at no cost. "Free File does all the hard work for you. It finds the right forms, benefits and does all the math," the IRS said.
Free File is a public-private partnership between the IRS and tax software providers that make their tax preparation products available at IRS.gov/FreeFile. Free File providers also offer state tax return preparation either for free or for a fee.
Along with the Free File service, many employees are eligible for free tax help from trained volunteers at community sites around the country.
Earned Income Tax Credit
The IRS is also asking employers to remind workers about the earned income tax credit (EITC), the federal government's largest refundable federal income tax credit for low- to moderate-income workers. It can give taxpayers a refund even if they owe no tax.
Taxpayers earning $56,844 or less can see if they qualify using the EITC Assistant tool at www.irs.gov/eitc.
The EITC is as much as $6,660 for a family with three or more children or up to $538 for taxpayers who do not have a qualifying child.
"The EITC is a vital tax credit that helps millions of hard-working working families around the nation," according to the IRS. "It's critical that people review the credit to see if they qualify."
In addition, the retirement savings contribution credit, commonly called the saver's credit, may be available for single filers who earned less than $32,500 in 2020 and for married couples filing jointly who together earned less than $65,000. Few low-wage workers know they can get a tax credit by contributing to an employer-sponsored 401(k) plan or to an individual retirement account.
Informing eligible employees about these options can help relieve some of their financial stress during tax season.
Check Benefits Reporting
Employees should check wages reported on Form W-2 and confirm that all eligible benefit elections were taken on a pretax basis. "If an error occurred with the pre- or post-tax status of the benefit elections, employees may face a higher tax liability when completing their tax returns," said Erica Cordova Zinkie, vice president and legal counsel at HR advisory firm OneDigital.
In Box 12 of Form W-2, for instance, items that can affect an employee's taxable income if not correctly reported include the amount of health savings account (HSA) and 401(k) contributions made through payroll deferrals.
[SHRM members-only HR Q&A: Can an employer accept a W-4 form from an employee claiming 99 dependents?]
Consider HSAs for Last-Ditch Withholding
Employees who didn't withhold enough from their 2020 pay might be able to avoid tax penalties if they're eligible to make additional contributions to an HSA, said Samantha Malovrh, an employee benefits attorney at OneDigital.
"Contributions to an HSA get an above-the-line tax deduction, meaning they will reduce the individual's adjusted gross income," she explained. HSA maximum contributions for 2020 are $3,550 for self-only coverage and $7,100 for family coverage. If individuals are 55 or older by the end of the tax year, they can contribute an additional $1,000.
"HSA contributions can be made up until the filing due date for an individual's tax return for that year—April 15 for most individual taxpayers—and these contributions can be allocated to the prior year," Malovrh said.
Expect HSA Forms ...
HSA holders should expect two tax documents each year from their HSA administrator:
- Form 1099-SA reports HSA withdrawals made during the previous tax year. This form should have been received in the mail in late January/early February by HSA holders who elected to receive paper documents if they made withdrawals from their HSA in 2020.
- Form 5498-SA reports HSA contributions made during the previous tax year and the current market value of the account. This form is not posted until May because HSA holders can contribute to their account for the previous year through mid-April. Consequently, while Form 1099-SA should be kept in the evident of a future audit, most taxpayers will have filed their taxes before they receive this form.
These forms help HSA account holders with tax preparation but do not need to be filed with their return, said Todd Berkley, vice president of BenefitWallet, a company that manages HSAs and other benefits.
"Some administrators mail account holders both the 5498-SA and 1099-SA in January and then send an updated 5498-SA in May for account holders who make prior-year contributions up until tax day," Berkley pointed out.
Employees should make sure the Form 1099-SA correctly shows whether withdrawals were for IRS-eligible "qualified" medical expenses, he added.
Finally, HSA holders should complete and file Form 8889 with their tax return to declare total HSA contributions and withdrawals, and whether withdrawals were for qualified medical expenses.
... and Health Care Forms
The IRS extended until March 2 the original Jan. 31, 2020, deadline for employers to distribute health care information Forms 1095-C or 1095-B to employees for tax year 2020.
Employers with 50 or more full-time or equivalent employees file Forms 1095-C with the IRS—and provide employees with copies—to show that eligible employees were offered health coverage compliant with the Affordable Care Act (ACA). Smaller, self-insured employers or insurance companies file and distribute Forms 1095-B.
Because the IRS updated these forms to reflect that Congress eliminated the penalty on individual taxpayers for not having ACA-compliant health coverage, employees no longer need to report whether they had coverage when filing their federal income tax returns. As a result, they don't need to worry about forms 1095-C and 1095-B unless they reside in a state that has enacted its own requirements for individual coverage, such as Massachusetts, New Jersey or Washington, D.C.
California, Rhode Island and Vermont passed laws to reinstate the individual mandate beginning in 2020.
Employers should alert affected employees if their states of residence require health coverage, and if so, what action employees will need to take, said Kim Buckey, vice president of client services at DirectPath, a benefits education, enrollment and health care transparency firm. If employers haven't already done so, tax-planning season "is certainly a good time to begin such communications," she advised.
Additional Tax Reminders
Tax-time communications also can address the following:
- Responding to payroll errors. Employees should know what to do if their employer made payroll processing errors on a distributed Form W-2 and subsequently provided a corrected Form W-2C. "Help [employees] understand how to file an amended tax return if necessary, which may provide them with a tax benefit," DiLorenzo advised.
- Handling multistate tax filings. As the workforce becomes increasingly mobile, more employees generate income in more than one state and must file multiple state income tax returns. "Help [these employees] understand how nonresident state tax credits work and where, if you're paying tax to another state, you're going to receive a credit on your resident return to offset that nonresident state tax liability," DiLorenzo said.
Related SHRM Articles:
Employees Working Out-of-State Often Fail to Let HR Know, SHRM Online, February 2021
Deadlines Ahead as Employers Prep for ACA Reporting in 2021, SHRM Online, January 2021
Saver's Credit Can Spur Retirement Plan Contributions, SHRM Online, January 2021
2021 Wage Cap Rises Modestly for Social Security Payroll Taxes, SHRM Online, October 2020