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COVID-19 affected nearly every area of our lives in 2020. Why wouldn't it put a new spin on tax season as well? If you're getting ready to file taxes for 2020 and wondering how the pandemic will have an impact, here are a few items to consider.
Tax Season Is off to a Late Start
The IRS usually begins processing tax returns in mid-January, but this year it didn't begin until February 12. In a more normal time, you might think this buys you some extra time to do your taxes. But in COVID times, you may actually want to get a jump on your taxes. While the IRS extended the federal tax deadline to May 17 this year, if you expect a refund, it's best to file your return ASAP. The fastest route to a refund is to e-file and link your bank account for direct deposit.
Additionally, if your 2019 income did not qualify you for economic stimulus payments but your 2020 income might, filing your 2020 taxes sooner could enable you to receive stimulus payments. The upshot: Don't wait.
What to Know About Stimulus Payments and 2020 Taxes
Did you receive Economic Impact Payments? If you earned less than $75,000 as a single person, $112,500 as head of household or $150,000 as a married couple in 2019 or 2020, you may have been eligible for the first two rounds of COVID-19 relief payments. The first of these payments began going out in April 2020, and the second round in late December. A third round of payments is still being debated as of this writing.
Here's what to know about Economic Impact Payments, also called stimulus checks, and your taxes:
- COVID-19 stimulus payments are not taxable. Receiving these payments won't affect how much you owe in taxes and they won't reduce the amount you receive as a refund.
- You do not have to return stimulus money. If your 2020 tax return shows that your income exceeded the limits listed above, don't worry. As long as your 2019 or 2018 income qualified you, you may keep the money. In addition, if you received $500 for a child who turned 17 in 2020, you do not have to return that payment either.
- You can file for stimulus money you are eligible for but have not received. By claiming the Recovery Rebate Credit on your 2020 tax return, your stimulus payment will be applied to your taxes as a credit, reducing the amount you owe or increasing your refund payment, depending on your situation.
- Keep the notice you received with your payment(s) on file. The IRS mailed out Notice 1444, Your Economic Impact Payment within 15 days of sending out stimulus payments. You should keep this notice with your 2020 tax records so you know how much you received in stimulus money and when you received it.
What if COVID-19 Changed Your Job Status or Income?
COVID-19 has changed people's work lives in many ways. Some of these changes may affect your taxes.
- Your unemployment benefits are taxable. If you collected unemployment benefits, including the supplemental $600 per week provided by the federal government for part of the year, you must pay federal taxes on your unemployment benefits. You should receive Form 1099-G, Certain Government Payments, which shows the amount of unemployment compensation paid to you in Box 1 and any federal income tax withheld in Box 4. If you did not request taxes to be withheld or pay estimated taxes on your unemployment benefits in 2020, you will owe them at tax time. You may or may not owe state and local taxes depending on tax laws where you live.
- Was your income reduced in 2020? You may be eligible for the Earned Income Tax Credit (EITC). The IRS can help you calculate your eligibility using either your 2019 or 2020 income, whichever is more favorable for you. Also, if you had at least $2,500 in earned income and have qualifying children ages 17 and under, you may also be eligible for an Additional Child Tax Credit (ACTC). This year, taxpayers who are eligible for ACTC may receive any portion of the $2,000 Child Tax Credit that is left over after paying taxes as a refund. Normally, if the Child Tax Credit exceeds your tax bill, the remaining credit simply goes away.
- Your home office expenses are not deductible. If you've been doing your full-time job from home, you cannot deduct these or other business-related expenses, such as office supplies. However, if you've developed a side business to supplement your income, your home office and business-related expenses are deductible.
- The side income you made is taxable. Did you do odd jobs, freelance or start a homebased business this year? The income you made is taxable, and you may be required to file Form 1040 Schedule C, Profit or Loss from a Business.
Special Rules for Retirement Withdrawals and Medical Expenses
COVID-19 required many taxpayers to take unusual actions to help preserve their financial health. Here's how two of them affect your taxes:
Retirement withdrawal: Did you withdraw money from your 401(k) or IRA to cover expenses this year? The IRS allowed taxpayers who were affected by COVID-19 to take up to $100,000 from a 401(k), 403(b) or IRA account between January 1, 2020, and December 30, 2020, without paying a 10% additional tax on early distributions. You may report the distribution over three years. And if you repay the distribution within three years, you can file amended tax returns to recoup the taxes you paid.
Medical expenses: Did you pay more than 7.5% of your adjusted gross income for medical expenses in 2020? You may deduct that amount from your taxes. If you have a qualifying high-deductible health plan, you can also self-fund your health savings account before the tax deadline and use those funds to pay any outstanding medical bills—or any medical expenses you incur going forward.
What to Do Now for Your 2021 Taxes
Although there's plenty of time between now and next April for new tax laws to go into effect, you can still do some early planning now.
- Optimize your withholding. If you had a large refund this year or ended up owing money, take a moment to adjust your withholding now. Ideally, you want to have just enough money withheld from your paychecks to cover your tax bill. Anything more is a loan to the government; anything less means making a payment at tax time.
- Anticipate a smaller paycheck. Taxpayers who saw an increase in their 2020 paychecks due to the payroll tax deferral could see a temporary reduction in take-home pay from January to April of 2021.
- Stay tuned for updates. As the federal government continues to work on COVID-19 relief, a new round of stimulus payments and tax-related legislation is likely to be enacted. Be sure to figure out how any changes will affect your 2021 taxes, and take action if necessary.