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As if 2020 didn't bring enough challenges, it's time to put a wrap on the tax year. Although this year carries with it some of the usual year-end tax tips, 2020 also offers myriad new potential issues to consider. From unemployment and stimulus payments to potential medical expenses and payroll deductions, here is a brief rundown of what to think about—and what to do—as the end of the year approaches.
Coronavirus Relief and Your 2020 Taxes
In April, the IRS began issuing stimulus checks of up to $1,200 per taxpayer and $500 per qualified dependent child to help ease the financial strain caused by the COVID-19 pandemic and to help stimulate the economy. While the stimulus payment was technically a federal tax credit for the 2020 tax year paid in advance, it will not affect any tax refund you are due. Nor will you have to repay the money along with your taxes. The stimulus amount is not considered taxable income and should not have an impact on the total you owe in taxes.
The U.S. saw record unemployment in 2020, with tens of millions of Americans filing for unemployment benefits throughout the year. If you received unemployment benefits, including the $600 a week that the U.S. government added to qualifying state unemployment benefits between March 29 and July 25, this money is subject to federal, state and local income taxes. Your state will send you IRS form 1099-G, showing a record of how much you received in unemployment. This amount should be reported on your 2020 tax returns.
Retirement and Health Savings Contributions
As always, you can reduce your taxable income by contributing to a qualifying retirement plan. If you have not yet contributed the maximum amount and would like to, here are the contribution limits for 2020:
- Employees who participate in 401(k), 403(b), most 457 plans and the federal government's Thrift Savings Plan may contribute $19,500, with an additional catch-up contribution of $6,500 for employees ages 50 and older.
- The contribution limit for SIMPLE accounts is $13,500.
- If you do not have a company retirement plan and you meet income requirements, you may contribute up to $6,000 to an IRA ($7,000 if you are 50 or older at the end of this year).
- Self-employed taxpayers can contribute up to 25% of their net earnings or $57,000 (whichever is less) to a Simplified Employee Pension (SEP) or Keogh account.
If you have a high-deductible health plan, you can self-fund a health savings account to save toward covering deductibles and coinsurance—and pay for the out-of-pocket cost of medical, dental, vision and other health care expenses. You have until April 15, 2021, to maximize your 2020 contribution. The 2020 annual contribution limits are $3,550 for self-only coverage and $7,100 for family coverage. Eligible taxpayers 55 and older at the end of the tax year may increase their contributions by $1,000.
New Rules for Itemized and Standard Deductions
Although beating the bushes for itemized deductions has been an annual ritual for many, recent increases to standard deductions—along with limits on the amount you can deduct for things like mortgage interest and property taxes—are causing many taxpayers to second-guess it. Deciding whether to itemize your tax deductions or take standard deductions requires exactly the same math year after year: Estimate your taxable earnings with deductions and compare them with your taxable earnings using standard deductions. Whichever results in less taxable income is the winner.
Standard deductions have risen slightly since 2019. Here are the basics:
|Standard Deductions for the 2020 Tax Year|
|Filing Status||Standard Deduction|
|Married, filing jointly||$24,800|
|Married, filing separately||$12,400|
|Head of household||$18,650|
In this unpredictable year, you may find deductions that you haven't had in years past:
Charity: Unlike in previous years, you can deduct charitable contributions without itemizing your deductions in 2020. The CARES Act created a deduction of up to $300 for cash contributions from taxpayers who don't itemize. Donations must be made by the end of the year.
Freelancing: If you've taken on side work or freelanced to make ends meet, remember that your business-related expenses are tax-deductible. This includes business mileage on your vehicle, home office expenses and any business equipment and supplies you've purchased.
Medical expenses: If your medical expenses equal or exceed 7.5% of your adjusted gross income, they are deductible if you itemize.
Finally, 2020 comes with a bit of unconventional advice about deductions. The usual advice is to maximize your deductions by year's end in order to reduce your tax bill for the current year. There's nothing wrong with doing this; most of us would rather have a smaller tax bill than a larger one. But if you've had a disruption in your income this year and have earned less than you normally would, think about whether you're likely to earn more in 2021. If so, that last-minute charitable contribution or property tax payment might be worth more as a deduction in 2021 than it is in 2020. It may pay to think twice.
No Time Like the Present to Plan for the Future
What if this unusual financial year leaves you with a tax bill due come April? Let the saving and planning commence now. You have at least a little time to try to save up and avoid penalties.
- If you've underpaid, consider adjusting your withholding. Adjusting now to help compensate or increasing your last estimated tax payment of the 2020 tax year may help you avoid at least some underpayment penalties.
- Bracing for a tax bill? Start saving. Set aside some money each month in savings. Even if you can't save the entire amount, any portion will help.
- Look for loans or credit. Ask yourself what your options are. You may qualify for a personal loan to pay your tax bill or use available credit on credit cards. Just beware of high interest rates on your credit cards. They can make paying your taxes even more expensive in the long run.
One bit of good news: Unpaid taxes won't hurt your credit—at least not directly. Before 2018, tax liens could show up on your credit report, causing damage to your credit score and your ability to secure loans and credit. That's no longer the case, though having an outstanding balance with the IRS still isn't great for your financial health. The sooner you can resolve a tax bill, the better.
Looking Forward to Tax Year 2021
Thankfully, even 2020 must come to an end. As we round the corner into 2021, set yourself up for tax-filing success. Collect tax-related information in an envelope as W-2 and 1099 tax forms arrive in the mail so you have everything in one place when it's time to file.
Be forewarned that if you've seen an increase in your paycheck for the past few months as a result of President Trump's payroll tax deferral, you could end up with a temporary reduction in take-home pay from January to April of next year. The payroll tax deferral was just that: It postponed the withholding of Social Security taxes by employers and employees during these last four months of 2020. Payback begins in January, so expect to see your paycheck decrease by about the same amount it increased in September if this deferral applies to you.
The 2021 tax year probably won't begin with the triumphant return of predictability: The pandemic and accompanying recession are still playing out, but the start of a new tax year brings with it the possibility of preparedness. Use the adjustments you needed to make in 2020 to ensure that you're withholding the right amount of money—or sending in enough estimated tax—to cover your taxes in 2020. Keep better records. Contribute to your retirement every paycheck. Monitor your credit carefully. And while you're at it, stay healthy: With a new year comes hope.