This article was last updated on October 11
Not only has the COVID-19 pandemic thrown a wrench into our everyday lives, but its impact will also be felt by many as they file their 2020 tax returns next year. Unemployment, freelancing/gig-workers and the many federal stimulus payments will present challenges to millions of Americans when it comes to the 2020-21 tax filing season. So take the time before the end of this year to figure out where you land financially by planning ahead for some of the issues you may face when filing your tax return. With that in mind here are some of the key things to consider as we head toward the end of 2020.
Key provisions in the Coronavirus Aid, Relief, and Economic Security (CARES) Act enacted this year that may impact your 2020 tax return include:
Economic Impact Payments (a.k.a stimulus checks)
Under the CARES Act, single taxpayers that reported $75,000 or less in income on their 2018 or 2019 tax return received a $1,200 Economic Impact Payment, commonly known as a stimulus payment. Married couples earning up to $150,000 in 2018 or 2019 received $2,400 in stimulus payments. Taxpayers with eligible dependents under 17 years old were entitled to receive an additional $500 for each dependent.
Stimulus payments are considered advanced credits for your 2020 tax return. In most cases, you are not required to repay these. Even if your income in 2020 is higher than in 2018 or 2019, you are not required to repay the stimulus payments.
If you did not receive a stimulus payment, you might still be eligible to receive one when you file your return.
Unemployment Insurance is Taxable
Millions of Americans filed for unemployment compensation since the start of the COVID-19 pandemic. Weekly unemployment benefits are taxable.
With so many people struggling, they may have chosen to skip having federal or state taxes withheld from their check. But come time for Tax Day, they may be shocked to find out that they owe money when filing their 2020 tax return.
If you are receiving unemployment but don’t have taxes deducted, now is a good time to change this. You’ll have a little less money every week, but it will cut down on what you owe in April 2021.
Retirement Plan Early Distributions
Traditionally taking money out of your retirement plan before you were eligible to do so exposed the taxpayer to an early withdrawal penalty of 10%. That’s in addition to the taxes that would be due on your early distribution.
For taxpayers who qualified for the coronavirus-related distribution forgiveness under the CARES Act, the early distribution penalty of 10% was waived. Although taxes will still be due to this withdrawal, a taxpayer can spread it over three years. If you put back the early distribution into your retirement account within three years of taking it, it is considered a rollover. This means you don’t have to pay taxes on it.
The CARES Act also allowed taxpayers to take out a loan of up to $100,000 from their employer-sponsored retirement plan and delay making payments on the loan for up to one year. Interest starts accruing when you took out the loan. Loans must have been taken out between March 27, 2020, and September 22, 2020.
Unless you itemize your deductions, you won’t see any tax benefit to making a charitable contribution. However, under the CARES Act, you can take an “above-the-line” deduction of up to $300 if you’ve donated money to a qualified charity. This is good news for those who take the standard deduction on their tax return. Only cash donations are eligible for this special deduction.
If you itemize your deductions, charitable contributions were limited to 60% of your adjusted gross income. The CARES Act removed this limitation for cash donations, which means you can deduct more of your charitable contributions if you itemize.
Those who are undecided between itemizing or going with the standard deduction, keep a close eye on your donations. It may be helpful to bump up your charitable contributions this year to take advantage of this change.
What is set to expire in 2020?
The Further Consolidations Appropriations Act, 2020, extended a handful of expired tax provisions through December 31, 2020. These include;
Energy-efficiency credits – If you made energy-efficiency improvements to your home, you might be eligible for a tax credit of up to 10% of qualifying roofs, insulation, windows, and doors, plus the cost of materials for other qualified upgrades. This credit is subject to lifetime caps, which vary based on the qualifying purchase.
If you’ve been thinking about making some energy-efficiency improvements and haven’t taken advantage of this credit, this is the year to do this. Unless this credit is extended, it will expire at the end of 2020.
Mortgage insurance premium deduction – If you currently pay mortgage insurance premiums, these can be included within your itemized deductions. This will expire on December 31, 2020.
Qualified Principal Residence Indebtedness (QPRI) exclusion – Typically, debt on a principal residence that is foreclosed on or partially written-off in a short sale is subject to tax. However, taxpayers may be entitled to exclude up to $2 million dollars of the forgiven debt, if married, or $1 million dollars, if single. This exclusion is extended through the end of December 31, 2020.
If you find yourself in a situation where you are considering a short-sale, it may be advantageous to do this before the end of 2020.
Qualified tuition and related expense deduction – Eligible Taxpayers can take an “above-the-line” tax deduction of up to $4,000 in qualified tuition and related expenses for dependents enrolled in an undergraduate or graduate program. This amount is deducted from your gross income, so it doesn’t matter if you itemize or take the standard deduction. This deduction is reduced if your income exceeds $65,000 if you are single at $130,000 if you are married.
Medical expense deduction – Taxpayers who itemize can deduct medical expenses that, in total, exceed 10% of their adjusted income. Under this expired law, the threshold was rolled back to 7.5%. If you plan to itemize, this might save you extra money.
Freelancer Tax Challenges
Many people turned to freelancing in 2020 to make ends meet. Many became drivers for Uber or Instacart or picked up a few side gigs in such things as graphic design, website development, or copywriting.
If you received freelancing income in 2020, there are few things you need to know.
- When you file your tax return, you can deduct the direct expenses that you incurred from your freelancing activities. Typical expenses include computer supplies, software subscriptions, and even paper for your printer. In some cases, you may be able to deduct a portion of your home office expense.
- After deducting these expenses, your net freelancing income is subject to federal and state taxes.
- Net freelancing income is also subject to social security and Medicare.
Be sure to keep all receipts to support any deductions that you’ve taken. If you are still doing freelance work, take a good look at what you’ve paid. If there are purchases you’ve been putting off, consider making these before the end of the year.
It’s also a good idea to estimate how much tax you owe and make quarterly estimated tax payments on Form 1040ES. This can help you spread out what owe so you don’t have a big surprise come April 15.
Payroll Tax Deferral
In August 2020, President Trump signed an executive order that allows employees to defer the 6.2% deduction from their paychecks for social security taxes.
While this has provided some extra cash for employees, keep in mind that this will need to be repaid in 2021. If you took advantage of this deferral, you should expect that the social security deduction from your paychecks in 2021 may double until this paid back in full.
While there has been discussion that this deferral may be permanent, meaning you don’t have to pay it back, nothing has been decided. You should expect to repay this 6.2% deferral in 2021, so it may be a good idea to set this money aside now.
Telecommuting Tax Liability
The pandemic forced many people to work from home. If you live and work in the same state, most likely, this isn’t an issue. But, if they are different and you ended up telecommuting from home, you may be subject to additional taxes where you live.
For some states where it’s common for people to work in one state and live in another, they may have reciprocity rules in place that eliminate this additional tax. Or they may give you credit for taxes that you’ve paid in another state. But for those states that don’t offer this, telecommuters may be subject to higher taxes in the state that they live. It’s a good idea to check out the rules that apply to the state you live in to determine if you may be hit with an additional tax liability.