The coronavirus pandemic has changed how people live their daily lives. For many, it has reduced their income temporarily or, in some cases, permanently. Even if you know how to manage your money well, you may have felt the financial strain of 2020. Thankfully, the federal government stepped in to help with stimulus checks.
You may have heard that the stimulus payments, also known as economic impact payments, were actually advances on a tax credit, but that’s a bunch of complicated tax speak. What does it really mean? You may wonder how the stimulus check and your taxes work together.
Here are six important things you need to know about stimulus checks and taxes so you can properly prepare for filing your 2020 tax return.
- First: how the stimulus check amounts were calculated
- 6 Things You Need to Know About Taxes If You Got a Stimulus Check
- Your stimulus checks were refundable tax credits
- Your stimulus check mostly likely can’t be garnished
- You may have to fill out more paperwork
- You won’t have to pay it back if you earn more in 2020
- You could become eligible if your 2020 income is lower
- You could claim a baby born in 2020
- Bottom line
First: how the stimulus check amounts were calculated
First, a refresher on how we ended up with our stimulus checks. Congress authorized two stimulus checks in the calendar year 2020. The full amount of each was different and broke down as follows:
- The first stimulus check gave eligible taxpayers $1,200 if they filed a tax return as single, head of household, married filing separately, or qualifying widow(er) or provided a couple $2,400 if they filed a tax return as married filing jointly. It added another $500 for each qualifying child.
- The second stimulus check gave eligible taxpayers $600 if they filed a tax return as single, head of household, married filing separately, or qualifying widow(er). Eligible married couples filing jointly received $1,200. The check also included $600 per qualifying child.
For both checks, your adjusted gross income could limit the amount of your check. Each check was reduced by 5% of your AGI that exceeded the limits for your filing status. These limits were as follows:
- Single filers or married filing separately: $75,000
- Heads of household: $112,500
- Joint filers or qualifying widow(er)s: $150,000
Now, with this in mind, let’s look at six important things you need to know about your stimulus payment. There are a lot of rumors and myths right now, and it’s important to know the facts.
Your stimulus checks were refundable tax credits
To get the stimulus checks out as quickly as possible, Congress had to do some creative thinking. The stimulus checks that started trickling by direct deposit into bank accounts and as paper checks into our mailboxes in April 2020 weren’t just free money. They were tax credits authorized as part of the stimulus package in the CARES Act. The credit’s formal name is the Recovery Rebate Credit.
Some people may mistakenly think their stimulus check is a tax deduction. Tax credits are different from tax deductions. A tax credit reduces the amount you owe, while a tax deduction decreases your taxable income. Here’s why that matters a lot:
- A tax credit reduces the tax you owe by one dollar for each dollar of the tax credit. If you receive a $2,000 tax credit, it reduces the tax you owe by $2,000.
- A deduction reduces your taxable income by one dollar for each dollar of deduction. That means if you’re in the 12% marginal tax bracket, a $1 tax deduction gives you a 12 cent decreased tax bill.
That’s obviously a big difference. Thankfully, Congress set up the stimulus checks as tax credits that could be fully refundable. By doing this, Congress made it so everyone who qualified for a tax credit could get the money even if they didn’t owe any federal income tax.
Usually, you claim tax credits when you file your tax return. You would normally claim a 2020 tax credit when you file your tax return in early 2021. To speed up the process, Congress decided to give you an advance on that tax credit by mailing out stimulus checks or directly depositing the funds in your bank account.
By engineering the stimulus as a tax credit, Congress avoided a major potential issue. Because they’re tax credits, the stimulus checks don’t get counted as income. That means you don’t have to pay income tax on the amount you received.
Some people worry they may receive a smaller refund because of the stimulus check payments. The good news is the stimulus checks won’t decrease your usual tax refund amount you receive after filing your tax return. At a minimum, your stimulus check and tax credit should offset each other. This means your regular tax refund should remain unaffected.
In some cases, your tax credit may be larger than your stimulus check. If this happens to you, your refund could potentially be larger than normal. That said, other changes to your situation could change your usual refund in 2020 as it was anything but an average tax year.
Your stimulus check mostly likely can’t be garnished
When Congress passed the CARES Act and the Consolidated Appropriations Act, 2021 (the law that created the second stimulus check), it made rules regarding who couldn’t take your stimulus check money. Unfortunately, the laws didn’t cover every potential situation.
The first and second stimulus checks had different rules. For the first check, the Internal Revenue Service couldn’t take the money to pay back taxes. However, the money could be taken to pay back child support owed, and creditors could seize the funds to cover the debts you owed. Some states passed laws to limit creditors, but it didn’t happen across the U.S.
The second stimulus check provided Congress an opportunity to learn from its mistakes. The second check could not be garnished to pay back taxes, child support, or creditors.
Unfortunately, the system still isn’t perfect. If you have a negative bank balance due to overdrafts and your stimulus check gets deposited into that account, banks can technically use it to offset that negative balance. Many large banks have said they will not do this, but it depends on the particular bank you use.
You may have to fill out more paperwork
Within 15 days of receiving each of your stimulus check payments, you should have received a letter from the IRS. The first stimulus check letter was Notice 1444. The letter for the second stimulus check was Notice 1444-B. These notices show you the amount of the stimulus check you received.
If you received the maximum possible stimulus check amounts based on the number of qualifying dependents you had, you don’t have to file any extra paperwork with your 2020 tax return. Those who received less than the maximum amount possible may be able to claim a credit if their circumstances in 2020 differed from the data used to calculate the stimulus check payment amounts.
To calculate the additional amount of the Recovery Rebate Credit you qualify to take on your 2020 tax return, filers should use the “Recovery Rebate Credit Worksheet - Line 30” worksheet. You can find this on page 59 of the IRS’s instructions to Form 1040. Take the result from this worksheet and report it on Line 30 of Form 1040 to claim the credit. If you aren’t filing your tax return by hand, your tax software or tax preparer should take care of this for you.
You won’t have to pay it back if you earn more in 2020
The stimulus check amounts were issued based on previous tax information. To calculate the stimulus check payment amounts, the IRS had to use an AGI amount to determine if you made too much money to qualify for a stimulus check. If you did, your check amount might have been reduced or you might not have qualified for stimulus money at all.
Whether the IRS used your 2018 or 2019 AGI information depended on each check and when you filed your 2019 tax return. If you received the checks based on 2018 or 2019 tax return information but your 2020 AGI would have disqualified you from receiving stimulus checks, you don’t have to worry about paying the money back.
You could become eligible if your 2020 income is lower
Sadly, many people faced enormous financial hardships in 2020. Companies laid off employees temporarily and others permanently shut down operations. If your income was high in 2018 or 2019, it might have limited your stimulus check amounts or eliminated your eligibility for a payment altogether.
Thankfully, people who qualify for the checks based on their 2020 income can still claim their stimulus check payment. Because the credit can be based on your 2020 AGI, you can claim the remaining amount of your stimulus credit when you file your 2020 tax return in early 2021. This will either decrease the amount of tax you owe for 2020 or result in a larger refund than you would have otherwise received, depending on your specific tax situation.
You could claim a baby born in 2020
If you’re like my family and had a child in 2020, the IRS didn’t know about them when they sent out your stimulus checks. As long as your baby was born on or before Dec. 31, 2020, they may be a qualifying child for the tax credit’s purposes.
You can claim the additional stimulus check amounts for your family’s new addition when you file your 2020 tax return in early 2021. As long as the baby qualifies, the ultimate result should lower the tax you would have owed or increase the refund you will receive, depending on your situation.
Congress designed the stimulus checks to help Americans get money to help offset a small part of the financial strain the COVID-19 pandemic has caused. The calculations required to figure out the stimulus check amounts and the way the checks were issued weren’t perfect. If you don’t double-check what you qualify for based on your 2020 tax information, you could be leaving money on the table.
Understanding all the tax rules and how to file taxes on your own can feel overwhelming. You don’t have to do it alone. The best tax software options can make filing your tax return much more manageable. All you have to do is answer questions and input your tax information. The software takes care of the rest, including calculating whether you’re eligible for a higher Recovery Rebate Credit than your 2020 stimulus checks paid you.