Not preparing for the tax changes resulting from the CARES Act — or from the economic impact of COVID-19 — could be one of your biggest money mistakes of the year, so it's more important than ever to get a handle on tax rules well ahead of tax filing season.
This means going beyond just looking for the best tax software. You'll also have to plan in advance for the tax implications of COVID-19 so you aren't caught unprepared when the time comes to file and pay your tax bill.
So what exactly should you expect when you do your taxes in this unusual year? Here are seven big ways your returns could look different for 2020.
One of the most important forms of coronavirus relief came in the form of the first "stimulus checks," valued at up to $1,200 per qualifying adult and $500 per qualifying dependent. Most Americans received them already, as they were sent out in the weeks following the passage of the CARES Act at the end of March.
However, some people didn't get their checks because the IRS used their income information from 2018 or 2019 tax returns to determine if they were eligible to receive them, and there were income limits for eligibility. To get the full payment, your income had to be below $75,000 for singles or $150,000 for married couples.
Unfortunately, because the IRS was working with older income data, this meant people whose income fell in 2020 should have gotten a check, but the IRS didn't send one. Some people also didn't get the full amount of money they were owed because the IRS didn't know about their dependents or didn't have their information at all.
The good news is, these stimulus checks were actually an advance on tax credits. And the tax credit can still be claimed when filing 2020 tax returns. If you didn't get the full amount of your stimulus payment for any reason, you should claim the money you are owed by filing a 2020 tax return right away once the IRS begins accepting returns.
There's also more good news: if your payment was higher than it should have been because your income in 2018 or 2019 was lower than your earnings in 2020, you don't have to pay back any extra money you received.
Penalties for early withdrawals
Usually, when you withdraw money from a 401(k), individual retirement account (IRA), or similar retirement account, you have to pay a 10% early withdrawal penalty unless you are at least 59 1/2 or fall under some specific exemption.
But in 2020, the CARES Act waived those penalties for early withdrawals. If you took a coronavirus-related distribution, you won't owe the extra 10% penalty on the money. You still have to report the distribution you took out of your account, and the amount will be included in your taxable income, so you'll be taxed on it at your ordinary income tax rate.
The good news is you can spread out payment of the taxes due on withdrawn funds over three years. You can also put back any withdrawn money for up to three years. If you repay the amount you withdrew, you won't be taxed.
Unemployment benefits are subject to income tax on the federal level and sometimes by your state as well (here’s a guide to unemployment benefits in all 50 states for more info). If you received unemployment benefits, you have to report the income when you file your taxes. And if you didn't have enough taxes withheld from your unemployment checks as you received them, you could owe a lot of back taxes.
In some cases, workers received more money in unemployment than they earned while working. If your unemployment benefits were higher than your ordinary income, this could affect your tax bracket and it could mean you owe more money even if you had some taxes withheld from your checks.
You could also lose out on tax credits or deductions that are subject to income limits if your unemployment pushed your earnings over eligibility limits. For example, if you normally qualify for the Earned Income Tax Credit but you made more money this year because of higher unemployment benefits, you may not be eligible for it in 2020. This could make your tax bill higher.
Required minimum distributions
Once you reach age 72, you are normally mandated by tax laws to take withdrawals from certain retirement accounts every year, including your traditional 401(k) and IRA. These are called Required Minimum Distributions. If you don't take out the minimum amount required, you're taxed at 50% of the amount you should've withdrawn from your accounts.
These RMD rules were suspended for 2020. If you didn't take a withdrawal this year, your taxable income will probably be lower than it would've been in an ordinary year when you took the required distribution from your account. Your tax bill might be lower not just because you don't owe taxes on the withdrawn funds, but also because your reduced household income may mean you're in a lower tax bracket.
Sick leave and family leave tax credits
The Families First Coronavirus Response Act (FFCRA) entitled certain employees to paid leave. Specifically, workers were entitled to receive payment of 100% of their wages (up to $511 per day) for up to two weeks of paid sick leave if they took time off because they were subject to quarantine, were experiencing COVID-19 symptoms, or were caring for someone who was sick with COVID-19 symptoms.
Workers were also entitled to up to 12 weeks of extended leave paid at 2/3 of their wages up to a maximum of $200 per day if they had to take off from work because their children's school or child care center closed due to COVID-19.
Employers who paid out this leave to eligible workers are entitled to refundable tax credits to cover 100% of the money paid for up to 10 days of qualified sick leave and up to 10 weeks of qualified family leave. They can also get credits to cover their share of Medicare tax they normally owe on worker wages.
Employers have been allowed to report qualified leave on their federal employment tax returns. They have also been allowed to request an advance on the credits. But if you are an eligible employer, including a self-employed individual, and you paid out sick leave or family leave and you didn't get your credit yet, you're allowed to claim it when you file your 2020 return.
Normally, you're required to itemize on your taxes if you want to deduct any contributions you made to a charitable organization. In 2020, however, the CARES Act entitles you to claim up to a $300 deduction for contributing to a qualifying nonprofit even if you claim the standard deduction and do not itemize. To determine what charities should count to make you eligible for this deduction, check out this searchable guide put out by the IRS.
Changing state taxes
As many offices shifted to remote work due to COVID-19, some taxpayers have found themselves working in a different state than they ordinarily work in.
This may happen because you usually commute to work some place other than where you live (such as if you work in New York but live in New Jersey). Or it may occur because you decided to skip town and find a quiet place to hunker down and work away from your normal home base for a few months.
But if you live and work in a new state, you may find yourself owing income taxes to it. And depending on your home state's rules and the requirements in the place where you worked, you might end up being taxed in two places: your home state and the spot where you performed your job.
That double taxation can happen if the state where you live and the one where you actually work don't have reciprocity agreements that prevent double taxation or if your home state doesn't offer tax credits for taxes paid in other places.
Things can get really confusing when dealing with state tax rules from multiple locales, so if you worked in a new place due to the coronavirus pandemic, it may be worth talking with a tax specialist to find out what your obligations are.
Figuring out how to manage your money has been challenging this year due to the coronavirus. And the changes to your financial situation wrought by COVID-19 won't necessarily come to an end anytime soon. In fact, when you're determining how to file taxes this year, you may find that coronavirus impacts your obligations to the IRS and to your state government too.
With all these potential tax changes, you may not want to wait until the last minute to start the process of filing your return. Start gathering your paperwork and research what implications, if any, have been wrought by coronavirus on your tax situation. The sooner you prepare, the more likely it is you'll be ready to cope with any changes COVID-19 has caused to your 2020 returns.