2021 tax season: How to file your 2020 taxes
The most tumultuous year in recent memory—2020—may have come to an end, but we still have to file taxes for it. Before you begin accounting for last year's ups and downs, it's important to understand how the impacts of 2020 may affect your tax return in order to maximize your potential refund and prepare for any tax liabilities. From unemployment claims to new tax credits, learn the answers to five important questions many taxpayers are asking this year.
How do stimulus checks affect taxes?
During 2020, the federal government approved a first and second stimulus payment to qualifying taxpayers. If you received a stimulus check from the federal coronavirus relief package, you do not have to pay taxes on it. The stimulus payment is considered a refundable credit on your taxes.
However, if you qualified for a stimulus check but did not receive it or did not receive the entire amount, you can claim a credit for the unreceived amount on your 2020 taxes. You can also check your stimulus payment amount and claim a Recovery Rebate Credit through the IRS website.
Congress has passed a third stimulus payment of up to $1,400 per adult and the IRS began distributing these third stimulus payments during tax season. Recipients will be qualified based on the income reported on their 2020 tax return, or if they have not yet filed for 2020, they will be qualified based on their 2019 tax return. If your income decreased during 2020 and you think you may qualify for a third stimulus check (or for a larger amount) based on your 2020 income, file your taxes as soon as possible.
How does a furlough or layoff affect taxes?
If you were furloughed or laid off from your job in 2020, or if you earned less income for other reasons, you may owe less in taxes this year. When you are an employee, income is withheld from your paycheck to pay your taxes, based on your anticipated income for the entire year. If you went weeks or months without income or with lower income than usual, your tax bill will be lower.
If your income was significantly lower in 2020, you may have dropped into a lower tax bracket. That could also mean you end up with a tax refund after filing—or a larger refund than expected.
As a result of mass layoffs and furloughs in response to the pandemic, millions of Americans filed for unemployment in 2020. If you received unemployment benefits in 2020, you’ll need to report that income on your tax return if your state requires it. You can report unemployment income on IRS Form 1099-G.
Do you qualify for coronavirus tax credits?
Self-employed individuals who missed out on some earnings due to COVID-19 may qualify for tax credits. For example, if you had to take time away from your business because you were sick with COVID-19, you may be eligible for qualified sick and family leave equivalent tax credits. Also, if you had to take time away from your business to care for a sick family member or take care of children due to school closure or loss of childcare, you may be eligible. You can file for these credits using IRS Form 7202.
What about deductions?
Deductions are the portion of your income that are not subject to taxes. You can choose to itemize your deductions and take incremental deductions for various expenses, or you can take the standard deduction allowed by the IRS. For 2020, the standard deduction rose to $12,400 for individuals and $24,800 for married couples filing jointly.
Typically, only taxpayers who itemize deductions are able to deduct charitable contributions. But for 2020, the coronavirus stimulus bill known as the CARES Act allows people taking the standard deduction to take an additional $300 deduction for cash contributions to charity.
Those who itemize deductions are typically allowed to deduct only up to 60 percent of their adjusted gross income for cash contributions to charity. But for 2020, that limitation on cash contributions is lifted; taxpayers can now deduct charitable donations of up to 100 percent of their adjusted gross income for the year.
How are retirement plans affected by tax changes?
The CARES Act also allowed some people to take an early withdrawal from their tax-advantaged retirement accounts, such as IRAs or 401(k)s, without paying the usual penalty of 10 percent. To qualify for this early withdrawal, known as a coronavirus-related distribution, you have to prove that you, your spouse, and/or your dependent were either diagnosed with COVID-19 or experienced financial hardship as a result of the pandemic.
If you took a coronavirus-related distribution, it will be taxable. However, you can pay the related taxes over three years instead of paying the full amount in the tax year of the withdrawal. Also, if you pay the funds back to your retirement plan within three years, it will not be taxable.
Typically, people who have reached the age of 70 ½ are required to take minimum distributions from their traditional IRAs or 401(k) accounts. But for 2020, the required minimum distribution from your tax-advantaged retirement account has been waived. If you have already taken a required minimum distribution in 2020, you can roll it back into the plan within 60 days and defer paying taxes on the amount.
Also for 2020, people were allowed, if permitted by the plan, to take a loan of up to $100,000 or the full amount in their employer-sponsored retirement plan (whichever is less) as a result of coronavirus hardships. If you've already taken a loan from your retirement account, you can delay payments on it for up to one year, but the interest on that loan will accrue.
Tax season can be daunting for any taxpayer, especially following such an unprecedented year. The good news is knowing the answers to these common questions will help you better prepare your books, get educated on pandemic-related tax changes, and maximize your tax filing options.