Coronavirus. Tiger King. Friends challenging you to do dozens of pushups on Instagram. There’s no doubt that 2020 threw a lot at us.
Well, we hate to break it to you, but it looks like it could throw a wrench into this upcoming tax season too.
With hundreds of billions of dollars in stimulus money, business loans, and unemployment benefits floating around, everyone is trying to keep up with what all this means for you when you sit down to file your taxes this year.
First, don’t panic! Here are some answers to some of the biggest questions about how the coronavirus (and everything that followed because of it) might affect your 2020 tax returns, plus some action steps you can take to prepare yourself and avoid any nasty Tax Day surprises.
1. Will the stimulus check money I received be taxed?
Nope, the stimulus money that you received from Uncle Sam will not count as taxable income. So that’s one less thing you have to worry about when Tax Day rolls around!
Let’s back up a little bit. In March 2020, the U.S. government passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act in an effort to try and provide help to everyday Americans during the height of the coronavirus pandemic.
Individuals who filed taxes in 2018 or 2019 received $1,200 for each adult and $500 for each child. So a household with two adults and two children, for example, most likely received $3,400 in stimulus money.1
So, why isn’t that money being counted as taxable income? Because it’s being treated like a refundable tax credit for 2020. Translation: Your stimulus check is sort of like an advance on money you would have received anyway as part of your tax refund in 2021.
2. I took money out of my 401(k). What’s going to happen with the money I took out?
Another thing the CARES Act did is allow people to take a type of “hardship withdrawal” of up to $100,000 out of their retirement accounts until the end of 2020 without having to pay the usual 10% early withdrawal penalty.2
But even without the early withdrawal penalty, you’ll still have to pay income taxes on any money you take out of your traditional 401(k)s and IRAs. If you’re not careful, you could bump yourself into a higher tax bracket and owe Uncle Sam even more in taxes for this year.
Look, if you’re currently staring at your 401(k) balance with hungry eyes, let us dump a bucket of ice-cold water on that idea: Don’t do it. We don’t want you to even think about taking money out of your retirement accounts. The only time it ever makes sense to tap into those accounts is to avoid bankruptcy and foreclosure. That’s it.
Even without the early withdrawal penalty, raiding your 401(k)s and IRAs is a bad idea for two reasons. First, you’re sabotaging your money’s ability to grow over the long term and basically stealing money from your future self. Not cool. And second, like we just talked about, you’ll have to pay taxes on the money you take out.
But to the point, what if you already took some money out of your 401(k)s and traditional IRAs? The good news is you can undo that mistake! The CARES Act allows you to return any funds within the next three years and file an amended return.3 That way, you can get a refund on the taxes you paid on that money and get your retirement savings back on track.
3. I lost my job and received unemployment benefits. Are those benefits taxable?
That depends. Up until recently, all unemployment benefits counted as taxable income. But with the March 2021 passing of the American Recovery Plan (ARP), things got a little funky.
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Here’s why: Before the ARP passed, in the early onset of the coronavirus, millions of Americans lost their jobs or were furloughed and record numbers of people signed up for unemployment benefits.4 Plus, some folks not usually eligible for unemployment benefits—freelancers, independent contractors and the self-employed—became eligible to file for Pandemic Unemployment Assistance through the CARES Act.5
The plan was for all those unemployment benefits to be taxable, but now the ARP is changing that in order to provide some pandemic relief. So now, if you received unemployment benefits in 2020, the first $10,200 ($20,400 per married couple) will not be subject to federal taxes.6
Of course, there’s some fine print:
1) You will still have to pay taxes, according to your tax bracket, on any benefits you got in excess of $10,200—so if you got $10,500 in unemployment, you’d pay taxes on that extra $300.
2) The tax break only applies if your annual household income was below $150,000. If you earned a higher household income than that in 2020, you’ll have to claim your unemployment benefits just like before.7
If I Have to Pay the Taxes, How Do I Do It?
If you do need to pay taxes on all or some of your unemployment benefits, there are a few ways you can do it, depending on what you chose when you first signed up for unemployment. Here are your three options:
- You could opt to have 10% of each payment withheld to cover all or some of what you owe in federal income taxes (you can’t withhold more or less from unemployment benefits).8 That’s probably the easiest option!
- If you chose not to have taxes withheld from your benefits, then you could pay quarterly estimated taxes on that money.
- Claim and pay them all at once during tax season. That’s not what we normally advise, but this is not a normal year. If you hesitated to do anything with taxes ahead of time, or the moment has passed, we get it.
4. I took on some side jobs to make up for some lost income. What should I expect?
Whether you were delivering groceries all over town or selling everything in your house that wasn’t nailed down to the floor, you might have taken on a side gig (or three) to replace lost income or pile up cash to ride out the pandemic. Hey, you gotta do what you gotta do!
But guess what? That money you made freelancing or doing odd jobs here and there will be taxed, so here’s a rundown of what you need to know:
- First, you’ll owe regular income taxes on that money at your ordinary tax rate.
- On top of that, you’ll also have to pay the self-employment tax—that’s a 15.3% tax which covers your share of Social Security and Medicare taxes—if you made more than $400 in self-employment income for the year. Don’t worry, you can probably write off half of that 15.3% on your tax return.9,10
- If you expect to owe more than $1,000 in taxes for the year, the IRS wants you to pay quarterly estimated taxes, so it doesn’t all pile up toward the end of the year.
- You’ll probably receive 1099 forms from those you did work for, so keep an eye out for those. And you’ll need to fill out a Schedule SE form to report any other self-employment income you might have made during 2020.
Here’s a good rule of thumb for the future: Since the taxes from your side hustle income usually won’t be withheld like they would be in a “normal” job, you should set aside 25–30% of every paycheck you get for taxes. That way, you’re not scrambling around to pay your taxes when the deadlines roll around.
5. I’m working remotely for my company from a different state. How will that impact my taxes?
This one’s a little tricky. According to the Pew Research Center, about 1 out of 5 Americans relocated because of the pandemic or know someone who did.11 If you’re one of those remote workers who crossed state lines, you might be in for a tax surprise—and not the good kind.
You see, each state has its own tax system with its own set of rules—and most states that have their own income tax will impose them on anyone doing work in their state, even if they are just passing through.
Now, a few states already have “reciprocity agreements” in place that prevent income from being taxed twice, and a few others have offered tax relief for remote workers because of the pandemic. But some states are not budging on their state tax laws. That means a lot of folks who work in one state but live in another could end up owing taxes in two states this year.
6. Since I was working from home, I can claim the home office deduction on my tax return, right?
Not so fast! Remember the Tax Cuts and Jobs Act that was passed a few years back? That law did away with a bunch of “miscellaneous itemized deductions” in exchange for a higher standard deduction. That means writing off the cost of setting up and maintaining a home office is off the table for most taxpayers.
Generally, the home office tax deduction is only available for self-employed individuals, freelancers or independent contractors who have a home office that is used exclusively for business purposes on a regular basis. That means office workers sent home by their employers during the pandemic don’t count, since they don’t work exclusively out of their home.
But that doesn’t mean you’re out of options! If you’ve had to spend some money on supplies that you needed to do your job from home, ask your employer if they’d be willing to reimburse you for those expenses.
7. I’m a college student and took out some funds from a 529 plan to pay for college. Then we were sent home and the university refunded some of it. What happens to that money?
Many colleges and universities across the country decided to shift all their classes online and send students home for the year. As a result, many students (or their parents) got a refund for what they paid for tuition and student housing. But if you used a 529 plan or Educational Savings Account (ESA) to pay for those educational costs, you might find yourself in some tax trouble.
Here’s why: Any money you take out of a 529 plan or ESA must be used for qualified educational expenses in order to be tax-free. Makes sense. But since that money isn’t being used to cover education expenses anymore, now you’ll have to pay income taxes on it and the IRS might smack you with a 10% penalty.13 Uh-oh.
To avoid paying those taxes and penalties, you need to put that money back into your 529 or ESA account. But don’t wait too long, because you only have 60 days from the date the refund was issued to do that.14 Clock’s ticking!
8. My company decided to defer my payroll taxes for the remainder of 2020. What does that mean?
Some workers might have noticed that their paychecks got slightly bigger during the last few months of 2020. That’s because the Trump administration signed an executive order that allowed companies to defer payroll taxes (Social Security payroll taxes, to be specific) from Sept. 1, 2020, to Dec. 31, 2020.15
So if you’re a federal government employee or work at a company that decided to defer your Social Security payroll taxes for the rest of 2020, you saw a temporary 6.2% bump in your paychecks. Don’t jump for joy just yet, because there’s a catch.
The key word here is deferred. This is not a tax break—those taxes still need to be paid. That means companies will have to make up that money between January and April 2021, so you’ll be seeing less money in your paycheck during that time. So brace yourself for that!
9. I tested positive for COVID-19 and piled up a bunch of medical expenses as a result. Can I deduct those costs from my taxes?
It depends. The IRS lets you deduct medical, dental and other health expenses that fall above 7.5% of your adjusted gross income (that’s the part of your income that is taxable) for the year.16
For example, if your adjusted gross income is $50,000, first you would multiply that by 7.5% to find out that you can only deduct expenses that exceed $3,750. If you spent $5,000 in medical expenses in 2020, that means you can only deduct $1,250 in medical expenses.
But here’s the kicker: You can only deduct medical expenses if you choose to pass on the standard deduction and itemize your deductions instead.
Does it make sense to itemize your deductions? For 2020, the standard deduction is $12,400 for single filers and $24,800 for married couples. It really only makes sense to itemize if your itemized deductions (including medical expenses) are greater than the standard deduction, so choose wisely!
10. I’m a small business owner who took out a PPP loan. How will that impact my taxes?
The CARES Act didn’t just set out to help individuals and families—it also tried to provide some financial assistance for struggling small business owners by offering them Paycheck Protection Program (PPP) loans. These loans were designed to be “forgiven” as long as they were used for certain business expenses—particularly payroll, rent or interest on mortgage payments, and utilities.
And while income from debt forgiveness usually counts as taxable income, the CARES Act makes an exception for PPP loan forgiveness. That means that as long as you used those PPP funds for eligible expenses, that money will not be taxed . . . as long as your loan forgiveness application is approved (more on that in a minute).
Here are a couple of things to know about these PPP loans:
- In December 2020, the IRS announced that “eligible expenses” you paid with money from those PPP loans can be deducted from your taxable income—things like payroll, rent and utilities.17
- You’ll have to get your loan forgiveness application approved by the Small Business Administration before you’re off the hook for the amount you borrowed.
But Dave has said it from the very beginning: Do not take out a PPP loan! There are a lot of strings attached to these loans, and if you’re not careful you could be on the hook for paying back the entire amount if your forgiveness application gets rejected. President Ronald Reagan once said that the nine most terrifying words in the English language are “I'm from the government, and I'm here to help.” He might have been onto something!
Got Questions? Work With a Tax Pro!
Without a doubt, this tax season is going to be a hot mess for millions of Americans who have seen their lives turned upside down by this pandemic. If you’re one of them, it might be a good idea to reach out to a tax advisor who is up-to-date on the latest news and changes for this tax season. If you have a simple return, check out our new Ramsey SmartTax to file with confidence.
If your return is more complicated and you want to avoid making huge mistakes that could cost you hundreds or thousands of dollars, our tax Endorsed Local Providers (ELPs) are ready to help!