The two emergency relief bills passed in 2020 and another in 2021 in response to the COVID-19 pandemic will make this an unusual tax season for many taxpayers. The Coronavirus Aid, Relief, and Economic Security (CARES) Act was passed in March, a second relief package was attached to the Consolidated Appropriations Act, 2021, in December, and just recently the American Rescue Plan.
The federal government relied on the tax system to deliver financial lifelines to struggling households, boost consumer spending, and help speed the economic recovery.
The following provisions may affect many households when they file their tax returns for 2020.
Recovery Rebate Credit
Most U.S. households received two Economic Impact Payments (EIPs) from the federal government in 2020. They are not taxable because technically they are advances on a refundable credit against 2020 income taxes.
The CARES Act provided a Recovery Rebate Credit of $1,200 ($2,400 for married joint filers) plus $500 for each qualifying child under age 17. The second bill provided another $600 per eligible family member.
Any individual who has a Social Security number and is not a dependent generally qualifies for the payments, up to certain income limits. The amounts are reduced for those with adjusted gross incomes (AGIs) exceeding $75,000 ($150,000 for joint filers and $112,500 for heads of household) and phase out completely at AGIs of $99,000 ($198,000 for joint filers and $112,500 for heads of household).
For the money to be delivered quickly, eligibility was based on 2019 income tax returns (or 2018 if a 2019 return had not been filed). Eligible taxpayers who did not receive two full payments, possibly due to errors or processing delays, may claim the money as a Recovery Rebate Credit on their 2020 tax return. Households that reported a lower AGI in 2020 (or added a dependent) might be eligible for additional funds. To calculate the credit, filers will need to know the amounts of any payments they already received. The credit amount will increase the refund or decrease the tax owed, dollar for dollar.
Taxpayers who received two full payments don’t need to fill out any additional information on their tax returns. Filing electronically usually results in a faster refund.
Another measure in the CARES Act allowed IRA owners and employer-plan participants who were adversely affected by COVID-19 to withdraw up to $100,000 of their vested account balance in 2020 without having to pay the 10% tax penalty (25% for SIMPLE IRAs) that normally applies before age 59½.
Still, withdrawals from tax-deferred retirement accounts are typically taxed as ordinary income in the year of the distribution. To help manage the tax liability, qualified individuals can choose to spread the income from a coronavirus-related distribution (CRD) equally over three years or report it in full for the 2020 tax year, with up to three years to reinvest the money in an eligible employer plan or an IRA.
Taxpayers who elect to report income over three years and then re-contribute amounts greater than the amount reported in a given year may “carry forward” the excess contributions to next year’s tax return. Taxpayers who recontribute amounts after paying taxes on reported CRD income can file amended returns to recoup the payments.
Qualified individuals whose plans did not adopt CRD provisions may choose to categorize other types of distributions — including those normally considered required minimum distributions — as CRDs on their tax returns (up to the $100,000 limit).
Other Notable Changes
For those who itemize deductions, the limit on the charitable gift deduction increased to 100% of AGI for direct cash gifts to public charities. For nonitemizers, a new $300 charitable deduction for direct cash gifts to public charities was available.
The floor for deducting medical expenses has been permanently lowered to 7.5% of AGI (it was scheduled to increase to 10% in 2021).
Unemployment Aid is Taxable
Unemployment benefits, which sustained many families impacted by the pandemic, are considered taxable income, and many recipients may not have correctly withheld taxes from their 2020 payments. Avoiding a surprise tax bill typically requires opting into a 10% withholding rate and, in some cases, paying additional quarterly taxes during the year.
However, with the recent passage of the American Rescue Plan, the bill made the first $10,200 in benefits received to be tax free for households under $150,000. This applies to 2020 only. If you already filed, you may have to amend your return.
Looking Ahead to 2021
The special rules for charitable gift deductions enacted for 2020 as discussed above have been extended through 2021. For nonitemizers, a $300 charitable deduction for 2021 direct cash gifts to public charities is available. For joint filers, this deduction increases to $600 for 2021 cash gifts to charitable organizations.
Starting in 2021, there is no deduction for qualified tuition and related expenses. Instead, the modified adjusted gross income (MAGI) phaseout range for the Lifetime Learning credit was increased to be the same as the phaseout range for the American Opportunity credit ($80,000 to $90,000 for single filers; $160,000 to 180,000 for joint filers).
A temporary provision that allows taxpayers to exclude discharged debt for a qualified principal residence from gross income was extended through 2025, though the limit has been reduced from $2 million to $750,000. Also, through 2025, employers can pay up to $5,250 annually toward employees’ student loans as a tax-free employee benefit.
For 2021 only, the American Rescue Plan will increase the amount of the Child Tax Credit to $3,000 per child ($3,600 for children under 5) for children 17 and younger. For 2021 this credit is fully refundable even if you have no taxes due. To qualify your modified adjusted gross income (MAGI) depending on how you file must be less than $75,000 for Single, $150,000 Married or $112,500 Head of Household. After that amount, the excess credit ($1,000 or $1,600 for children under 5) is reduced by $50 for every $1,000 above the MAGI limits.
We recommend you consult a tax professional who can further explain the relevant changes and recommend strategies to help reduce your tax liability for 2021.
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2021. Edited by BFSG.
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