By: Mitch Christensen, CPA, CFP®
In the past year, the Coronavirus has upended almost every conceivable aspect of our lives. From holidays to work arrangements to grocery shopping and more, very few things have remained the same in the wake of the pandemic. Even one of the most consistent annual rituals, tax filing, did not escape unchanged. The CARES Act was passed by Congress in March 2020, and a second round of relief legislation was passed in December. These two packages were intended to ease the economic tumult caused by the pandemic and will continue to have an impact through 2020 tax returns. Here are three ways the relief legislation could affect your taxes.
Impact #1: Stimulus Checks and Tax Credits
Millions of Americans received stimulus checks during 2020 and early 2021. The first Economic Impact Payment paid $1,200 per eligible adult and $500 per eligible dependent. The second paid $600 per eligible adult and $600 per eligible dependent. According to the IRS, if you did not receive these payments (or received a reduced amount) and were eligible, you may be able to claim the Recovery Rebate Credit on your 2020 tax return.
This will especially affect filers whose 2020 tax returns vary significantly from their 2019 or 2018 returns. The two stimulus payments were calculated based on the most recent tax return filed, either 2018 or 2019, while the Recovery Rebate Credit is based on the 2020 return. If you experienced an income reduction or added a new dependent in 2020, you may qualify to recover some of the stimulus money you previously did not receive.
Impact #2: Changes to Retirement Accounts
The CARES Act also adjusted the rules related to distributions of retirement accounts. It allowed individuals to withdraw funds from a 401(k), 403(b), 457(b) and Thrift Savings Plan before age 59 ½ without incurring the standard 10 percent penalty for an early distribution. Any distributions taken will still be included in taxable income over a three- or one-year period, depending on your choice.
Required minimum distributions from IRA accounts were waived in 2020. Similarly, if a distribution was taken before the CARES Act was passed, it could be returned by August 31, 2020 and not be included in your 2020 taxable income.
Due to these highly unusual circumstances, the reporting of these RMD reversals is a bit tricky. The distribution will be reported on the form 1099-R received for the IRA account, even though the amount reversed is not taxable. An amount equal to the reversal will be included on form 5498 to confirm the return of the distribution (and therefore its non-taxable nature), but that form is not available until May 2021. Therefore, if you did reverse your RMD, it is crucial that you consult with your tax advisor about how much of the distribution reported on the 1099-R is taxable.
Impact #3: Tax Benefits for Business Owners
The CARES Act implemented two main benefits for business owners: The Credit for Sick and Family Leave and the Employee Retention Credit. The Credit for Sick and Family Leave allows eligible employers to receive a credit in the full amount of the required sick leave and family leave for the period of April 1, 2020 through December 31, 2020. The refundable credit is applied against certain employment taxes on wages paid to all employees.
The Employee Retention Credit is a refundable tax credit equal to 50% of up to $10,000 in qualified wages paid after March 12, 2020 and before January 1, 2021. Eligible employers are businesses with operations that have been partially or fully suspended because of governmental orders due to COVID-19, or businesses that have a significant decline in gross receipts compared to 2019.
In addition to these explicit benefits from the CARES Act, there could be other ways to benefit from COVID-adjusted work arrangements. For example, many business owners opted, or were ordered, to work from home in 2020. Depending on the circumstances, these business owners may be able to classify their home as a home office, gaining access to the home office deduction on their 2020 tax return.
Although 2020 was a challenging year, knowing what additional resources are available can relieve the stress that normally accompanies tax season. Whether you are getting ready to file soon, or you have not yet thought about it at all, make sure you keep these changes in mind when you talk with your tax advisor.