It’s that time of year again, tax season. Needless to say, 2020 was an unexpected year for most. The COVID pandemic played a role in the lives of most, from corporate businesses to small mom and pop business owners. Government involvement in the economy attempted to help businesses survive the financial hardships experienced throughout the year. Now as taxpayers prepare to file their tax returns, they face questions of how to incorporate the financial support they were given among other aspects of their annual income.
Minimize your chances of being audited by IRS this tax season by following these tips when preparing your tax filings.
Employee Retention Credit (ERC)
The Employee Retention Credit was enacted as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act to encourage businesses to keep employees employed and on their payroll. It allows employees to qualify for a tax credit of 50% of paid wages, up to a maximum of $10,000 per year per employee. Originally, this relief package is only available to taxpayers that did not receive a PPP loan. This has since been modified to allow PPP recipients to also benefit from the ERC with the stipulation that they are not eligible to claim credit for wages that were paid and forgiven with their PPP loan. Taxpayers may need to file amended payroll tax returns to claim the proper credit.
Unknown to some, unemployment benefits are taxable. Millions of Americans began receiving unemployment benefits following layoffs and budget cuts resulting from the onset of the COVID pandemic. Following a significant increase in unemployment benefit recipients, IRS released information to remind recipients that these benefits are indeed taxable and must be reported as income on federal returns.
As the tax season continues, recipients of unemployment benefits are reminded of this as they are required to declare their income as such on their returns. While benefit recipients can voluntarily elect to have had taxes withheld from each of their unemployment payments, not all recipients choose to do so. If you did not choose to have these deductions made over the course of your receipt of benefits, you will be expected to repay owed taxes upon submitting your tax return.
Economic Impact Payment
Economic impact payments, also known as stimulus payments, were another of the government’s responses to the ongoing economic effects caused by the COVID pandemic. Eligible recipients earned a maximum of $1,200 and $600 in each of the consecutive payment rounds during 2020. Unlike unemployment benefits, these payments are not tax-deductible.
While these payments are not tax-deductible, their receipt must be declared when completing your tax return. Additionally, if a taxpayer was eligible and should have received a stimulus payment but did not or did not receive the correct amount that they were due, filing as such will qualify them to receive the proper payment as was due. Eligible recipients will be able to claim a Recovery Rebate Credit when they file their 2020 Form 1040 or 1040-SR.
Discharge of indebtedness on principal residence
The exclusion from income for discharge of indebtedness on a principal residence has been extended through 2025. In the current real estate explosion in California, this is not a concern, however, in areas of the US where real estate prices have been further deflated because of the economic crisis caused by the pandemic, the indebtedness discharge allows a tax write-off based on certain criteria centered on the amount of mortgage debt an owner carries in relation to the value (current market) of the property. There are exceptions and allowances for capital improvements and adjustments based on refinancing amounts as they relate to the current valuation and remaining debt levels. Consult with a qualified CPA, well versed in real estate tax law to fully understand your tax implications for your principal residence.
Required minimum distributions (RMDs)
The required minimum distribution requirement for all retirement plans has been waived for 2020. Traditionally, once a taxpayer turns 70 ½ years old, they are required to begin making withdrawals from their retirement plan. The amount required to be withdrawn on an annual basis can be calculated with the use of IRS-provided worksheets.
RMDs were waived entirely for all retirees, including those not affected by the COVID pandemic. The decision to waive RMDs in 2020 provides flexibility for those who can afford not to take retirement plan distributions. While this waiver is beneficial for the current year, it does not change individuals’ required start date for RMDs past 2020.
Earned Income Tax Credit and the Child Tax Credit (EITC and CTC)
The “lookback” rule allows taxpayers to use either their 2019 or 2020 income, whichever is most beneficial, to get the most out of the Earned Income Tax Credit and the Child Tax Credit. This tax break will be beneficial primarily to low to moderate-income taxpayers.
Taxpayers should still be careful and aware that there are two different calculations for EITC and CTC. While EITC recipients may be eligible to receive between $538 and $6,660, CTC recipients are eligible to receive up to $2,000.
Deductible Meal Expenses
Business meal expenses incurred after December 31, 2020, will be eligible for 100% deduction, rather than the previous 50% deduction. Additionally, this adjustment will only persist through the end of 2022. While this will not be notable as part of 2020 returns, it is of notable significance for the upcoming tax year.
Retirement Account Withdrawals
Should a taxpayer have found the need to withdraw funds from their retirement account as a result of financial hardships due to the COVID pandemic, they will be granted a three-year period to repay the withdrawal funds without penalty. In addition to the ability to repay the withdrawn amount to their account, the CARES Act also allows for withdrawn amounts to not be recognized as earned income for tax purposes. The law also waives the 10% early withdrawal penalty for COVID-related distributions (CRDs) between January 1 to December 31, 2020.
Every year, tax season brings about a certain amount of stress and concern. It’s not ideal for anyone to file incorrectly and be at risk of an IRS audit. The economic events that stemmed from the COVID pandemic in 2020 have added an extra layer of uncertainty to taxpayers as they prepare their returns. Uncertainty and confusion in preparing your taxes could be the equivalent of leaving the door open for IRS to perform an audit. Following these tips is a starting point to ensure that your 2020 tax return is completed correctly. Consult with a qualified CPA and, in case of IRS audit, contact the team at MIlikowsky Tax Law. We keep business in business.