The COVID-19 pandemic has brought changes to nearly every aspect of public life, including tax season. Both the Coronavirus Aid, Relief, and Economic Security (CARES) Act (March 2020) and the Coronavirus Response and Relief Supplemental Appropriations (CRRSA) Act (December 2020) contain provisions that affect taxpayers in a number of ways.
Because the stimulus payments authorized by the CARES Act are considered refundable credits rather than taxable income, taxpayers must determine their allowed CARES Act stimulus payment/credit for their 2020 tax returns. If their payments (which were based on 2019 tax figures) were underestimated or if they never received stimulus payments in 2020, taxpayers will get an additional credit when filing their 2020 income tax return. The CRRSA added a separate, additional credit that works much the same way.
“If a taxpayer qualified for a stimulus payment, but the advance payment was overestimated, guidance from the IRS seems to suggest taxpayers will not need to return ‘excess’ credit payments,” said James Chyz, Pugh Professor of Accounting at the University of Tennessee, Knoxville’s Haslam College of Business. “However, if a taxpayer received a stimulus payment in error—for example, if they should not have qualified for any stimulus payment based on their 2019 and 2020 adjusted gross incomes but received one anyway—they should make arrangements to return the payment to the IRS.”
The CRRSA repealed the deduction for qualified tuition and related expenses but increased the phase-out limits on the lifetime learning credit.
“With the increased phase-out, if a couple files a joint tax return and one spouse returns to school while another spouse works—something that is quite common with many of our graduate students—they may be able to receive some tax benefit from tuition and related expenses on their 2020 income tax returns,” Chyz said.
Normally, only taxpayers who itemize deductions can deduct charitable contributions. However, for taxpayers who claim the standard deduction, the CARES Act allows an additional charitable contribution deduction of up to $300. The CRRSA increases the allowed deduction for those who do not itemize to $600. The CARES Act also raises the limit of charitable contributions to 100 percent of adjusted gross income.
“It should be noted that taxpayers who overstate this benefit are subject to a pretty steep underpayment penalty equal to 50 percent of the underpayment,” Chyz said.
Deferred Payroll Tax
If employees and employers chose to do so, employers were permitted to defer collection of employees’ portion of payroll taxes (e.g., Social Security and Medicare) temporarily. Employees who selected this option must ensure that their employer increases their payroll tax withholding starting January 1, 2021, and collects all deferred payroll taxes ratably by December 31, 2021.
Retirement and Pension Plans
Around 70 years of age, the IRS requires taxpayers with tax-deferred retirement plans such as IRAs and 401(k)s to take required minimum distributions from these plans. Typically, this increases taxable income for some people and deprives them of potential tax-deferred gains. The CARES Act eliminates required minimum distributions for 2020.
For individuals affected by COVID-19, the CARES Act and CRRSA waive the additional 10 percent penalty on early withdrawals of up to $100,000 from certain tax-deferred retirement plans. If taxpayers repay withdrawn amounts within three years, the distributions will not be considered ordinary income for individual income tax purposes. If taxpayers choose to keep withdrawn amounts, then they will be considered ordinary income subject to income tax.
“Taxpayers are permitted to pay the tax associated with any 2020 withdrawals included in ordinary income ratably over three years beginning in 2020,” Chyz said. “Taxpayers need to either commit to repaying their withdrawals and set aside funds to do so or begin including withdrawals as income on their 2020 tax return.”
Stacy Estep (865-974-7881, firstname.lastname@example.org)