The COVID-19 pandemic has created some unique—and often challenging—financial circumstances for many taxpayers over the past year. The University of Tennessee, Knoxville’s Haslam College of Business shares things to keep in mind as you file your taxes for 2020.
Like normal unemployment compensation, unemployment benefits authorized by the Coronavirus Aid, Relief, and Economic Security (CARES) Act are considered taxable income when received. However, recipients do not have to pay Social Security and Medicare taxes on this income. Taxpayers could choose to withhold income taxes from each benefit payment or to collect the entire amount.
“Taxpayers who chose not to have income tax withheld from unemployment compensation they received in 2020 should estimate their taxable income and likely tax due early to give themselves time to set aside funds to pay the liability when it becomes due on April 15, 2021,” said James Chyz, Pugh Professor of Accounting.
Home Business Expenses
Working from home these days? Keep in mind that only individuals with self-employment income (including independent contractors who work for an organization but do not receive a W-2) can take a home office deduction. To qualify, the home office space must be located in the taxpayer’s primary residence and be used exclusively for conducting business on a regular basis.
Even if a taxpayer collects self-employment income, not all work from home qualifies for the home office deduction, Chyz cautioned.
“Taxpayers who qualify for a home office deduction can typically deduct the business portion of real estate taxes, mortgage interest, rent, casualty losses, utilities, insurance, depreciation, maintenance, and repairs,” he said.
Perhaps you’ve been able to save money this year because you’ve been staying home more, and you are looking for tax-free ways to grow those savings.
Contributing to an IRA (individual retirement account) is a simple way to earn tax-deferred income on savings and to receive a tax benefit through an adjusted gross income (AGI) reduction. For 2020, taxpayers can contribute up to $6,000 ($7,000 if 50 or older) to a traditional IRA, Roth IRA, or a combination of both. One of the biggest advantages of an IRA is that it can be implemented after the tax year has ended—contributions can be made at any time up until the income tax return filing deadline.
“Traditional IRA contributions tend not to get phased out based on income, but these contributions might not be deductible if the taxpayer or their spouse participates in an employee-sponsored retirement plan,” Chyz said. “Even if the contribution is not tax deductible, it’s still tax deferred, meaning any earnings on contributions are not taxed until withdrawn from the IRA. Roth IRA contributions, which are not tax deductible, do phase out based on income, so taxpayers need to be careful when deciding which type of account to fund.”
Taxpayers who have school-age children and have phased out of Roth IRA contributions may want to consider a 529 plan, a tax-free investment account that can be used for education savings. These plans have no income-based phase-outs and no limits on annual contribution amounts. Another advantage is that the beneficiary of the account does not have to be your dependent.
A 529 plan works very much like a Roth IRA in that after-tax amounts contributed to the plan and earnings on those amounts can be withdrawn tax free if withdrawals are used for qualified education expenses. Qualified higher education expenditures include, but are not limited to, tuition at a college, university, trade school, or vocational school; apprenticeship expenses; room and board; books, and computer equipment.
“Taxpayers can also use 529 plan withdrawals for K–12 tuition of up to $10,000 per student per year at a public, private, or religious school,” Chyz said.
Read more about how the Coronavirus Aid, Relief, and Economic Security (CARES) Act (March 2020) and the Coronavirus Response and Relief Supplemental Appropriations (CRRSA) Act affect your taxes.
Stacy Estep (865-974-7881, email@example.com)