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We are well into tax season, and ordinarily I would say it’s time to get serious about filing your 2020 Form 1040 if you’ve not already done so. But so far, 2021 has not been much more ordinary than 2020, the year we would all like to forget. Now, with the expected enactment of the Democrats’ American Rescue Plan (Round 3 of COVID-19 related relief and stimulus) any day now, your 2020 return has become a moving target.
Plus, there are some other tax-saving changes that you may qualify for with your 2020 return. Bottom line: if you’ve not yet filed last year’s return, please wait. You don’t want to have to file an amended 2020 return to collect the tax-saving breaks I’m about to explain. Here goes.
Claim tax-free treatment for up to $10,200 of 2020 unemployment benefits
The Senate version of the American Rescue Plan is expected to be the final version, and it includes a brand-new break that will allow you to treat up to $10,200 of 2020 unemployment compensation as federal-income-tax-free. I don’t yet have the details, so stay tuned. I’ll explain after I know them. If you’ve already filed your 2020 Form 1040, unfortunately you’ll have to file an amended return to collect your tax savings.
Claim the ‘universal’ $300 charitable deduction
For the 2020 tax year, you can claim an above-the-line deduction for up to $300 of cash contributions to IRS-approved charities. This temporary COVID-19 tax relief measure was included in the Coronavirus Aid, Relief and Economic Security CARES) Act. Above-the-line means you can take the write-off whether you itemize deductions or not. The $300 limit applies equally to unmarried individuals and to married joint-filing couples. However, if you use married-joint-filing status, the limit is $150.
Tax-saving tip: Claim your rightful deduction on Line 10b of Form 1040. Side note: The Consolidated Appropriations Act that became law late last year extended the $300 write-off into 2021 and doubled the deduction limit for 2021 to $600 for married joint-filing couples.
Claim recovery rebate credit to collect your rightful stimulus payments
You can potentially collect the first round and second round of so-called economic impact payments from the federal government if you didn’t receive a payment even thought you were eligible. These free-money payouts are better known as stimulus payments. Your 2020 Form 1040 can come into play in collecting any underpaid amounts. Here’s how that works.
First-round stimulus payments
First-round stimulus payments can be up to $1,200 per unmarried adult, up to $2,400 per married couple, and up to another $500 per qualifying child. Singles and those who use married filing separate status can collect the maximum first-round amount if their 2020 adjusted gross income (AGI) does not exceed $75,000. The AGI threshold is $150,000 for married joint-filing couples and $112,500 for those who use head of household filing status. Singles and those who use married filing separate status who have 2020 AGI above $99,000, joint-filing couples with 2020 AGI above $198,000, and heads of households with 2020 AGI above $136,500 are ineligible.
However, if you’ve already received a first-round stimulus payment based on your 2018 or 2019 AGI, you get to keep it even if you would not be entitled to that much based on your 2020 AGI.
Second-round stimulus payments
Second-round stimulus payments can be up to an additional $600 per unmarried adult, up to an additional $1,200 per married couple, and up to an additional $600 per qualifying child.
Singles and those who use married filing separate status can collect the maximum second-round amount if 2020 adjusted gross income (AGI) does not exceed $75,000. The AGI threshold is $150,000 for married joint-filing couples and $112,500 for those who use head of household filing status. Singles and those who use married filing separate status who have 2020 AGI above $87,000, joint-filing couples with 2020 AGI above $174,000, and heads of households with 2020 AGI above $124,500 are ineligible.
However, if you’ve already received a second-round stimulus payment based on your 2018 or 2019 AGI, you get to keep it even if you would not be entitled to that much based on your 2020 AGI.
Recovery rebate credit on your 2020 return squares the deal
Most folks have already collected their first and second round stimulus payments, based in information shown on their 2018 or 2019 federal income tax returns or information provided to the IRS. What you may not know is that those already-collected payments were in effect just estimated amounts. The maximum payment that you are actually entitled to is based on your 2020 income, which will be reported on your 2020 Form 1040.
If your 2020 AGI entitles you to bigger stimulus payments than what you’ve already collected, you can claim a so-called recovery rebate credit for the difference on our 2020 Form 1040. In effect, you’re allowed to “true up” your allowable stimulus payments based on your 2020 income now that it’s finally known. Use the Recovery Rebate Credit Worksheet in the Form 1040 instructions to see if you’re entitled to more free money. If you are, enter the amount on Line 30 of Form 1040.
Use 2019 earned income to claim bigger 2020 refundable credits
You can collect so-called refundable tax credits even if you have no federal income tax liability. For 2020, eligible individuals can claim a refundable child tax credit (CTC) equal to 15% of earned income in excess of $2,500, subject to a maximum refundable amount of $1,400. While the CTC can be up to $2,000, only up $1,400 can be refundable. Weirdly enough, the refundable amount is called the additional child tax credit (ACTC). Whatever. Just make sure to snag the maximum refundable credit that you’re entitled to.
The fully refundable earned income tax credit (EITC) equals the applicable percentage of an eligible taxpayer’s earned income. Earned income for purposes of these two refundable credits means wages, salaries, tips, other taxable employee compensation, and self-employment income. More earned income can translate into bigger refundable credits, and less earned income can translate into smaller refundable credits. Obviously, lots of folks had lower earned income in 2020 due to COVID-19 economic fallout, which could result in lower refundable credits. Not good!
Tax saving tip: For purposes of calculating the refundable ACTC and the refundable EITC for the 2020 tax year, you can use either your 2020 earned income or your 2019 earned income if that’s more than the 2020 figure and would result in bigger credits. The Form 1040 instructions explain how to make the election to use your 2019 earned income for purposes of claiming these two credits.
Make your choices if you took a coronavirus-related IRA distribution last year
If you are an IRA owner who was adversely affected by the COVID- 19 pandemic in 2020, you may have taken a tax-favored coronavirus-related distribution from an IRA last year. This privilege was thanks to the CARES Act. I call these tax-favored IRA distributions CVDs. Elsewhere, you may see them called CRDs. You can then contribute all or part of the CVD amount(s) back into one or more IRAs within three years of the distribution date(s). You can treat each distribution and later recontribution as what amounts to a federal-income-tax-free IRA rollover.
There are no restrictions on the use of CVD funds. Cash-strapped individuals can use the money to pay bills and recontribute later (within the three-year window) when their financial situation improves. You can help out your adult kids now and recontribute later. Or you can keep the CVD money and pay the resulting tax hit, which may be modest depending on your tax circumstances for last year. Whatever works. So, CVDs can be a useful cash-management tool for those who are experiencing a cash crunch in the COVID-19 era.
If you took a CVD, you will receive a Form 1099-R (Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.) that reports the distribution, and the IRS will get a copy too. To treat an eligible distribution as a CVD, include IRS Form 8915-E (Qualified 2020 Disaster Retirement Plan Distributions and Repayments) with your 2020 Form 1040. So far, so good. Now you must decide what to do with the CVD, or CVDs if you took more than one.
- If you recontribute all or part of a CVD by the due date, including any extension, for your 2020 Form 1040, it’s effectively treated as a federal-income-tax-free rollover. So, if you extend your 2020 return to October 15, 2021 you have until that date to recontribute and get the desired tax-free treatment. Report the contribution on Form 8915-E.
- If you choose to not recontribute any part of a CVD amount by the magic date, taxable income is triggered, but you won’t owe the 10% penalty that usually applies to taxable IRA distributions taken before age 59½. You have two options for how to handle the CVD income. You can choose to report the entire amount on your 2020 return, or you can choose to spread the income evenly over 2020-2022. If you later recontribute any part of a CVD amount within the three-year window, you can recover the federal income tax hit(s) by filing an amended return to report the recontribution. When all is said and done, you’ll have achieved federal-tax-free treatment for the recontributed amount.
- You must treat all CVDs received in 2020 the same way. You must either report all the taxable income on your 2020 Form 1040 or you must spread all the income evenly over 2020-2022. Either way, you must include Form 8915-E with your 2020 return to tell the IRS what you’ve chosen to do. Key point: The aforementioned favorable federal income tax treatment applies equally to CVDs taken from traditional IRAs, SEP-IRAs, and SIMPLE-IRAs. Key point: Similar rules apply if you took a CVD from a company retirement plan last year. Your tax pro can explain the details and your tax planning options. The bottom line The COVID-19 pandemic, its economic fallout, and available federal income tax relief provisions can make your 2020 Form 1040 a whole new ballgame. You don’t want to miss out on tax-saving breaks that you may have been unaware of until now. And the soon to be enacted American Rescue Plan includes at least one brand-new tax break that can make your 2020 return a moving target. So, if you’ve not yet filed your 2020 Form 1040, you may be well-advised to wait until the dust settles. Check back here for updates.
