Written By: Scott Crowe
The COVID-19 pandemic has brought changes to the tax landscape for the second consecutive year, as legislation surrounding stimulus beginning with the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), and continuing with the recently passed American Rescue Plan Act, altered the tax code. Amid the changing tax landscape, the IRS has pushed back the 2020 federal income tax-filing deadline from April 15 to May 17.
With these and other changes in mind, tax filers have a lot to consider for the 2020 tax season. Below are some key takeaways:
Understanding stimulus check eligibility and impact on tax liability
Stimulus checks are top of mind for many tax filers for 2020, as eligibility was based on 2018 or 2019 tax returns. Perhaps you didn’t qualify but your adult children did. It is important to understand the implications of the stimulus program. If you didn’t qualify, or you qualified for a reduced amount based on your 2019 tax return, and your income fell in 2020 to the point where you would now qualify for the full amount, you will retroactively receive those funds based on your 2020 tax return. The difference will be calculated in your refund or your tax liability will be reduced.
Conversely, if you qualified for and received stimulus funds based on your 2019 tax return, and your income increased in 2020 to the point where you would not have qualified, the IRS cannot take that dollar amount back or reduce your tax refund.
Making the appropriate tax liability payment
The CARES Act enabled retirement investors to access their retirement accounts, including their IRAs and 401(k)s, before reaching retirement age without penalty. Therefore, those who needed income or an additional resource could leverage the funds without incurring added tax.
In addition, the IRS allowed those who made withdrawals for COVID-related purposes to spread the tax liability over three years. So if you made a COVID-related withdrawal, it’s important you make at least one-third of the total tax liability payment as part of your 2020 tax return.
Of note, the CARES Act also allowed those who made COVID-related withdrawals to replenish their retirement accounts over the next three years without having to pay taxes on those funds. If you’re unsure whether you will be able to pay back your account in full, you may want to go ahead and make that first third of the tax liability payment. If you end up fully replenishing your account over the next three years, you will receive a refund for any tax payments.
Taking advantage of charitable deductions and the deadline extension
The 2020 federal income tax-filing deadline extension alleviates pressure on tax filers as well as tax professionals and the IRS. This extension gives you additional time to dot all your i’s and cross all your t’s. Consider consulting a tax professional to ensure your tax planning is comprehensive so you can leverage all of the available credits and deductions to maximize your refund or reduce your tax liability. In particular, the CARES Act allows for ‘above-the-line’ charitable deductions of $300 for tax filers utilizing the standard deduction. For tax filers utilizing itemized deductions, the CARES Act allows charitable deductions of up to 100% of AGI. These enhanced charitable deductions have also been extended for the 2021 tax year.
As you look to review your 2020 finances, it also marks a good time to connect with your financial advisor to ensure you are best-positioned for the 2021 tax year. Given potential changes to existing tax law from the new administration, you may want to strategize accordingly. Considerations include accelerating your income in 2021 to take advantage of the current tax rates, reviewing tax-loss harvesting strategies to offset realized capital gains, exercising stock options and leveraging the current lifetime gifting exemption.
According to Scott Crowe, one of our Advisors here at Merit, “In the future, tax rates may be higher, including the capital gains rate, which could increase significantly.” He notes, “If there are capital gains that you normally wouldn’t realize due to the taxes, you may want to reconsider and pay the taxes at the current rate. If you were planning to liquidate the investments in the next couple of years, you may want to do so now.”
When it comes to financial planning, you don’t know what you don’t know, especially in a landscape that’s continuously changing. That’s why we offer clients personalized planning, helping them to work toward their financial goals and improve their quality of life. Contact our team to learn about our wealth management services and how they can benefit you in and beyond tax season.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. The content provided herein is based on our interpretation of the CARES Act and is not intended to be legal advice or provide a tax opinion. This document is a summary only and not meant to represent all provisions within the CARES Act.