COVID-19 and Taxes: What To Know Before Filing Your Return

COVID-19 threw the world for a loop in 2020, forcing some companies to close and sending unemployment sky high in the U.S. To help alleviate the financial pressures Americans were feeling, the U.S. government released two economic impact payments tied to a pair of relief bills: the CARES Act and the Coronavirus Response and Relief Supplemental Appropriations Act of 2021.

Most taxpayers are used to paying income taxes on any additional income they have coming in. Below, we'll explore whether the stimulus payments will have any impact on filing taxes in 2021 and your tax refund. Plus, we'll look at what other situations may impact your taxes.  

Will Pandemic

In 2020, most American families received two economic impact payments, also called stimulus checks, in response to the coronavirus pandemic. 

The 2020 stimulus payment, which was part of the CARES Act, provided $1,200, plus $500 for each dependent under 17 years old, to individuals who earned $75,000 or less and heads of household who earned $112,500 or less in 2019. Married couples filing joint taxes who earned $150,000 or less in 2019 received $2,400, plus $600 per dependent under 17 years old.  

As part of the Coronavirus Response and Relief Supplemental Appropriations Act of 2021, the government released more stimulus funds. This second round provided $600, plus $600 for each dependent under 17, to individuals who earned $75,000 or less and heads of household who earned $112,500 or less in 2019. Married couples filing joint taxes who earned $150,000 or less in 2019 received $1,200, plus $600 per dependent under 17 years old.  

If you didn't file a 2019 tax return, the Internal Revenue Service (IRS) used the information from your 2018 return to determine eligibility. 

Recipients of  the stimulus checks may have been understandably concerned about how the payments might impact filing taxes in 2021, including whether the IRS would tax it as income. 

According to the IRS, the "payment is not includable in your gross income," meaning it isn't taxable income and will not impact your tax refund or your taxes due. The IRS also stresses the stimulus payments won't affect your income eligibility for any government assistance programs.  

What if I Never Received My Stimulus Check?

There were two ways to receive your stimulus check if you qualified for it: mail or direct deposit. 

If you received your 2019 tax refund through direct deposit, the IRS used the same banking information to deposit your stimulus check. If you changed banks or didn't have a tax refund directly deposited, the IRS offered the ability to update your banking information online. 

If the IRS had no direct deposit information for you, it mailed your check to the address on your 2019 federal tax return. 

There are several reasons you may not have received your stimulus check despite qualifying for it, including: 

• Incorrect mailing address.

• Incorrect banking information.

• Not filing taxes in 2018 or 2019.

If you qualified for the stimulus payment but never received it, you can file for a Recovery Rebate Credit on your 2020 federal income tax return.

The IRS released a worksheet in the 2020 tax year 1040 tax filing instructions to determine how much your Recovery Rebate Credit should be. The full calculation instructions can be found in the  "Line 30" section. The "Recovery Rebate Credit" from line 21 on the worksheet can be transferred to line 30 on your 1040 tax return. 

If you use tax software or a tax professional for your 2020 tax filing, the software or the professional can handle the Recovery Rebate Credit calculation for you. 

The IRS will confirm you’re owed a stimulus check and include it with your 2020 tax refund or credit it back to any taxes owed. However, if you owe back taxes or any other defaulted government debt, the IRS may apply the credit to these debts. 

Keep in mind, the COVID-19 pandemic is ongoing, and the stimulus payment programs are continually changing. As these programs change, so may the effects on taxes. 

What Factors Can Impact Filing Taxes in 2021?

While the stimulus checks most likely won't impact your tax refund, many other factors may affect the amount you get back or the amount you owe in taxes. 

Job or income change

A job or income change is a common cause for your tax return to be different. 

If you got a raise or landed a new job with a different salary, your tax bracket may have shifted up or down. Not only will a change in income impact the taxes you owe, but a big raise could push you into a higher tax bracket, leading to the IRS taxing a larger portion of your income. 

For example, if you earned $35,000 in 2019, the IRS taxed the first $9,700 of your income at 10% and the remaining income at $12%, according to the 2019 income tax brackets. If you got a promotion in 2020 that put your income at $45,000 per year, the IRS taxed the first $9,785 at 10%, the next $9,876 to $40,125 at 12% and the remaining $4,875 at 22%, according to the 2020 tax brackets. This would lead to more taxes owed, which could reduce your tax refund. 

An income change may also impact your eligibility for the earned income tax credit (EITC). In 2020, the EITC was worth $538 to $6,660, depending on the number of qualifying children you have. 

If your income went up in 2020, pushing you over the EITC income threshold, you could get a smaller tax refund or a higher tax bill. If your income went down, putting you within the EITC income threshold, you could receive a larger income tax refund or a lower tax bill.   

Filing status change

You can choose from five filing statuses when you file your taxes. They include:

• Single.

• Married filing jointly.

• Married filing separately.

• Head of household.

• Qualifying widow(er).

The filing status you select can affect how much you owe in taxes.

For example, if you got married at any time during 2020, you are eligible to change your filing status to "married filing jointly." This filing change will almost double the income thresholds between tax brackets, which can impact your income taxes.

Early Withdrawal From Retirement Funds

Saving for retirement and paying off credit card debt is a key part of financial independence, and experts say you should only withdraw money from retirement funds as a last resort. They don't say that just because it interrupts your savings — there are also serious tax repercussions for doing so. 

For example, if you withdraw $5,000 from your 401(k) balance, you not only pay income tax on that money, but you also pay a 10% tax penalty in most cases. That's an extra $500 taken from your tax refund or added to the income tax you owe.

Relocation

You could deduct any moving expenses in years past if you were relocating for a new job. But the most recent tax code updates eliminated this deduction for most Americans. 

However, certain active-duty military members who move due to a permanent change of station can still deduct their moving expenses from their taxable income, increasing their tax refund or reducing their tax bill. 

Dependents

Children are expensive, and the IRS knows this, so it offers a relatively generous Child Tax Credit of up to $2,000 per child if you owe taxes and $1,400 per child if you're getting a refund. This means you can get up to $2,000 knocked off your tax bill per child if you owe taxes. If you owe no tax or are getting a refund, you can get up to $1,400 extra per child. 

The IRS offers this credit in full to married taxpayers with an adjusted gross income (AGI) — your income after tax deductions — of $400,000 or less and to individual filers with an AGI of $200,00 or less. After these income levels, the IRS reduces the credit amount.

Tax Season Preparation Tips

Whether you plan to e-file your own taxes or use a tax preparation service, you can streamline the tax filing process with these tips. 

Find Last Year's Return

When filing your taxes, the IRS will ask for last year's AGI to verify your identity — you can find your AGI on line 8b of last year's 1040. So, whether you plan on filing taxes with the IRS free file service, with tax software or with a tax preparer, you can make your life easier by having last year's tax returns handy. 

If you don't have last year's 1040, you can use the IRS' Get Transcript feature to view it. 

Gather All Your Income Statements

Companies must have all income statements to employees and contractors by Feb. 1, 2021, including W-2 and 1099 statements. Before filing taxes, collect all these documents in one place and verify they cover all your income for the year. 

If you're missing a tax form from an employer or a client and it's after Feb. 1, 2021, contact the company's payroll department and ask them to send you a new copy. If you can't reach the company or they refuse to send new tax information, you can contact the IRS at 1-800-TAX-1040 for assistance in getting the documents. 

Have Your Deduction Evidence Ready

The new tax laws have removed many deductions from the tax filing process, but there are still some tax deductions and credits you can take to lower your tax bill or increase your tax refund. 

If you plan to take any of these credits or tax deductions, make sure you have all the required documents proving you're eligible for the credit. 

For example, if you plan to take Residential Energy Credits for installing solar panels or other energy-saving technology, make sure you have all your bills of sale proving you made the purchase in the appropriate tax year. 

Stimulus Checks and Filing Taxes in 2021

Struggling families in America got some relief with the two rounds of stimulus money, but it left many wondering if the extra income would impact their taxes. Fortunately, the IRS has been adamant that the first two stimulus payments won't have any impact on your 2020 taxes. 

Keep in mind, there are still other stimulus payments in the works, and they may come with different tax implications. 

While the stimulus payments won't impact your 2020 taxes, there are some changes that may impact your income tax refund or tax bill this year. These include: 

• Changing jobs or income.

• Changing filing status.

• Having children.

• Withdrawing from retirement funds.

• Relocating.

So, if your tax refund goes up or down when filing taxes in 2021, it isn't due to the stimulus payments. Instead, one of the above tax situations likely changed.  

Learn how Tally can help make your stimulus payment work for you.