In response to widespread social and economic hardship during the COVID-19 pandemic, sweeping legislation and relief programs sought to aid struggling Americans and businesses. Meanwhile, millions of Americans temporarily (if not permanently) turned to remote work and freelance opportunities from the comfort of their homes.
Even into 2021, the unpredictable impacts of COVID-19 continue to unfold. Unfortunately, some common situations could result in a few surprises when it comes to your 2020 tax liability. As we approach the 2020 tax season, here are five common ways the pandemic could negatively impact your tax bill.
COVID-19 forced many businesses to cut operations and staff, resulting in millions of out-of-work Americans filing for unemployment. To help those most affected, the CARES Act increased benefits by $600 for the first 13 weeks of the pandemic and extended an additional 11 weeks after that.
Unfortunately, unemployment benefits are considered taxable income, meaning many taxpayers may find that they earned more overall income in 2020 due to receiving unemployment benefits. If you received unemployment benefits but did not elect to have taxes withheld from your unemployment checks, those taxes will need to be paid when your taxes are due.
Early Withdrawal from Retirement Accounts
To better help those financially burdened by the pandemic, the CARES Act also made it easier for individuals to access emergency funds from their retirement accounts. Under normal circumstances, early withdrawal from retirement savings accounts under age 59 ½ is subject to a 10% penalty.
Under the CARES Act, individuals under the age of 59 ½ could make COVID-related withdrawals through December 30, 2020, without facing a penalty. Withdrawn funds could be treated as a loan to be paid back over the course of three years, or it could be recognized as a taxable distribution to be taxed over three years. If you made an early withdrawal from a qualified retirement account, it must be recognized as taxable income if not paid back.
Working from Home
Many businesses embraced a remote work model to keep employees safe and healthy during the pandemic. With the ability to work virtually anywhere, many employees took the opportunity to escape expensive cities and relocate to locations with lower costs of living.
If you continued to live and work in the same state, your taxes should remain the same. However, if you relocated to another state and continued to work remotely, you will likely need to file taxes in both states. It’s crucial to note that this could also require taxes to be paid in your current state of residence as well as the state of your employer. The tax burden will ultimately vary by state, so it’s a good idea to look into any reciprocal agreements that the two states may have to avoid paying duplicative taxes.
In addition to working remotely, many businesses and workers found themselves significantly limiting (if not eliminating) work-related travel in 2020. In industries where expenses relating to travel, hotels, and meals added up to substantial tax write-offs in previous years, this dramatic decrease in deductions may become apparent come tax time.
It’s worth noting that the Tax Cuts and Jobs Act of 2017 substantially limited the extent to which businesses could deduct food and beverage expenses; however, the Consolidated Appropriations Act of 2021 reversed this law and reinstated the full deduction for certain business meals and expenses for the years 2021 and 2022.
Entrepreneurship and Side Hustles
In response to a struggling job market, many Americans took 2020 as an opportunity to start their own business or side hustle. For new entrepreneurs and freelancers, this likely means a stark change in how your taxes are calculated and when they need to be paid. For example, you will likely need to pay estimated taxes every quarter. To minimize your tax liability and maximize your legal protection, a CPA or financial advisor can help guide you on the timing of these payments and assist in choosing the right business structure to fit your particular situation.
Employer Withheld Social Security Taxes
To help workers earn as much money as possible during the pandemic, the Trump Administration allowed employers to voluntarily defer withholding Social Security taxes from employee paychecks. If employers participated in the program, essentially, the 6.2% Social Security tax that employers generally withhold from employee paychecks went directly to employees earning less than $4,000 per biweekly period between September 1, 2020, and December 30, 2020.
Although this provided a generous paycheck boost, the caveat is that those taxes will need to be paid back by December 31, 2021. For those whose company opted into this program, this will effectively pan out to paying double Social Security taxes when the company resumes withholding. It’s a good idea to speak to your payroll department to fully understand the company’s plan for collection and how that plan may impact your future paychecks.
If you have questions about how any of the above situations may affect your 2020 taxes, we are here to help. Please do not hesitate to contact us for more information.