Last year's unemployment benefits could cost Americans $50 billion at tax time
With tax season officially starting on Friday, millions of Americans could be in for a shock: owing taxes on unemployment benefits they received in 2020. The federal government and most states consider jobless aid taxable income. But unlike a paycheck, taxes typically aren't automatically deducted from such benefits, with the IRS expecting its cut.
Goldman Sachs estimates people could end up owing as much as $50 billion in taxes on unemployment insurance benefits they got last year — as layoffs soared during the coronavirus pandemic — come the April 15 tax filing deadline. That could wipe out many taxpayers' refunds and even dent the economy.
"These surprise tax bills would reduce tax refunds or possibly even require net tax payments for vulnerable households, which may force some to cut back on spending," analysts with the investment bank wrote in a report.
For now, the Internal Revenue Service is not considering extending the April 15 deadline or waiving penalties for Americans who find they underpaid taxes throughout the year, Ken Corbin, chief taxpayer experience officer at the IRS, said on a call Thursday.
Congress could still ride to the rescue. Democratic lawmakers have introduced a bill to exempt unemployment benefits from taxes, with worker advocates noting that taxing unemployment assistance undercuts the purpose of the payments.
In the meantime, workers can make their own calculations to see if they'll owe money. Unemployment benefits are subject only to federal income tax paid at income-tax rates (not Social Security or Medicare taxes that are taken out of employer paychecks.) People living in states without an income tax or in select states that don't tax such benefits — including Alabama, California, Montana, New Jersey, Pennsylvania and Virginia — don't need to worry, said Robbin Caruso, a partner in the tax practice at Prager Metis.
Read on to learn about other ways doing your taxes might differ this year.
Moved for work? You may owe in multiple states
Millions of Americans who started working from home or relocated to a different state during the pandemic may find themselves owing state tax in multiple locations.
"Many millions of taxpayers will have more complexity this year — they'll have to file in two states," Jared Walczak, vice president of state projects at the Tax Foundation, told CBS MoneyWatch. "A smaller number may experience actual double taxation."
During the health crisis, and even as Americans started working remotely, employers continued to send taxes to the states they normally did — without adjusting for workers' new location.
A number of states also have what are called "tax convenience" laws, under which the state collects taxes from workers based on the location of their employer, regardless of whether someone commutes to the office. Typically, a worker's state of residence will provide a credit for taxes paid to another state so that an individual doesn't get taxed twice on the same income.
If you moved permanently or temporarily last year — especially if you spent more than 180 days in a new state — it may be advisable to consult an accountant to figure out what tax applies to you. Double taxation could cost a lot.
"Someone subject to this should basically think of a doubling of their state income tax liability, or potentially more," Walczak said.
Home office expenses and deductions
Many workers who've spent the last year with their "office" in their living room may be wondering if they can deduct the costs of setting up a home workspace.
"Unfortunately, unless you have a business, you can't," said Alicia Jegede, a CPA in Brooklyn, New York, and founder of New Gen Financial Planning.
The 2017 Tax Cuts and Jobs Act barred workers from deducting unreimbursed work expenses — anything from news subscriptions to business travel to union dues — from their income. Jegede suggests that anyone who spent money on their work-from-home set up ask if their employer can reimburse the cost. "The business can deduct it, but the employee can't," she noted.
There's one exception to this rule: Independent contractors and small business owners can deduct home office costs from their business income. To qualify for the tax break, the workspace must be "exclusively and regularly" used as a place of business, Lisa Greene-Lewis, a CPA and tax expert at TurboTax, told the Associated Press. That means working from the dining room table doesn't qualify.
Self-employment costs
Workers who turned to the gig economy to make ends meet in 2020 could find themselves owing a lot more in taxes. For one, their payroll tax would be double what a regular employee owes — 15.3% on any income up to $137,000. This is separate from federal income tax.
As a result, gig workers and freelancers should make sure they're deducting all their business costs. Any money spent on work cuts into business profits — that includes equipment, office supplies, advertising or marketing-startup costs, or costs for a dedicated home office.
Gig workers for a delivery company should make sure to claim all the mileage they are eligible for, as well as costs for car maintenance, vehicle supplies or washing, which are eligible expenses.
Above-the-line deductions
Taxpayers can deduct $300 worth of charitable donations this year, even if they don't itemize their deductions. The IRS estimates that about nine in 10 taxpayers now take the standard deduction instead of itemizing.
Teachers can deduct $250 spent on teaching supplies from their income, provided their employer didn't reimburse those costs. That includes personal protective equipment.
Earned Income Tax Credit and Child Tax Credit
Taxpayers used to claiming the Earned Income Tax Credit (EITC), which is worth between $538 and $6,660 depending on income and number of children, can continue to do so — with a twist. Taxpayers who had big income changes in 2020 can use their income from 2019 to qualify for the credit. The same is true for the Child Tax Credit (CTC), which is worth up to $2,000 per child.
Normally, a taxpayer's income in the prior year will determine if they can claim the EITC. But the credit typically applies only to money earned from work. Unemployment benefits, though they are subject to federal income tax, don't count as earned benefits for the purposes of the EITC or CTC.
With many unemployed workers potentially facing a smaller credit this year or even owing taxes, Congress adjusted the eligibility criteria for the EITC and CTC as part of a December pandemic relief package, allowing taxpayers to use their 2019 income to qualify for these credits.
These are considered the two most valuable tax credits for low- and moderate-income working families. A family of four earning up to $53,000 can claim the EITC, while the CTC is applicable to families making as much as $400,000.
Those expecting to claim either credit should be prepared to wait a little longer to get their refund, as the law requires the IRS to hold these refunds as it verifies claimants' qualifications to prevent fraud.
For taxpayers who file immediately, "the refunds should land in bank accounts by the first week of March if there are no other issues," Corbin said.
No tax on your stimulus check — or that PPP loan
And now for some good news: Americans don't have to pay federal taxes on any of the Economic Impact Payments the government has distributed as coronavirus relief.
"It's a tax credit, basically, and it's a refundable credit," Caruso said. That means a person whose income is low enough could potentially owe no taxes and still qualify for a stimulus check.
Eligibility for the full stimulus payment last year included an income of $75,000 or less for a single person and $150,000 or less for a married couple; people who earned above those amounts may have qualified for a reduced payment. If you fell within the income brackets but didn't get a payment, you'll want to claim it on your tax return. If you earned too much to qualify based on 2019 but your 2020 income was lower, filing your tax return will allow you to get a payment based on your 2020 income. And if you had a child last year, you'll qualify for a back payment of $500 or $600 (or potentially both) if you haven't already received the dependent payment.
Small business owners whose Payment Protection Program loans were forgiven are also exempt from income tax on the value of the forgiven loan.
Unlimited business losses
With many businesses last year losing money and even closing, Congress has increased the amount of losses a business owner can use to offset their income.
"We're expecting more people to have business losses. Before, you could deduct up to $250,000 [in losses] for single people. Now you can deduct an unlimited amount," Jegede said.
If you had a large business loss but no other income last year, you could potentially wind up owing no taxes. A taxpayer could even use a large loss from 2020 to offset income for prior years, potentially getting tax refunds for, say, 2019 or 2018, said Robert Caplan, a partner at Caplan & Wong CPAs in San Mateo, California.
"Not only will their taxes go down this year, but also for five prior years," he said.
Investing gains — or losses
Many people jumped into the stock market for the first time in 2020 — that might entail new tax obligations.
The most important thing to understand is that you only pay taxes on investments when you "realize" their gains. So if you bought a stock in 2020 and its value went up, you won't pay taxes on those gains until you sell. And if it sank in value, the same rules of "realizing" apply. Investment losses hurt, but you can use them to offset your gains, up to a limit.
It's also important to understand that gains are taxed differently depending on how long you held on to the investment. If you sell a stock you held for less than a year, it is taxed at the higher short-term capital gains rate, versus the lower long-term capital gains rate for investments held for more than a year.
Higher-income households may also face a net investment income tax on capital gains and other investment income.
Made a killing on GameStop shares? That won't come up until 2021 taxes, which aren't due until next year. But it would be wise start making plans or anticipated payments on those taxes now.
Aimee Picchi and the Associated Press contributed reporting.
