- Your income tax obligation could be different this year if your income went up or down significantly.
- There are steps to take now to figure out how much you might owe, so you can try to avoid penalties and fees later on.
- There are tax moves worth considering before the end of the year.
The year 2020 has been unusual in almost every way, and that will likely be true for most people's taxes this year.
In the months since COVID-19 started to ravage the world economy, nearly half of all Americans suffered a loss of income, according to a recent survey by Bankrate.com.
"You really have to pay attention to how much you have paid in so far, and how much are you likely to owe throughout the year or at the end of the year," says Christopher Williams, Principal at EY Private Client Services.
Here are some of the things you should consider:
1. Do a paycheck check-up
The IRS has a handy tool to make sure you are having the right amount of taxes taken out of your paycheck for your federal tax payments. You'll have to do some back-of-the-envelope math to figure out what you owe for state taxes, as you will if you're currently unemployed.
"Gather up whatever paystubs and statements you have and see what the federal and state withholdings have been," says Matthew Kenigsberg, VP of Taxes and Investments at Fidelity.
2. Pay your estimated tax on unemployment benefits
At the middle of July 2020, more than 30 million Americans were collecting unemployment benefits, according to the Department of Labor. All those payments—state and federal—are taxable as income, and you may not have had any taxes already taken out.
To be safe from fees and penalties, you need to pay the lesser of 90% of what you owe by the tax filing deadline in 2021 or pay 100% of last year's payment due (110% for filers who make over $150,000 in adjusted gross income). You may also owe estimated taxes throughout the year. Otherwise, you could end up with both an underpayment penalty and a late penalty from the IRS, calculated when you file.
3. Recalculate your stimulus
If you did not qualify for the stimulus payment authorized by the CARES Act because your income was too high in 2018 or 2019, you might qualify for it in 2020 when you file your return if your income has declined. The payment is based on the return for this year, and there will likely be a worksheet with the IRS Form 1040 that reconciles your income and will add the CARES credit as a refund if you qualify.
Note: If your income went up in 2020 and you no longer qualify, you will not be asked to return any payments you might have received up to that point.
4. Look for tax savings
If you are working from home as a self-employed person—which includes many professionals like doctors and lawyers—you will want to keep track of the space you are using and any expenses you incur to file for a home office deduction.
For all those full-time employees working from home and having to buy desk chairs, printers, and other supplies—sorry, you are out of luck for a federal income tax deduction, as the one that would have covered you for home office and unreimbursed employee expenses was removed by the Tax Cuts and Jobs Act. (Note, however, that some states still allow it for state income tax purposes.)
Everyone will qualify for a new above-the-line tax deduction of $300 for charitable giving, and you can deduct even more if you itemize your expenses.
You will also want to watch your medical costs for the year. If you had a particularly low income year but also had high medical expenses, you might qualify for a deduction if they exceed 10% of your income and you itemize your deductions.
"It probably makes sense to track those receipts," says Williams.
5. Maximize your workplace retirement savings
If your income went up this year, or you just generally want to help reduce your tax liability in 2020, consider increasing your contribution to a 401(k) or any other pre-tax retirement accounts offered through your workplace. You can use a calculator like Fidelity's to see how your bottom line would be affected if you change your contribution level.
On the other end of the spectrum, if you took a hardship withdrawal loan, you will have to account for that on your taxes over 3 years, but not pay penalties. You also have those 3 years to return the money to the account, so if your situation stabilizes, as it has for 17% of the people Bankrate.com surveyed, you can have a do-over.
6. Pause your RMDs
The IRS now requires most people to start taking money out of their tax-deferred retirement accounts once they reach age 72, but that is on pause this year. If you are a 74-year-old who has $1 million saved in an IRA, that amounts to about $40,000 less in income for the year and could yield as much as $14,800 less in federal income tax for the year, depending on your financial situation.
"It's an opportunity for retirees to save on taxes or look into converting some of their tax-deferred savings to a Roth IRA," says Kenigsberg.
Tip: For more on RMD vacation strategies, read Make the most of your RMD vacation.
7. Stash your extra savings
If you skipped some vacations or haven't been spending as much, you may have some extra cash suddenly. In April, savings rates in the US hit a historic 33%, according to the Bureau of Economic Analysis, up from 8% in April 2019.
Some ways to put those dollars to work for you in a long-term tax-savings way are to contribute to accounts like a Roth IRA, a 529 college savings plan or a health savings account, where the growth accrues tax-free.
You might also want to do some tax-loss—or tax-gain—harvesting: Look at the current balance of your investments throughout the year and make sure everything stays aligned with your goals as the stock market fluctuates. If not, then you can buy or sell stock to fit your needs.
Tip: Check out more ways to cut investment taxes.
8. Small-business concerns
If you are a small business owner, there are several tax-related scenarios that might come into play for you in 2020. If you applied for any of the government assistance through the Paycheck Protection Program or an Economic Injury Disaster Loan, there will be paperwork to reconcile.
If you had a shift in income, your ability to claim the Qualified Business Income Deduction might have changed. That is a 20% deduction for those who meet certain criteria.
The best place to start is with your most recent tax return, which you might just have filed by the July 15, 2020 deadline. No matter how you compiled that return—whether you used a professional or do-it-yourself tax software—there should be help available for sorting out what you need to do for 2020. Also, rules keep changing, so stay tuned to the news that will affect your personal situation and consult with a tax advisor for questions about your specific situation.