The pandemic has changed our lives in countless ways, and this year’s taxes are no exception. If you received stimulus payments or unemployment benefits in 2020, there are some critical things to know before filing your tax return.
Here’s how COVID-19—and its economic impact—may affect your taxes and helpful tips for after you file.
How stimulus payments affect your taxes
If you received stimulus payments in 2020, the good news is they won’t affect your tax return unless you haven’t received the money yet.
In the meantime, be on the lookout for fraud. The Internal Revenue Service (IRS) warns of scammers offering to expedite missing stimulus payments via email, text, phone, or even social media. The most up-to-date information is available at IRS.gov.
While there has been a steady stream of myths about the payments, the IRS has debunked some of the most common. To be clear, stimulus payments:
- Are not considered taxable income
- Won’t reduce your tax refund or increase your tax bill
- Don’t have to be paid back
How unemployment benefits impact your taxes
If the pandemic affected your work status in 2020, you may have been among the millions of Americans who received unemployment benefits.
Although these benefits offer some much-needed cash, the income could cause issues at tax time. Here’s why: Unemployment benefits are taxable, and if you didn’t withhold enough, you could owe money when you file your tax return.
You should receive Form 1099-G by the end of January from the agency that paid your unemployment benefits. The form will specify how much income you received and the amount you withheld for taxes. Be sure to hold on to these details, as you’ll need them to file your tax return.
While it’s too late to change last year’s withholding percentage, you can benefit from filing your tax return early. If you owe money, filing sooner will give you more time to save before the April 15 payment deadline.
What to do if you need more time to file your return
The IRS allows a six-month filing extension for anyone who needs more time to prepare their federal return. An extension would push the deadline from April 15 to October 15, and you must submit a formal request to receive one. You don’t have to explain why you’re asking for the extension, and the IRS will contact you only if your request is denied.
While an extension may offer more time to file your return, it doesn’t apply to your tax payment, which will accrue interest after the deadline. You should estimate and pay any owed taxes by April 15 to help avoid possible penalties. According to the IRS, the failure-to-pay penalty is 0.5% per month up to a maximum 25% of your unpaid balance, until you pay off your bill in full.
What to do if you’re not getting a refund or can’t pay your tax bill
Once you file your taxes, it can be frustrating to learn you won’t be getting a tax refund—or worse, that you have an unexpected tax bill. Fortunately, it may be possible to improve your outcome in both cases.
Start by double-checking your tax return for ways to boost your refund or lower what you owe through tax credits and deductions. For example, if you donated money to qualified organizations in 2020, you may deduct up to $300 of your cash contributions. Other commonly missed savings opportunities may include credits for your dependents, credits for low-to-moderate earners, and deductions for mortgage points.
When in doubt, review your return with a tax professional.
While tax bills can be nerve-wracking, especially when you can’t afford them, the IRS may be willing to work with you. Start by calling the agency at 800-829-1040 to discuss your options. Depending on your situation, you may qualify for a short-term extension, installment agreement, or an offer in compromise. You may even be able to temporarily delay the collection process until you can afford payments.
Try to avoid future tax bills by checking your tax withholding and making adjustments as needed. If you’re self-employed or a contract worker, you can make quarterly estimated tax payments throughout the year.
What to do if you’re getting a refund
If, on the other hand, you’ve filed your taxes and learned you’re getting a refund, it can be welcome and exciting news. Now, the question is, what should you do with that money?
After a long year in quarantine, it may be tempting to spend your refund on a dream vacation in late 2021 or 2022—especially, when you’ve been cooped up in the house for so long. But splurging on travel or other desires could cause you to miss out on ways to strengthen your finances.
If you still have holiday debt or other lingering balances, for example, a refund could be an excellent opportunity to pay down your high-interest credit cards. Consider either the debt snowball or debt avalanche methods, which are proven strategies that can help you meet your debt payoff goals.
You also can use your refund to create an emergency fund or pad your savings. While experts recommend setting aside three to six months’ worth of expenses, even $500 to $1,000 could make a difference when you have an unexpected expense or bill.
Another savvy way to use your refund is home maintenance. According to HomeAdvisor’s latest State of Home Spending report, the average homeowner spent $1,640 on emergency projects in 2020. If you have been ignoring a home repair due to financial constraints, you could use your refund to stop it from becoming a bigger, more costly problem in the future.
After taking care of the basics, like debt, savings, and your home, there’s nothing wrong with a modest indulgence on something fun. Small rewards can make it easier to stick with long-term financial goals.
If you have questions about this year’s taxes or filing, visit the IRS website or seek assistance from a qualified tax professional.