In the whirlwind of a year that was 2020, your financial situation and cash flows were likely different than expected. Millions have experienced reduced pay or unemployment, and thousands of businesses underwent hardship and bankruptcy. The pandemic has altered the financial landscape, and that massive adjustment will certainly extend to your tax return.
Many tax code line items were changed for the calendar year of 2020, and plenty of new ones were added to help workers weather the economic situation. As you prepare to file your return this spring, you may be surprised by 1) what has changed for this year, and 2) by what has somehow remained constant. If there was ever a time to consult a professional as you file, the time is now. Here are some of the major ways the pandemic could impact your state and federal taxes:
Special Business Expenditures
If you own a business, you will likely have several things to consider this season that you wouldn’t in an average tax year. If your business was impacted by the pandemic, talk to your tax professional about which expenses can be offset, or even spread over the next several years. Business meals will be treated differently in 2020 than in years past, and outfitting your home (or your employees’ homes) with remote capabilities will only qualify as a valid expensable item under specific circumstances. Any loans you received for economic hardship and the repayment status of those loans may also affect your tax return. Above all, make sure you keep clear and detailed records of all sources of income and expenditures for 2020, regardless of the source or nature of those cash flows. It is much better to document items just in case, than to be required to dig through 3-year old files in the event of an audit.
If you had personal investment earnings that you capitalized on in 2020, you will have to report those earnings as income and pay the requisite taxes on them, as you have in any previous year. Despite any economic downturn you or your business may have experienced this year, the tax treatment and brackets have largely remained constant through the pandemic.
However, if you were personally impacted by COVID-19, and as a result, took an emergency early withdrawal from your 401k or IRA account, there may be special stipulations that apply. If the withdrawal was made before the end of 2020, and COVID-19 had adverse impacts on your finances, it’s possible that the penalty for an early withdrawal will be waived. However, any taxes due on the earnings are still required (for 401k and Traditional IRA accounts), but they can be spread over the coming 3 tax years.
Unemployment benefits you may have received in 2020 are also taxed as income, BUT certain stimulus checks that you received are not: these are treated as an advance on your 2020 tax credit, and will have to be reported on your return. Be sure to confirm these line items with your tax professional. As the stimulus situation continues to evolve after many individuals have already filed, be sure to have an open line of communication with your tax professional to clarify the treatment of any relevant payments.
You likely spent a sizable portion of your work hours operating from a home office in 2020. However, unless you are self-employed or an independent contractor, you are not eligible to claim a home office deduction – even if remote work was mandated by your employer. You will increase your risk of being audited if you claim the home office deduction, and even if it’s an honest mistake, you may owe IRS fines if you are found not to qualify for said deduction. When in doubt, don’t take any chances when it comes to your tax return.
Additionally, if you moved to a lower-cost area during the pandemic but continued working from home at your existing job, you may owe taxes in two jurisdictions, especially if you moved states. Many localities have signed reciprocity agreements to ease this issue, but it’s important to double check where your taxes may be due this season.
This tax filing might be one of the more complex returns you’ve ever filed. As much as you are able, spend the time and resources to consult a knowledgeable tax professional regarding your unique situation. Filing with the guidance of a professional in the field will give you accuracy and peace of mind, as well as provide you with an ally if you are required to confer with the IRS. At Schmidt & Schmidt, we have years of experience handling the custom accounting needs of our clients. Contact us today to learn how we can help streamline your tax season.