Takeaways from the WSJ Guide to Filing Your Taxes for 2020, understanding pandemic tax changes and other provisions
Recently the Wall Street Journal pointed out that “2020 was a tax year like no other, due to the coronavirus pandemic.” In a historic decision, the IRS chose to delay the April 15 filing deadline and others until July 15 to give overwhelmed taxpayers time to comply with the law. Congress mandated two rounds of stimulus payments to more than 160 million households, and it also passed two massive laws with dozens of tax changes to provide relief to individuals and businesses. Meanwhile, millions of workers fled their offices to work remotely from other states and may have to file returns and perhaps pay taxes to more than one state. The pandemic effects have spilled into 2021.
In mid-March Congress passed a third stimulus package and enacted unprecedented tax breaks for families with children for 2021 only. Soon after, the IRS delayed the April 15 tax-due date for 2020 returns to May 17 for individuals—but not other taxpayers such as corporations.
There were other key tax changes unrelated to the pandemic, such as for cryptocurrency capital gains enforcement, medical-expense deductions, and education benefits, plus the annual inflation adjustments that affect some tax benchmarks but not others.
Now, with the arrival of the tax-filing season for 2020, comes a flood of questions:
- How do I file for a stimulus payment through my tax return, and is it taxable?
- What about those Flexible Spending Account dollars I didn’t use in 2020?
- Will I owe zero tax on my capital gains?
- What’s the deadline for contributing to a Roth IRA? Does the March 2021 relief law affect me?
The Wall Street Journal put together a long comprehensive (69-page) 2021 tax guide whitepaper to help taxpayers navigate all the changes. And since the IRS has extended the April 15 deadline for filing and paying 2020 federal individual income taxes and IRA contributions to May 17, so making an IRA contribution before the filing deadline is a good idea if you haven’t made a contribution yet or haven’t maxed out your contribution and have the available funds.
This is a pretty long tax article guide so I have made a table of contents that will make it easier to skim and skip to the sections that are most pressing or relevant to you.
- Investment-Tax Rates and Brackets
- Withholdings and Estimated Taxes- Including Unemployment Benefits
- Pandemic Stimulus Payment
- State Taxes on Remote Work
- Bitcoin and other Cryptocurrency Tax Compliance
- Estate and Gift Tax
- Tax Deductions Credits and Exemptions
- State and local Tax deductions
- Mortgage Interest Deduction
- Medical Expense Deductions
- Retirement Accounts – Including Pandemic Withdrawals
- Tax breaks For Education
- Deductions for Business owners
1. Investment-Tax Rates and Brackets
Congress didn’t make changes to rates on long-term capital gains and many dividends for 2020. Favorable tax rates for long-term capital gains and many dividends, including a popular zero rate on investment income for some lower- and middle-income households, remain unchanged.
Long-term capital gains are net profits on investments held longer than a year. Short-term capital gains on investments held a year or less are taxed at the same rates as ordinary income, an important distinction day traders should note. The favorable rates for dividends apply to those that are “qualified,” which most are. Nonqualified dividends are taxed at ordinary-income rates.
However, a 3.8% surtax applies to net investment income for most single filers whose adjusted gross income (AGI) exceeds $200,000 and most couples filing jointly with AGI above $250,000. This surtax applies only to the amount of net investment income above those thresholds.
The WSJ tax guide cites an example, “if a single filer has $150,000 of ordinary income plus a $50,000 taxable long-term gain plus $25,000 of qualified dividends, then $25,000 would be subject to the 3.8% surtax.”
As a result, top-bracket taxpayers typically owe 23.8% instead of 20% on their long-term gains and dividends. Some investors in the 15% bracket for this income owe the 3.8% surtax on part or all of them because their adjusted gross income is above the $250,000/$200,000 thresholds.
Another example, say a single filer with $210,000 of adjusted gross income, and $50,000 of that is a windfall from a long-term gain on an investment and some qualified dividends. In that case, David’s investment income would likely be taxed at a 15% rate, but he would owe an extra 3.8% on $10,000 because that is the amount of investment income above $200,000 of AGI. Thus his tax rate on the $10,000 would be 18.8%.
How the Zero Rate Applies
In some circumstances a person will not owe any taxes on their capital gains and dividends after a sale. The WSJ guide gives a simplified example. “say that Janet is a single taxpayer with $30,000 of taxable ordinary income for 2020 after deductions and exemptions, such as for tax-free municipal-bond interest or the sale of her home. Her taxable income is subject to regular rates up to 12%, as detailed in the income-tax brackets.”
But Janet also has a $20,000 long-term capital gain, and it “stacks” on top of her $30,000 of taxable income for a total taxable income of $50,000. For 2020, the 15% bracket for capital gains begins at $40,000 of taxable income for single filers. As a result, Janet would owe zero tax on $10,000 of her gain and 15% on the remaining $10,000.
2. Withholdings and Estimated Taxes- Including Unemployment Benefits
The pandemic wreaked havoc with many taxpayers’ income and forced the IRS to postpone two quarterly due dates for estimated taxes during 2020. Filers with uneven earnings or unemployment payments should check for underpayments to avoid penalties.
The U.S. income tax is a pay-as-you-earn system. The law requires most employees and self-employed business owners to pay at least 90% of their tax due long before the annual due date, which for 2020 is now May 17, 2021 for individuals but not for other types of returns.
With some exceptions, penalties based on current interest rates apply to underpayments. Recently this rate was 3%.
To avoid these penalties, employees and many retirees typically have taxes withheld from paychecks or Social Security and pension payments by year-end. In a typical year, business owners and others who don’t have withholding make quarterly tax estimated payments on April 15, June 15, Sept. 15 and Jan. 15 of the following year based on income earned during that period.
In 2020, the pandemic posed severe challenges both to taxpayers and the IRS. As a result, the agency postponed estimated tax payments due on April 15 and June 15 to July 15, 2020. Penalties on underpayments for those periods didn’t begin to accrue until July 15. For 2021, first-quarter estimated payments by individuals are still due by April 15.
Many employees had uneven earnings for 2020, and some received unemployment compensation. These payments typically are fully taxable, but in its March 2021 relief law Congress approved an exemption of up to $10,200 of unemployment benefits per worker receiving benefits in 2020 (not 2021) for those earning up to $150,000 of adjusted gross income, regardless of filing status.
The IRS has strongly urged taxpayers who qualify for this exemption and who have already filed a 2020 return not to file an amended return to claim the benefit. Amended returns often take many months to process, and the agency plans to make an automatic adjustment and issue refunds.
For those who haven’t yet filed 2020 returns, the IRS has released guidance that includes a worksheet and instructions to claim the exemption.
Unemployment payments are reported by the states to the IRS and recipients on Form 1099-G, which should have reached the agency by early February. States’ rules on taxing unemployment benefits may vary. The IRS has posted a calculator to help employees make withholding decisions, and it has been updated for 2021.
In past years the IRS has waived underpayment penalties for many filers after major disruptions. So far the agency hasn’t announced such waivers for 2020 and has expressed reluctance to change the usual rules. Tax payments made after the deadlines but before the May 17 due date help to reduce these penalties. Although the IRS is delaying the annual filing and payment dates for 2020 returns, it has not changed the April 15 date for first-quarter estimated taxes in 2021.
For more information on withholding and estimated taxes, see IRS Publication 505.
3. Pandemic Stimulus Payments
Stimulus payments aren’t taxable, and if you haven’t received a payment you can claim it on your tax return if you qualify.
Congress authorized three rounds of stimulus payments in response to the coronavirus pandemic. In the spring of 2020, the IRS sent the first round of payments totaling more than $270 billion to more than 160 million households. In late 2020 and early 2021 it sent another round of payments, estimated at more than $164 billion.
The first two rounds of stimulus payments were structured as an advance payment of a tax credit for 2020. This means that taxpayers can qualify for stimulus payments on their 2020 tax returns based on their 2020 income and family situation, even if they haven’t received payments so far or are eligible to receive more than they got. Most payments sent by the IRS were based on recipients’ 2018 or 2019 tax returns. The third round was similar, but it was structured as an advance payment of a tax credit for 2021. The payments are based on 2019 or 2020 tax returns.
People can get more after they file their 2020 returns, if the information on that makes them eligible for more than the payment they got based on 2019 information. And they can claim even more early next year if they are eligible for more, based on their 2021 income.
Stimulus payments aren’t taxable, and overpayments don’t need to be returned to the IRS in most cases. In addition, Congress said that stimulus payments can’t be applied to prior year taxes due, although some can be withheld for unpaid child support.
Taxpayers can claim stimulus amounts still due to them as a Recovery Rebate Credit, which is on line 30 of Form 1040 or 1040-SR for 2020 for the first two rounds and likely in a similar format for 2021 for the third round. The instructions have a worksheet to determine the correct amount. As opposed to the stimulus payments themselves and their limits on what IRS can do to them, the normal rules on tax refunds seem to apply, so, people who owe the government back taxes or owe back child support may not receive the full amounts of the credits they are claiming, though the government may be relaxing the rules on back taxes.
The Recovery Rebate Credit is calculated using 2020 income and family size data and the criteria Congress set for the first and second round of stimulus payments. First-round payments were of up to $1,200 per eligible adult and up to $500 per child under 17, and second-round payments were of up to $600 per adult and $600 per child under 17. In the first two rounds, dependents age 17 or older, such as a college student or an elderly relative, didn’t qualify for stimulus payments.
The third round had broader eligibility—$1,400 per person, including adults, children and adult dependents. It also had steeper income phaseouts so that individuals with adjusted gross income over $80,000 and married couples over $160,000 don’t qualify for anything, while those with incomes of up to $75,000 and $150,000, respectively, can get the full amount.
The first two rounds of payments had phaseouts beginning at $75,000 of adjusted gross income for single filers and $150,000 for married couples filing jointly. The first-round phaseouts ended at $99,000 for single filers and $198,000 for joint filers without children, while second-round phaseouts ended at $87,000 of AGI for single filers and $174,000 for joint filers without eligible children.
To be eligible for stimulus payments or the Recovery Rebate Credit, a taxpayer has to have a Social Security number. But the first round of payments often bypassed all family members if one filer didn’t have a Social Security number, while the second round included them if at least one spouse had an SSN and retroactively made that group eligible for the first payment. As a result, some couples who didn’t receive a first-round payment because one spouse didn’t have an SSN can claim a credit on their 2020 tax return.
Parents of children born in 2020 may also be eligible to claim a rebate credit on their 2020 returns. While the estates of people who died before Jan. 1, 2020 can’t receive payments, estates of people who died during 2020 are eligible for them.
4. State Taxes on Remote Work
The pandemic turned millions of Americans into telecommuters, with many working for much of the year in a state different from the one they usually work in. These people may be surprised to find they need to file returns and perhaps pay taxes to more than one state for 2020.
In many cases, this won’t be easy. Each state’s tax system is a unique mix of rules that consider how long a worker is there, what income is earned, and where the worker’s true home, known as domicile, is. When a person owes income tax to more than one state, these systems often clash, and that person can wind up owing more tax, or the same, or (rarely) less unless the states have agreements in place with other states to coordinate systems. In 2020 some states added more complexity by issuing special tax rules for the pandemic.
Fifteen states and the District of Columbia announced they won’t tax people working there remotely because of Covid-19, according to data compiled by the American Institute of CPAs.
That sounds generous, but some states offering this benefit, such as Massachusetts and Pennsylvania, also intend to tax remote workers whose jobs are based in-state while they are working remotely out of state due to the pandemic, according to Eileen Sherr, a state tax specialist with the AICPA. The states these people are working from may have rules that tax them as well.
While some states give credits for taxes paid to different states, others don’t—or the credit they give may not fully offset the amount paid elsewhere. How will states know that someone has worked there? In various ways: employers will ask workers and tax preparers will ask clients about their work locations.
DIY filers using commercial software should remember that tax returns are signed under penalty of perjury.
5. Bitcoin and other Cryptocurrency Tax Compliance
The IRS is on a crusade about cryptocurrency tax compliance. I have recently written a whole article about how investors need to understand the tax implications of investing in Bitcoin and other crypto or virtual currency assets. The WSJ tax guide points out that “by making a change to the 2020 tax form, the IRS is trying to strip away excuses for millions of cryptocurrency owners who it thinks are ignoring tax rules.”
The change moves a key question to the front page of the Form 1040, in a prominent position just below the taxpayer name and address. It says: At any time during 2020, did you sell, receive, send, exchange or otherwise acquire any financial interest in any virtual currency?
The taxpayer must check the box “Yes” or “No.”
Cryptocurrency owners who fail to answer the question or are untruthful risk higher penalties should the IRS audit them, as it will be harder to claim ignorance of the rules.
If cryptocurrencies are held for personal use, as a home is, rather than primarily as an investment, then profits are taxable but losses typically aren’t deductible. The IRS hasn’t issued guidance in this area.
In 2019, the agency issued more rules in this area, including controversial rules on splits known as forks. Cryptocurrency tax specialists urge holders to take care when answering the question on the 1040 form because of its broad wording.
The WSJ tax tax guide talked to Chandan Lodha, co-founder of CoinTracker who stated “people who have bought cryptocurrencies during the year must check the box ‘Yes’ even if they haven’t sold and don’t have to fill out other tax forms. They don’t have to do that with stocks or bonds.”
In late 2020, the Financial Crimes Enforcement Network (FinCEN), a Treasury Department unit separate from the IRS, announced that it may require U.S. taxpayers holding more than $10,000 of cryptocurrencies offshore to file FinCEN Form 114, known as the FBAR, to report these holdings. This rule hasn’t yet been adopted, so it wasn’t in effect for 2020.
6. Estate and Gift Tax
Remember the expanded estate- and gift-tax exemption expires at the end of 2025. The federal estate- and gift-tax exemption applies to the total of an individual’s taxable gifts made during life and assets left at death. In 2017, Congress doubled the exemption starting in 2018, and the amount will continue to rise with inflation through 2025. This expansion reduced the number of taxable estates to about 3,000 in 2019 from about 8,000 in 2017, according to estimates by the Tax Policy Center.
For 2020, the exemption was $11.58 million per individual, or $23.16 million per married couple. For 2021, an inflation adjustment has lifted it to $11.7 million per individual and $23.4 million per couple. For 2020 and 2021, the top estate-tax rate is 40%.
The increase in the exemption is set to lapse after 2025. But the Treasury Department and the IRS issued “grandfather” regulations in 2019 allowing the increased exemption to apply to gifts made while it was in effect if Congress was to lower the exemption after those gifts.
The WSJ tax guide gives a simplified example. Say that John gave assets of $11 million to a trust for his heirs in 2020. This transfer was free of gift tax because the exemption was $11.58 million for 2020.
Now say that in 2022 Congress lowers the exemption to $5 million per person, and John dies in 2023 when that lower exemption is in effect. Under current Treasury rules, John’s estate won’t owe tax on his 2020 gift of $11 million, even if $6 million of it is above the $5 million lifetime limit in effect at the time of his death.
Capital Gains at Death
Under current law, investment assets held at death aren’t subject to capital-gains tax. This is known as the “step-up in basis.”
For example, say that a person dies owning shares of stock worth $100 each that he bought for $5, and he held them in a taxable account rather than a tax-favored retirement plan such as an individual retirement account (IRA).
Because of the step-up provision, Robert’s estate won’t owe capital-gains tax on the $95 of growth in each share of stock. Instead, the shares go into his estate at their full market value of $100 each. Heirs who receive the shares then have a cost of $100 each as a starting point for measuring taxable gain when they sell.
Annual Gift Tax Exemptions
For both 2020 and 2021, the annual gift-tax exclusion is $15,000 per donor, per recipient. Thus a giver can give anyone else—such as a relative, friend or even a stranger—up to $15,000 in assets a year, free of federal gift taxes. A couple with two married children and six grandchildren could give away a total of $300,000 per year to these 10 relatives, plus $30,000 to as many friends as they want.
Above the annual exclusion, gifts are subtracted from the giver’s lifetime gift- and estate tax exemption. Annual gifts aren’t deductible for income-tax purposes, and they aren’t income to the recipient.
If the gift isn’t cash, the giver’s “cost basis’ carries over to the recipient. So if Aunt Ruth gives her godchild Betty 15 shares of long-held stock worth a total of $15,000 that she acquired for $200 each, then Betty’s starting point for measuring taxable gain when she sells is $200 per share. If she sells a share for $1,200, then her taxable gain would be $1,000.
Gifts to pay tuition or medical expenses are also free of gift tax. To qualify for this break, the giver must make the payment directly to the institution.
Bunching Gifts for College
Using a different strategy, givers can “bunch” five years of annual $15,000 gifts to a 529 education-savings plan, typically for children or grandchildren.
No tax is due, but the IRS says a gift tax return should be filed.
7. Tax Deductions, Credits and Exemptions
The expansion of the standard deduction and repeal of the personal exemption are affecting millions of Americans.
The standard deduction is the amount taxpayers can subtract from income if they don’t break out deductions for mortgage interest, charitable contributions, state and local taxes and other items separately on Schedule A. Listing these deductions separately is called “itemizing.”
For 2020, the standard deduction is $12,400 for single filers and $24,800 for married couples filing jointly. For 2021, it is $12,550 for singles and $25,100 for married couples. In 2017 Congress made a landmark change by nearly doubling the standard deduction, and the percentage of tax filers using it rose to 87% in 2019 from 68% two years before, according to IRS data and an estimate by the Tax Policy Center. This shift has simplified returns for about 35 million filers and lightened the IRS’s burden by reducing the number of deductions it needs to monitor.
However, people who take the standard deduction don’t get a specific tax benefit for having mortgage interest or making midsize charitable donations. (For 2020 and 2021, Congress is allowing charitable deductions of small amounts by filers who don’t itemize.) That’s expected to affect many filers’ future decisions about donations or owning a home.
Personal Exemption Repealed until 2026
The 2017 repeal of the personal exemption was a landmark shift as well. This benefit was a subtraction from income for each person included on a tax return—typically the members of a family. The 2017 amount was $4,050 per person, and it phased out for higher earners.
The personal exemption was also integral to figuring out an employee’s correct withholding from pay.
The interaction of the expanded standard deduction, repealed personal exemption and expanded child credit is complex, and the effects on individuals have varied widely. In part this is because the personal exemption was a deduction from taxable income, while the child credit is a dollar-for-dollar offset of taxes—and some taxpayers can get a portion of it even if they don’t owe income taxes.
The repeal of the personal exemption—and the expanded standard deduction and child credit—expire at the end of 2025.
8. State and local Tax deductions
The limit for deducting state and local taxes is $10,000 per return, but there is a new workaround for some business owners. One of the major changes of the 2017 tax overhaul was to cap the deduction for state and local property and income or sales taxes, known as SALT, at $10,000 per return. Previously these deductions were unlimited for individuals, although many people who owed the alternative minimum tax lost the benefit of some or all of their SALT write-offs.
This $10,000 cap expires at the end of 2025.
Here is how it works. Say that Tom is a single filer who owes $6,000 of state income tax and $6,000 of property tax on his home. For 2017, he could deduct the $12,000 total of these taxes if he itemized his deductions. But for tax years 2018- 2025, the deduction for state and local taxes is capped at $10,000 per return, and it isn’t indexed for inflation. This change has prompted many filers to switch to taking the standard deduction rather than itemizing write-offs on Schedule A.
According to the Tax Foundation, this change has hit taxpayers hardest in six high-tax states: New York, California, Connecticut, New Jersey, Maryland and Oregon. It has affected taxpayers least in Alaska, South Dakota, Tennessee, North Dakota, New Mexico and Washington.
Since the overhaul, a number of wealthy people, including former President Donald Trump, have decided to leave high-tax northeastern states for Florida, which doesn’t have a state income tax. Some other residents of high-taxed areas are pulling up stakes as well.
Lawmakers in some states have also adopted strategies that preserve the deductibility of state and local taxes in some cases. The most popular is a provision for owners of “pass through” businesses such as partnerships, S-Corps., and limited-liability companies that usually pass profits and losses through to the owners for inclusion in their own taxable income. This allows them to bypass corporate tax on a business’s earnings.
Using the workaround, pass-through owners can deduct state taxes on their business income at the entity level, which avoids the $10,000 SALT cap that applies only once the income shows up on an individual tax return. As a result, a smaller amount of taxable income passes through to the owner’s personal return. The Treasury Department issued guidance approving this change in November 2020 but hasn’t yet issued regulations detailing what’s allowed.
According to state-tax specialist Jamie Yesnowitz of Grant Thornton, the states that now allow this strategy include Connecticut, New Jersey, Maryland, Louisiana, Oklahoma and Wisconsin, while New York, California and others are considering it.
Mr Yesnowitz notes that the workaround helps only with state taxes on business income, not state taxes on wages, investment income or property. The SALT cap is affecting many married couples more than singles, because the $10,000 SALT limit is per return, not per person.
Can two spouses file separately and claim two $10,000 deductions? The answer is no. Although married couples can file separate returns, in this case each spouse would get a $5,000 deduction for state and local taxes. To qualify for two $10,000 deductions, the couple would have to divorce and file as two single taxpayers.
9. Mortgage Interest Deduction
Near-doubling of standard deduction, caps on eligible mortgages mean that many fewer filers are taking this popular write-of. Less than half of filers who took deductions for mortgage interest in 2017 did so in 2019, in part because the 2017 tax overhaul enacted both direct and indirect curbs on deductions for mortgage interest. These changes expire at the end of 2025.
A big reason for the change is that millions more filers are claiming the expanded standard deduction rather than listing write-offs separately on Schedule A. The Wsj guide uses an example, if a married couple’s mortgage interest, state taxes and charitable contributions total $22,000 in 2020 or 2021, they won’t benefit from itemizing deductions on Schedule A in either year. That’s because their standard deduction is $24,800 for 2020 and $25,100 for 2021.
In addition, Congress imposed new limits on the amount of mortgage debt that new purchasers can deduct interest on. The upshot is that about 15 million filers likely deducted home mortgage interest in 2019 vs. about 34 million in 2017, according to IRS data and an estimate from the Tax Policy Center.
Limits on Eligible Mortgage Debt
Limits apply for taxpayers who do take mortgage-interest deductions, although they are more generous for homeowners with older mortgages.
For new mortgages issued after Dec. 15, 2017, taxpayers can deduct interest on a total of $750,000 of debt for a first and second home. However, homeowners with existing mortgages on or before that date can still deduct interest on a total of $1 million of debt for a first and second home. These limits aren’t indexed for inflation.
Here’s an example: John had a $750,000 mortgage on a first home and a $200,000 mortgage on a second home as of December 15, 2017, so he can continue to deduct the interest on both on Schedule A. But if he bought one home with a $750,000 mortgage in 2015 and then bought a second home with a $200,000 mortgage in 2020, he can’t deduct the interest on the second loan.
Homeowners can refinance mortgage debt up to $1 million that existed on Dec. 15, 2017 and still deduct the interest—but often the new loan can’t exceed the amount of the mortgage being refinanced.
Here’s an example provided by Evan Liddiard, a CPA with the National Association of Realtors: If Linda has a $1 million mortgage she has paid down to $800,000, then she can refinance up to $800,000 of debt and continue to deduct interest on it. If she refinances for $900,000 and uses $100,000 of cash to make substantial improvements to the home, she could also deduct the interest on $900,000, according to the NAR.
But if Linda refinances for $900,000 and simply pockets $100,000 of cash, then she can deduct interest on only $800,000 of the refinancing.
The law now prohibits interest deductions for such debt unless the funds are used for certain types of home improvement. Before 2018, homeowners could deduct the interest on up to $100,000 of home-equity debt used for any purpose. To be deductible, the borrowing must now be used to “buy, build, or substantially improve” a first or second home. The debt must also be secured by the home it applies to, so a Heloc on a first home can’t be used to buy or expand a second home. For more information and a list of improvements that are eligible, see IRS Publications 936 and 523.
10. Medical Expense Deductions
The income threshold for deducting medical expenses is now permanent. In December 2020, Congress enacted a permanent threshold of 7.5% of adjusted gross income for taxpayers who want to deduct medical expenses. This means that filers can deduct eligible expenses only to the extent that they exceed 7.5% of their AGI.
This threshold has varied over the years, and without the recent change it would have risen to 10%. Relatively few taxpayers benefit from this write-off be
cause their expenses don’t exceed the threshold. But it covers a wide range of unreimbursed costs when it does apply, and it is valuable to people with large medical expenses such as nursing home costs. Other eligible costs include insurance premiums paid with after-tax dollars, prostheses, eyeglasses, and even a wig if needed after chemotherapy, among other things. This deduction is only available to those who itemize. For more information and a long list of eligible expenses, see IRS Publication 502.
11. Retirement Accounts – Including Pandemic Withdrawals
Congress hasn’t authorized emergency pandemic withdrawals from retirement accounts for 2021. To aid Covid-19 victims, Congress allowed taxpayers affected by the pandemic to make withdrawals of up to $100,000 from retirement-plan accounts such as 401(k)s. The income and taxes on such withdrawals are spread over three years, although amounts put back into these accounts aren’t taxable. For more on this complex area, see IRS Form 8915-E. In addition, eligible taxpayers making such withdrawals won’t owe the 10% penalty on early withdrawals even if they are under age 59½. So far, Congress hasn’t allowed pandemic victims to make similar tax-favored withdrawals in 2021.
Contribution Limits for 2020 & 2021
With a traditional IRA or 401(k) plan, savers typically get a tax deduction for contributions and owe ordinary income tax on withdrawals. With Roth IRAs and 401(k)s, there’s no upfront tax deduction, but withdrawals are often tax-free in retirement.
While the money is in both types of accounts, its growth is tax-free.
For both 2020 and 2021, the limit on contributions to traditional IRAs and Roth IRAs is $6,000, plus $1,000 for those age 50 and above. As of 2020, there is no age cap for individuals contributing to traditional IRAs, although savers must still earn wages or self-employment income to be eligible to contribute to these accounts or have a spouse who does. Other limits may apply, based on income or participation in a workplace retirement plan such as a 401(k).
The limit on contributions to regular 401(k) and Roth 401(k) savings plans is higher: up to $19,500 per worker, plus $6,500 for those age 50 and above, both for 2020 and 2021.
For 2020, the limit on contributions to SEP IRAs and Solo 401(k) plans is $57,000, plus an additional $6,500 for Solo 401(k) plans for people who are 50 and older. For 2021, the base limit rises to $58,000.
For more information, see IRS Publication 590-A.
As of March 24, the IRS hadn’t said whether the April 15 deadline to fund traditional and Roth IRAs would be extended to May 17.
In many cases, savers with SEP IRAs and Solo 401(k)s can make contributions for 2020 until Oct. 15, 2021 if they have an extension to file their returns.
Roth IRA Conversions
Savers can convert all or part of a traditional IRA to a Roth IRA, but they will owe income tax on the transfer. That can make sense for people who expect their future tax rates to be higher than their current tax rate. Future tax-free withdrawals from the Roth account won’t push the saver into a higher tax bracket or trigger higher Medicare premiums.
However, savers can no longer undo a Roth conversion by “recharacterizing” it by the October tax-filing date of the year following the original conversion.
A law change in 2019 means that many heirs of Roth or traditional IRAs whose original owners died after Dec. 31, 2019 will have to empty the accounts within 10 years. Annual payouts aren’t required during this period. Under prior law, younger heirs could often take required withdrawals over many decades, a technique known as the Stretch IRA.
This law has exemptions for some heirs, including surviving spouses. They can continue to stretch required payouts—and taxes on them—over their lifetimes. For minor children of the deceased IRA owner, the 10-year withdrawal period often begins when they reach the age of majority, which is 18 in most states. Students may be able to delay the 10-year period up to age 26.
12. Tax breaks For Education
The Lifetime Learning Credit has been expanded and the tuition-and-fees deduction has been repealed.
Late in 2020, Congress permanently repealed the longstanding tuition-and-fees deduction, beginning in 2021, and expanded the Lifetime Learning Credit. It and the American Opportunity Credit are now the principal education tax credits.
For 2021 and beyond, both credits now have the same income phaseout: $80,000 to $90,000 of adjusted gross income for most single filers, and $160,000 to $180,000 for most married couples filing jointly. These limits aren’t adjusted for inflation.
But they apply differently. The American Opportunity Credit provides a maximum tax reduction of $2,500 per student per year, which is composed of 100% of the first $2,000 of eligible expenses and 25% of the next $2,000. It is typically available for the first four years of undergraduate education, and applies to tuition and course-related expenses, but not room and board.
The Lifetime Learning Credit is typically less generous but applies to a broader range of education expenses. It is a tax offset of 20% of up to $10,000 of eligible expenses, or up to $2,000 per taxpayer per year. It can be used not only for undergraduate education but also for graduate education, continuing education, and jobs-skills classes even if the skills aren’t related to current employment. A taxpayer can’t claim more than one of these credits for the same student and same expenses in a year.
For more information, see IRS Publication 970.
13. Deductions for Business Owners
For most U.S. business owners, the political fighting over the corporate tax rate and taxation of foreign income is irrelevant. That is because most U.S. businesses are organized as so-called pass-through entities for tax purposes, so that the income and expenses pass through to the owners’ individual tax returns and any taxes are paid at individual tax rates.
That means everything that affects individual taxpayers also affects the owners of S corporations, partnerships, limited liability companies and sole proprietorships.
For many, the most important tax-code feature is the special deduction for passthrough businesses. Congress created this 20% deduction in 2017 as part of the tax cuts pushed by then-President Donald Trump, and it was designed to give them an effective tax rate cut just like the one that corporations received.
In 2020, for individuals with taxable income up to $163,300 and married couples with taxable income up to $326,600, the pass-through deduction is unlimited, regardless of industry, employees and assets. Those numbers move up to $164,900 and $329,800 for tax year 2021. Above those thresholds, there are limits. Specified service businesses—including medical practices and accounting firms—start losing the deduction. For others, the deduction is limited by a formula that takes into account the wages they pay and the tangible assets they have.
For more information, see IRS Publication 535.
During 2020, Congress made a series of tax-law changes designed to help businesses weather the pandemic. Here are highlights.
Paycheck protection Program
The Paycheck Protection Program created plenty of tax controversy during 2020, but most of it got resolved.
The program was designed as forgivable, low-interest loans to businesses that kept employees on the payroll. The law specifically said that forgiven loans wouldn’t be treated as taxable income, but the Treasury Department issued a ruling that businesses receiving forgiven loans couldn’t take the normal deductions for expenses tied to those loans.
That ruling would have negated much of the benefit of making the loans tax-free, and businesses successfully lobbied lawmakers, who said they had intended to allow the deductions. Congress overturned the IRS decision in late December 2020, so that businesses will be able to take deductions for those payroll costs just like they would do in a normal year. However, some businesses may still face this issue on their state income-tax returns.
Employee Retention and Paid leave Tax Credits
Congress also created and expanded a tax credit for businesses that retain employees. It can’t be used for the same expenses as a PPP loan.
The credit, as expanded in December, effectively operates as a wage subsidy. It covers 50% of wages from March 13, 2020 through the end of that year and 70% of wages paid in 2021. Businesses can receive up to $5,000 per employee for 2020 and up to $28,000 in 2021. The credit can vary based on the details of the business, and the latest law changes extended the credit and offered new benefits to start-ups.
For 2020, businesses are generally eligible to receive the credit if they suffered a quarterly revenue decline, compared with 2019, of 50% in 2020.
For 2021, the decline only needs to be 20%, which should make more employers eligible for this benefit. Businesses can also become eligible if they were subject to government restrictions or closures.
Businesses with 500 or fewer workers in 2021 can generally get the credit to cover their workers; that threshold was 100 for 2020. Above those levels, larger businesses are limited in that they can generally get the credit only if they are paying people not to work.
In 2021, smaller employers can also request advance payment of the credit to assist with cash flow. Smaller employers can also get tax credits for providing paid leave, particularly for workers who are sick or quarantining.
Payroll Tax Deferrals
During 2020, employers were allowed to defer paying their half of Social Security payroll taxes as a way of giving them a temporary cash cushion. They are required to pay the money back in two installments, half by the end of 2021 and half by the end of 2022.
That is separate from the payroll tax deferral that then-President Donald Trump authorized by executive action. That was for the employee share of the tax and few employers decided to participate in that. For those who did, the deferred taxes from the final four months of 2020 must be paid back during 2021.
In December, Congress expanded the tax deduction for business meals, fulfilling a priority for President Trump, who wanted the change to boost the ailing restaurant industry as the economy recovers.
Before the change, business meals were 50% deductible. They will now be 100% deductible for 2021 and 2022, but not for meals purchased during 2020. The deduction applies to delivery and carryout meals as well as to those consumed in restaurants.
Other Tax Breaks
Congress also extended a variety of other tax breaks that had been scheduled to expire at the end of 2020. For businesses, those include the deduction for energy-efficient commercial buildings, lower excise taxes on alcohol, and the work opportunity tax credit that provides an incentive for hiring people from disadvantaged groups.
Other extended breaks with more limited application include a tax credit for maintenance of short-line railroads, accelerated depreciation for racehorses, a credit for two-wheeled plug-in vehicles and expensing rules for film, television and theater productions.
How is President Biden’s tax agenda going to affect you? Democratic control of the Senate gives President Biden a much stronger chance of raising taxes on corporations and high-income households, sending another round of stimulus payments and expanding the child tax credit.
With Democrats holding the White House, Senate and House simultaneously for the first time in more than a decade, they are poised to use that power. They are still talking about raising taxes on the richest, cutting them for others, and raising benefits for the lowest earners. These rates would revert to pre-2018 levels for taxpayers with more than $400,000 of taxable income. That would mean a top rate of 39.6%, versus 37% now. Lately there has been talk on the business news channels about Biden wanting to raise the rates on long term capital gains and many dividends and tax them at the same rates as ordinary income for people with taxable income above $1 million. The top rate could be as high as 39.6%, versus 23.8% now. There is also talk about raising the corporate tax rate. For corporations, the tax rate would rise to 28% from 21%, impose a minimum tax on companies with lower effective tax rates and increase taxes on U.S. companies’ foreign earnings.
Even so, Democrats face a series of tough challenges to turn those proposals into law with narrow legislative margins, a weak economy and a still-raging pandemic. The results might look quite different from the campaign-trail outlines, and the slim majorities may yield less than the $3 trillion in tax increases that Mr. Biden sought. This past year was a little chaotic and there were a bunch of changes fpr both businesses and individuals. If you have any questions about filing taxes or deductions, feel free to reach to Huckabee CPA with any questions and request a free consultation about your specific situation.