Last year the federal government implemented legislation within the Coronavirus Aid, Relief, and Economic Security (CARES) Act that included more than a few generous income tax provisions structured to provide financial relief to taxpayers. Those provisions may have an impact on your 2020 tax liability as well as your 2021 tax and financial planning. Below are 10 of the most important points you should know and discuss with your income tax preparer.
1. COVID-related early distributions from your retirement plan count as income.
Typically, if you take an early distribution from your retirement plan, you must pay a 10-precent early withdrawal penalty. That penalty was waived in 2020 for people who needed access to those funds to help them during the pandemic. This provision allowed you to take a penalty-free distribution of up to $100,000 provided you had a qualifying COVID-related event (unemployment and/or a reduction in hours you work, having to quarantine, closing your business due to safe-at-home orders, losses sustained for having COVID-19).
Even though the penalty was waived, the money you withdrew from your retirement plan must be included as ordinary income on your taxes. You can claim the entire distribution in 2020’s income, or you can spread the amount across a three-year period. You can also choose to redeposit some or all of the funds you withdrew early within three years and suffer no tax consequences. Just remember to file an amended return.
2. You must take your required minimum distribution (RMD) in 2021.
While some needed to take an early distribution in 2020, Americans were also given the opportunity to forego taking their RMDs if they did not need it. In the face of the pandemic, not taking a distribution effectively reduced your 2020 tax bill. And keeping those funds in your retirement account also gave it more time to grow. However, this provision has not been extended for 2021. You must prepare for and schedule your RMD this year.
Remember, your RMD amount is based on your account balance at the end of the previous year. So, if you didn’t take your RMD last year, your retirement account balance may have been higher at the close of 2020. This means your RMD for 2021 may be significantly higher than you expect, which, in turn, also means an increased tax liability on your annual income for this year. Coordinate with your tax professional when the best time this year for you to take your RMD. They can also help you with strategies to help you deal with higher income taxes in 2021.
3. There is an extension for charitable contribution deductions in 2021
One extension for 2021 effects your adjusted gross income (AGI). If you make a cash contribution to a qualified charity (excluding donor-advised funds) you can deduct up to 100 percent of your AGI.
There is also an extension for above-the-line deduction for cash contributions. As long as you don’t itemize your taxes, you can take advantage of the extension through this year.
- If you are married filing jointly, you can now deduct $600 (up from $300).
- For single filers, your above-the-line charitable deduction is $300 (for non-itemizers).
Keep in mind this is a temporary extension through 2021 only. When combined with other tax-efficient strategies, taking advantage of this option can help reduce your income tax liability to offset a Roth conversion.
4. Standard deduction increased for inflation.
The amounts of standard deductions increased as follows to accommodate for inflation for 2020. These numbers apply to most taxpayers. Please consult your tax professional for specific guidance.
- Single taxpayers and/or married couples filing separately: $12,400
- Married filing jointly: $24,800
- Head of household filer: $18,650
5. You can deduct medical expenses if they exceed 7.5 percent of your AGI.
This applies to qualified medical expenses that you aren’t reimbursed for and is an exciting provision. The previous threshold only allowed deductions if your medical expenses exceeded 10 percent of your AGI. The lower 7.5 percent is a great help, but only applies if you itemize your expenses. Itemizing these deductions can play an integral role in tax savings if you bunch your deductions and charitable contributions. Bunching is the practice of making more charitable donations in one year and itemizing for that year and then claiming the standard deduction within other income tax years. Your tax professional can help you determine if bunching is the right strategy for you.
6. You can take a 100 percent deduction on business meals.
Through the end of 2022, you can deduct 100 percent of your business meals at restaurants. This is an incredible incentive to begin safely networking with clients, prospects, and peers again.
7. There is an extension for employers to make tax-free payments of student loans.
Your employer’s ability to make tax-free payments of employee’s student loans is extended until 2025. This provision allows an employer to make annual payments of up to $5,250 for the student loan principal or interest. Check with your employer to see if the company you work for provides this benefit.
8. Employers have an extension to pay deferred employee taxes.
Small business employers now have an extension of the deadline for repaying deferred employee payroll taxes. That date for this repayment was initially April 30, 2021. Per Internal Revenue Notice 2021-11, the new deadline to pay deferred employee taxes is now December 31, 2021.
9. There is a third round of PPP loans now available to help small businesses.
This round of PPP loans, included in the Consolidation Appropriations Act 2021, aims to provide relief to some of those who received the Paycheck Protection Program (PPP) loan in the first round and also for new applicants.
There are eligibility requirements for this third round of PPP loans. If your business has 300 or less employees, but you’ve already spent all of your first PPP funds, you can receive a second loan—or second draw—of up to 2.5 percent average of your monthly payroll costs (not to exceed $2 million). You must also show your business suffered a 25 percent reduction in gross receipts in any 2020 quarter compared to the same timeframe in 2019.
Provisions allow you to select an 8-week or a 24-week covered period for spending loan funds. And if your loan is under $150,000, the process to apply for loan forgiveness is simpler than it was for the first PPP loans.
10. You can take deductions for expenses paid by forgiven PPP loan funds.
New legislation has been amended to allow you to take a normal tax deduction on business expenses paid for by PPP loans—even if your loan received a “forgiven” status. Additionally, your forgiven PPP loan will not be considered as income on your tax return. For more in-depth information, this article published by SheppardMullin explains PPP loans in detail. You should also consult with your income tax preparer to ensure you take the proper steps to comply with loan forgiveness, and/or to see if you meet the criteria for a second PPP loan if you need one.
Final Thoughts from Pantheon Wealth Planning
The provisions outlined above refer to federal income taxes only and state taxes vary from state-to-state.
Income tax and financial planning are crucial elements that help you achieve the financial security you desire. It’s important you clearly understand how the above provisions impact your tax reporting to ensure you comply with IRS rules and regulations. When in doubt, always consult with your tax and/or financial professional for guidance.
This article was written for general informational purposes only and should not be construed as tax or legal advice. Please seek appropriate counsel to determine your income tax planning and legal needs pertaining to the information in this article.