Coronavirus and Taxes: Recent Challenges to Tax Law and What You Need to Know
Some of the Coronavirus relief measures put in place in 2020 are likely to have an impact on you this tax season. There were also some significant changes to day-to-day life for a lot of taxpayers that could have an impact on them this tax season. Here are some of the common tax impacts that may affect you, as well as guidance on some of the additional records you should provide to us when we prepare your tax return, to make sure you get every tax benefit you can.
Rebate Recovery Credit
The stimulus checks you received were an advance payment of a tax credit. If you did not receive the full stimulus payment you were entitled to, you have a second chance to get it now when you file your tax return. The first stimulus check should have been $1,200 per taxpayer plus $500 for each dependent you are entitled to claim on your tax return. The second stimulus check should have been $600 per taxpayer plus $600 for each dependent.
This credit will be of particular importance for those who have children in custody cases. If there is uncertainty as to which party was entitled to claim the child, it is more likely the child’s stimulus payment may have been paid to the wrong parent. We can help you determine if you are entitled to claim this credit for your child this year, and help you get the money you were entitled to receive. This credit is also likely to come into play if you do not traditionally file a tax return and therefore may have been missed when the stimulus checks were distributed.
To claim this credit, we will need a record of how much you received from the two rounds of stimulus checks. If you are claiming a dependent, we will also need records showing where the child resided for the whole year, which may include your custody order, your child’s school enrollment records, and a calendar identifying where your child spent each overnight throughout the year.
The increase to the standard deduction starting with the 2018 tax year essentially did away with charitable contribution deductions for many taxpayers who no longer benefitted from itemizing. This year, up to $300 in charitable contributions are deductible in addition to claiming the standard deduction.
For individual taxpayers who itemize and for corporations, the limit on the number of charitable contributions that can be deducted has increased. Individual taxpayers can deduct cash contributions made to qualifying organizations during the 2020 calendar year usually up to 60% of the taxpayer’s Adjusted Gross Income (AGI). If the cash contribution was made to a qualifying organization during the 2020 tax year, it may be deducted up to 100% of the taxpayer’s adjusted gross income.
Corporations may deduct qualified contributions up to 25% of their taxable income and can carry forward excess charitable contributions to the 2021 tax year. A business that donated food inventory for the care of the ill, needy, or infants can deduct up to 25% of the business’s aggregate net income from all trades or businesses, whereas this would usually have been limited to 15% of aggregate net taxable income.
You will need to have records to substantiate your charitable contributions. The IRS has indicated it will impose more severe penalties than usual for taxpayers who over-report their charitable contributions for the 2020 tax year. Your records for charitable contributions should include acknowledgment letters from the recipient organizations, receipts, and canceled checks.
Medical Expense Deductions
Typically taxpayers who itemize their deductions can only deduct unreimbursed medical expenses to the extent that they exceed 10% of the taxpayer’s adjusted gross income (AGI). For the 2020 tax year, and continuing forward into future years, this deduction floor has been reduced. Now taxpayers can itemize and deduct unreimbursed medical expenses that exceed 7.5% of their AGI.
You will need to provide a record of the medical expenses you paid out of pocket. This may include copies of medical bills and records of your payments, pharmacy receipts for your prescriptions, or you may be able to obtain a statement from your medical providers of all expenses paid throughout the year.
Early Withdrawal From Retirement
Typically, there are tax penalties for withdrawing funds from retirement before you reach 59 ½ years old. This included a 10% penalty tax in addition to having to pay the ordinary income tax on the withdrawn funds. In the 2020 tax year, the 10% penalty has been waived. Additionally, for many retirement accounts, the age at which you are permitted to retire and begin receiving ordinary distributions has lowered to 55 years of age.
Student Loan Interest Deduction
There has not been a change to the provisions for the student loan interest deduction, but there has been a change to student loan interest charged. As part of the pandemic relief, federal student loans were placed in an automatic deferral status, and no interest was charged. Taxpayers who made payments on federal student loans in 2020 will find that they likely did not pay enough interest on those student loans to reach the $2,500 limit they may be accustomed to deducting. However, these taxpayers should keep in mind that they very likely received more benefit in the long run from being able to pay their loan balances down without interest, or having relief from making their payments, than they would have received from the tax deduction. Student loan deferrals and 0% interest have been extended through at least September 2021, so this will also be the case for the next tax year.
Income Choice for Earned Income Credit and Additional Child Tax Credit
The Earned Income Credit and Additional Child Tax Credit both have qualifications based upon the amount of earnings the taxpayer received in the tax year and the number of dependents the taxpayer is entitled to claim. To qualify, you must have at least some amount of earned income, and that amount cannot exceed certain thresholds based upon your filing status and number of dependents. A temporary change for the 2020 tax year allows taxpayers to choose whether they want to use their 2020 earned income figures or their 2019 earned income figures to claim these tax credits.
If you think you may be entitled to claim the Earned Income Credit and/or Additional Child Tax Credit, you should provide not only your 2020 income tax records, but also your 2019 income tax records, including a copy of your 2019 tax return, to your tax preparer.
Business Use of Home
Self-employed individuals have long used the home office deduction to deduct some of their home expenses on their income taxes. In past years, certain employees could use the home office deduction so long as the use of their home met certain tests to establish it was for the convenience of their employer rather than for the convenience of the employee. This year, when many businesses were subjected to shut down orders and could only function if their employees set up home offices, a lot more employees were on track to meet this test than in past years. However, alas, changes to the Internal Revenue Code have eliminated the “convenience of the employer” test. The rule now is that employees are not eligible to claim the home office deduction, period. It may be possible for you to claim a home office deduction if you took advantage of the shutdown to start a small business, but keep in mind that is only if that small business is not deemed a hobby.
The mass shutdowns in 2020 gave a lot of taxpayers additional time that they could put towards hobbies. In particular, the pandemic created a market for reusable fabric facemasks, and crafty entrepreneurs stepped up to their sewing machines to meet this need. Others may have engaged in sales of other types of products in line with their hobbies, from woodworking to soapmaking.
You are required to report the income you received from a hobby activity. In years past, you could offset your hobby income by itemizing and deducting hobby losses up to the amount of the hobby income. Beginning in 2018, the hobby loss deduction was eliminated, and losses from a hobby activity could only be used to offset income if the taxpayer could establish that it was a business rather than a mere hobby.
In 2020, the stakes are higher than ever, with taxpayers having more incentive for their activities to be part of a small business, and the IRS has more incentive to argue that those are mere hobbies. To make matters worse, if you get audited in future years and lose this argument, the IRS will assess penalties including an underpayment penalty and a substantial understatement penalty. It would be nice if there could be a clear line between the two, but unfortunately, that is not the case.
In making the distinction between a hobby or a business, the IRS considers 9 factors. Those are:
- Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records.
- Whether you have personal motives in carrying on the activity.
- Whether the time and effort you put into the activity indicate you intend to make it profitable.
- Whether you depend on income from the activity for your livelihood.
- Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
- Whether you or your advisors have the knowledge needed to carry on the activity as a successful business.
- Whether you were successful in making a profit in similar activities in the past.
- Whether the activity makes a profit in some years and how much profit it makes.
- Whether you can expect to make a future profit from the appreciation of the assets used in the activity.
Come to your meeting with us prepared to discuss details of exactly how you carried on your business or hobby activity and what record keeping you did. We can help you determine whether you will be able to deduct business losses, or if you will be limited to reporting income only for a hobby. We can also help advise as to changes you may be able to make so a hobby can become a business in the future.
Even if your hobby business was a hobby, keep in mind that donated products are still deductible as charitable contributions. We should have records of any items you made and donated, including receipts for the materials and letters acknowledging the donations.
Call our office at 717-657-7770 to ask about a free consultation with one of our tax attorneys for tax preparation or your other legal needs. Scaringi Law provides tax preparation services at competitive rates, and we can also advise you on other legal matters, as your full-service law firm.