TL;DR: Stimulus checks are non-taxable, but additional pandemic unemployment benefits are taxable. There are other important changes you should know about too!
The CARES Act passed in late March 2020 provided many Americans with direct stimulus payments of $1,200, plus $500 for qualified children. These payments are not taxable income.
These payments do not raise your total gross income for 2020, which is important for things like income-based repayment of student loans.
In response to the pandemic, the Federal government added an additional $600 per week in unemployment benefits on top of normal State unemployment benefits. Just like normal unemployment benefits, the additional $600 per week is considered taxable income.
Most state unemployment programs automatically withhold income taxes on unemployment benefits. However, the amount of withholding may not be enough to cover the tax on the additional $600 weekly payments. This means you may owe additional money when you file your 2020 tax return. Here are a few examples:
- Mary is single and has no dependents. Her total 2020 income was $42,000, including $900 per week in unemployment benefits starting in March. She elected to withhold only 10% for Federal taxes. Because her tax rate is 12%, she will owe the 2% difference when she files her taxes. This is about $840.
- Jordan is married with one dependent child. While he began receiving unemployment of $1200 per week in April, his spouse continued to work. Together they earned $98,000 in 2020. Jordan elected to withhold 15% for Federal taxes on his benefit. Because this is more than their tax rate of 12%, they will receive a refund of their overpayment of 3% or about $2940.
Catch makes it easy to automate the process of withholding and even paying your taxes! The best time to get a jump start on 2021 is right now!
Catch also makes it easy to estimate your income tax rate! However, you should work with a tax professional if you are concerned that you did not withhold enough taxes from your unemployment benefits. If the additional tax you owe is a burden, you can apply for a payment plan through the IRS. Fortunately, the IRS provides free tax preparation services to those with income below $57,000/yr. or are elderly or disabled. The IRS also makes filing your taxes online free for most people earning less than $72,000/yr.
Retirement Account Withdrawals
Typically, early withdrawals from a retirement account mean you will owe income tax and a potential early withdrawal penalty of 10%. Under the CARES Act, if you were impacted by COVID, you are eligible to take a distribution of up to $100,000 penalty-free. While the distribution is still subject to income tax, you can choose to pay the taxes owed over 3 years or avoid the tax entirely if you return the total distribution to your retirement account within 3 years.
Payroll Tax Deferral
If you are self-employed or own a small business, you may be familiar with payroll taxes, including Social Security and Medicare taxes. Half of these payroll taxes are paid by an employer and the other half are paid by employees. If you are self-employed, you are responsible for paying both the employer and employee portions.
The CARES Act allows employers to defer 2020 payroll taxes and pay them later on in 2021 and 2022. If you are self-employed, this means you may be able to defer 50% of your payroll taxes and pay them later on. This is a relatively complex process that you can read more about here.
The CARES Act allows for a new $300 charitable tax deduction that is available to people who do not itemize their tax deductions. If you do not itemize deductions and made charitable contributions in 2020, you will receive a tax benefit on up to $300 of those donations. This is only for gifts made during 2020.
Other Tax Considerations
If you are self-employed, you should carefully track your work-related expenses and costs of doing business. You may be able to use some of these expenses to reduce your self-employed income. Here are just a few examples:
- Health Insurance! That’s right, if you are self-employed and purchased your health insurance, you can deduct a portion of your premiums on your taxes!
- The cost of tools and software you use for business purposes. While you want to be sure you correctly attribute the costs related to personal use, the cost of Catch may be included in this deduction!
- If you drive for a rideshare company, you can deduct mileage related to your driving. Apps like Uber and Lyft make this easy by logging miles driven with a passenger in the car. You can also deduct mileage driven on the way to your first passenger, between passengers, and on the way home! There are great apps available to help with this.
- The cost of a cell phone or internet access used for business purposes.
- If you use a portion of your home regularly and exclusively for your self-employed business, you may also be able to deduct a portion of the associated costs.