Tax Implications of COVID-19
Did You (Or Your Accountant) File Your Taxes in Accordance with All Applicable Pandemic Legislation and Rules?
There is no shortage of ways in which COVID-19 has affected the everyday lives of Americans. While much of the focus is rightfully on those who have lost their lives from the pandemic and the impact on the families, there are myriad other ways.
One such area that is particularly relevant this time of year relates to income tax filings. While the standard April 15th deadline has come and gone, both the Internal Revenue Service (IRS) and the State of Illinois extended the deadline to May 17, 2021. This should provide some much-needed relief to those whose timely filing has been delayed due to COVID-19 or other reason.
Normally, the IRS would begin processing returns in mid-January, but no area of the world, including departments of the federal government, are truly out of COVID-19’s reach. The IRS began processing returns on February 12, 2021. Beyond merely the start date for processing, COVID-19 has impacted the IRS in other ways also. While reports are out that nearly half of the adult American population has been vaccinated, many government offices still have reduced office staff and more employees working from home. The IRS is no exception and these constraints are likely to delay the processing of returns. This is exacerbated by the fact that the IRS has reduced its staff by 20% within the last year to address budgetary constraints.[1] While this is relevant for those relying on a timely refund, it is even more important for those receiving direct economic impact payments. Those who have filed their taxes and set up direct deposit have, and will continue to, receive their impact payments sooner. Those who have not filed and/or have the processing of their filing delayed, and do not have direct deposit set up should expect to wait. This should receive additional attention in light of recent calls for a fourth round of direct economic impact payments to individuals.
Equally important, the economic impact payments are not taxable. It is of practical importance as well. The distribution of the payments, also known as stimulus checks, was based on income levels reported in 2018 and 2019 filings. If it is discovered that the individual’s 2020 income would have disqualifying from receiving such payments, there is a safe harbor provision that would not require the stimulus checks to be returned. For those who haven’t filed (or received a partial check), however, the 2020 Recovery Rebate Credit allows individuals to claim a credit equal to the payment they would have received.
There are other ways in which COVID-19 impacts income tax filings. One significant aspect of the Families First Coronavirus Response Act, which was extended by the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), was the enhanced unemployment benefits for those laid off due to the virus. While the stimulus checks are not taxed, unemployment benefits, including the supplemental federal benefit, are. For those who did not lose their job due to COVID-19 but who saw reduced work hours, the Earned Income Tax Credit and/or the Additional Child Tax Credit for those with children aged 17 and under may apply.
In March 2020, nearly all non-essential workers were forced to migrate to work-from-home configurations. Many non-essential workers lacked a home office or substitute set up to effectively work from home and had to create a workspace from scratch. This may have included big ticket items such as the purchase of a computer, desk, drawers, etc., at the very least it included office supplies. While some may intuit that these expenses are deductible, they are not. They may, however, be subject to employer reimbursement.
There are countless others who were not filed, but who did see their hours or salary reduced, or otherwise suffered adverse economic consequences from the pandemic. These individuals may have picked up side jobs or found alternative ways to generate supplemental income. It should come as no surprise, however, that it would be taxable as ordinary income. There are no exceptions or exemptions.
There were many others still that did have hours or salary reduced and did not generate supplemental income, but otherwise needed funds. The CARES Act enabled individuals to withdraw up to $10,000 from a qualified retirement account during the 2020 calendar year without paying a 10% additional tax on early distributions The taxes can be stretched out over three years and, if the money is replenished within the qualified retirement account, the taxpayer can recover the taxes paid.
For health-related expenses, prior rules allowed individuals to deduct to 7.5% of their adjusted gross income for qualifying medical expenses. This amount was increased as a result of the pandemic. As an interesting side note for employees, former President Donald J. Trump deferred payroll taxes for employers. It remains to be seen how employers will adjust to the long-lasting and far-reaching effects of the pandemic, but there will certainly be consequences to employees, both foreseeable and unforeseeable, intended and unintended.
The final takeaway is to file your taxes ASAP (but also correctly) ensuring that all appropriate credits are received, deductions are taken, income sources are properly classified as taxable or untaxable, and be prepared for the unexpected to the extent practicable. Like everything else that has transpired since the pandemic began, you don’t know what will happen until it happens.