Last year was one of massive upheaval for millions of Americans. Many lost their jobs or saw their paychecks reduced; others worked remotely from makeshift offices. Some were forced to drain their retirement accounts to pay the bills; others bulked up their savings with stimulus checks.
All of these changes could affect your 2020 taxes — for better or for worse. With the following guidance, we’ll help you snag the biggest refund available to you, or at least reduce the amount you’ll owe. Because as the pandemic continues to wallop the economy, none of us can afford to leave any money on the table.
Tax tips for non-itemizers
The Tax Cuts and Jobs Act, enacted in December 2017, nearly doubled the standard deduction, which significantly reduced the percentage of taxpayers who itemize on their tax return. (The standard deduction for 2020 is $12,400 for singles and $24,800 for married couples filing jointly.) But the goal of simplifying tax preparation has proved elusive. The tax code is replete with credits and deductions for taxpayers who claim the standard deduction — and that list got a little longer in 2020.
The CARES Act, the economic stimulus bill enacted in early 2020, includes a provision that allows non-itemizers to deduct $300 in cash contributions to charity. Because the tax break is an above-the-line deduction, it will reduce your adjusted gross income and your taxable income.
The provision was designed to encourage taxpayers to help charities, many of which are struggling to fulfill their mission during the coronavirus pandemic. The deduction is based on your tax return, not per person, so the maximum a married couple who file jointly can deduct is $300.
To claim this deduction, you need to have made a cash contribution to a qualified charity by December 31. Noncash contributions, such as donations of used clothes to Goodwill, as well as donations to donor-advised funds, aren’t eligible. This tax break isn’t available to itemizers: If you still itemize, you’ll claim your charitable contributions on Schedule A (see below).
If you have children who are still dependents, make sure you take advantage of numerous tax breaks for parents:
Child tax credit. A new baby brings sleepless nights, unbounded joy and a $2,000 tax credit. Unlike a deduction, which reduces the amount of income the government gets to tax, a credit reduces your tax bill dollar for dollar. There’s no limit to how many kids you may claim on a return, as long as they qualify. But the credit begins to disappear as income rises above $400,000 on joint returns and above $200,000 on single and head-of-household returns.
Child care credit. The COVID-19 pandemic forced many schools to switch to remote learning, which required some parents to hire someone to take care of their children while they were at work. If you paid for child care and your children are younger than 13, you’re eligible for a credit of 20% to 35% for up to $3,000 in expenses for one child or $6,000 for two or more. The percentage decreases as income increases.
College credits. Many colleges and universities switched to remote learning, too. While they typically refunded costs for room and board, most continued to charge the full cost of tuition for classes taught remotely — much to the chagrin of some students and their parents. You can take some of the sting out of those bills by claiming the American Opportunity tax credit, which you can claim for students who are in their first four years of undergraduate study. The credit is worth up to $2,500 for each qualifying student. Married couples filing jointly with modified adjusted gross income (MAGI) of up to $160,000 can claim the full credit; those with MAGI of up to $180,000 can claim a partial amount.
The Lifetime Learning credit, meanwhile, isn’t limited to undergraduate expenses, and you (or your dependents) don’t have to be a full-time student to claim it. The credit is worth up to 20% of $10,000 in qualified expenses, up to a maximum $2,000 a year. For 2020, a married couple with MAGI of up to $118,000 can claim the full credit; those with MAGI of up to $138,000 can claim a partial amount. You can’t claim both this credit and the American Opportunity credit for the same student in the same year.
Student loan interest deduction. In response to the pandemic and economic downturn, Congress and the White House placed a moratorium on student loan interest and payments last year — and the relief continued into 2021. But if you decided to keep making payments on your federal student loans, take advantage of an above-the-line deduction on interest. You can deduct up to $2,500 in student-loan interest for you, your spouse or a dependent. The deduction phases out if your modified AGI is between $70,000 and $85,000 ($140,000 and $170,000 for joint filers). A former student can claim this deduction even if Mom and Dad are making the payments.
Low-income credit. Finally, if your income took a dive last year, you may be eligible for the Earned Income Tax Credit, which is designed to help lower-income working people. For 2020 tax returns, the maximum EITC ranges from $538 to $6,660, depending on your income and how many children you have. When the federal EITC exceeds the amount of taxes owed, you’ll receive a check for the balance. The income limits on this program are fairly low: If you have no children, your 2020 earned income and adjusted gross income (AGI) must each be less than $15,820 if you’re single, or $21,710 if you’re married and file jointly. But couples with three or more children can qualify with AGI and earned income of up to $56,844. The pandemic relief bill enacted in December allows families to use income from either 2019 or 2020, whichever year provides the largest credit. The bill also prevents unemployment benefits from reducing the size of EITC credits.
Tax tips for itemizers
Even with the larger standard deduction, about 10% of taxpayers will still get a lower tax bill by itemizing deductions on their tax returns. Tax software programs or a tax preparer can determine whether you should itemize or claim the standard deduction, but you’ll need good records to make sure you claim all of the deductible expenses available to you.
Deductions for homeowners. Homeowners with large mortgages are good candidates for itemizing. For home loans acquired after December 15, 2017, you can deduct interest on a mortgage—or mortgages—of up to $750,000. (For loans taken out before that date, you can deduct interest on mortgage debt of up to $1 million.)
Property taxes are also deductible—up to a point. The tax overhaul capped deductions for state and local taxes at $10,000. The cap primarily affects homeowners who live in high-tax states, such as New Jersey.
Charitable contributions. Charitable contributions are deductible, so if your mortgage and property taxes put you close to the itemizer threshold, make sure you claim credit for all of your philanthropy in 2020. And if you were extremely generous last year — perhaps in conjunction with estate planning — you will be able to take advantage of a provision in the Coronavirus Aid, Relief and Economic Security (CARES) Act designed to encourage charitable giving. Ordinarily, the maximum you can deduct for cash contributions is 60% of your adjusted gross income; for 2020, you can deduct up to 100% of your AGI.
If you used the time spent sheltering at home last year to clean out your closets, be sure to claim a deduction for items donated to charity. You can deduct the fair market value of donations of clothes, books and other noncash items. Some tax software will provide guidance on valuing your donated items.
Medical expenses. If you had extraordinary medical expenses in 2020—perhaps related to COVID-19 or another catastrophic medical event—you may be able to deduct a portion of your out-of-pocket costs, particularly if your income took a hit. You can deduct unreimbursed medical expenses that exceed 7.5% of your adjusted gross income. If your AGI was $50,000, for example, you would only be allowed to deduct the unreimbursed medical expenses that exceeded $3,750. The list of eligible expenses is long, ranging from long-term care to health insurance co-payments to prescription drugs. Costs for dental and vision care that aren’t covered by your insurance are also deductible.
Put your savings to work
One of the many anomalies of 2020 was this: Although many families struggled to get by, those who were able to keep their jobs saved more than ever. The personal savings rate, which measures the amount Americans have left over each month after spending and taxes, was 13% at the end of the year, the highest level since the mid 1970s.
Many people used that money to bulk up their emergency funds and pay off debt. But if you’ve already accomplished those goals, you can put that money to work and lower your 2020 tax bill.
Save for retirement. If you’re not enrolled in a workplace retirement plan, you can deduct a contribution to an IRA of up to $6,000, or $7,000 if you were 50 or older in 2020. Contributions to a traditional IRA will reduce your adjusted gross income on a dollar-for-dollar basis, which could also make you eligible for other tax breaks tied to your AGI.
Workers who have a company retirement plan but earn below a certain amount may qualify to deduct all or part of their IRA contributions. For 2020, this deduction phases out for single taxpayers with AGI of between $65,000 and $75,000; for married couples who file jointly, the deduction phases out between $104,000 and $124,000. If one spouse is covered by a workplace plan but the other is not, the spouse who isn’t covered can deduct the maximum contribution, as long as the couple’s joint AGI doesn’t exceed $196,000. A partial deduction is available if the couple’s AGI is between $196,000 and $206,000.
Save for health care. You have until April 15 to set up and fund a health savings account for 2020. To qualify, you must have had an HSA-eligible insurance policy at least since December 1. The policy must have had a deductible of at least $1,400 for individual coverage or $2,800 for family coverage. You can contribute up to $3,550 if you had single coverage or $7,100 if you had family coverage. You can contribute an additional $1,000 if you were 55 or older in 2020. Contributions will reduce your adjusted gross income. The money will grow tax-free, and withdrawals used to pay medical expenses are also tax-free.
If your investments earned money
The stock market seemed to be oblivious to the pandemic after the short-lived bear market in early 2020. Perhaps investors see better times ahead. How else to explain double-digit gains in the S&P 500 index?
As far as your tax-advantaged savings accounts, such as IRAs or 401(k) plans, are concerned, you can sit back and admire your gains. But if you harvested gains in your taxable accounts, you’ll probably need to share some of your profits with the IRS. And even if you didn’t sell, capital gains distributions from your mutual funds could trigger a tax bill.
To review: Capital gains on stocks, mutual funds and other assets held for one year or less are taxed at your ordinary income tax rate. For assets held for more than a year, capital gains rates range from 0% to 20%. If you are single and your 2020 taxable income was less than $40,000 (or $80,000 if you’re married and file jointly), you won’t have to pay any taxes on assets held for more than a year.
To avoid paying more than you owe, make sure you have the correct cost basis for any investment you sold in 2020. The cost basis is the price you paid for your shares, plus any reinvested dividends, capital gains distributions, sales commissions and transaction fees. The higher your basis, the lower the amount of gain that will be taxed. Financial services firms are required by law to track the cost basis of shares in mutual funds or stocks purchased in 2011 or later and provide the basis to investors when the securities are sold. For securities purchased before 2011, you may need to do some detective work, but it’s worth the effort—without a cost basis, the IRS will tax you on the entire proceeds of the sale.
If stocks were hot, bitcoin was a conflagration, topping $20,000 in December for the first time in its 12-year history. If you were fortunate enough to buy bitcoin when it was worth less than five figures, you’re sitting on big gains, so it’s particularly important to understand that the IRS views bitcoin and other cryptocurrencies as assets. That means they’re subject to taxes on capital gains, as is the case with stocks and mutual funds. Even if you use your digital currency to buy something, you’ll owe taxes on the difference between what you paid for it and its value when you used it to make a purchase. The IRS has taken pains to remind taxpayers that cryptocurrency profits are taxable, adding a line to Form 1040 asking whether you’ve bought or sold virtual currency.
If you were unemployed
If you claimed unemployment benefits for the first time last year, you may be in for an unpleasant surprise. Unemployment benefits are taxable at the federal level, and most states tax them, too. The extra $600 provided to jobless workers under the CARES Act through the end of 2020 is taxable as well. You should receive a Form 1099-G from your state that shows how much unemployment compensation was paid to you in 2020.
Taxpayers who received unemployment for a few months and then went back to work could be particularly hard hit by the combination of taxes on their wages and benefits. If you fall into that group, make sure you’ve taken advantage of strategies to lower your taxable income, such as contributing to an IRA. Depending on your income, you may be eligible to claim a saver’s credit for those contributions. For 2020, single taxpayers with $32,500 or less of adjusted gross income can claim a credit of up to $1,000; married couples who file jointly with AGI of less than $65,000 can claim a credit of up to $2,000. The credit is based on 10%, 20% or 50% of the first $2,000 ($4,000 for joint filers) you contribute to retirement accounts, including 401(k)s and IRAs. A credit is a dollar-for-dollar reduction in your tax bill, which means it will go a long way toward offsetting taxes on your benefits.
If you’re still receiving unemployment benefits — including the additional $300 a week included in legislation signed into law in December — you can take steps to avoid another tax shock when you file your 2021 tax return. For federal taxes, you can have up to 10% of your benefits withheld by filing W-4V. Contact your state for the appropriate form if you want money withheld for state taxes.
If you worked in more than one state
In past years, the process of preparing and filing a state tax return was often the easiest part of fulfilling your annual civic obligation. Once you’ve filed your federal tax return, most tax programs will fill in the state tax forms, ask a couple of questions and congratulate you on a job well done.
That may not be the case this year. As the pandemic forced millions of taxpayers to work remotely, some moved in with family members, others relocated to a second home, and some packed up and moved for good.
If you worked outside a state that’s your legal residence — even for as little as a day, in some cases — you may have to file a tax return in that state and pay taxes on the income you earned while you worked there. For example, New York Gov. Andrew Cuomo said in May that health care workers who traveled from other states to help with the pandemic will owe New York taxes if they worked there for more than 14 days.
Fortunately, most states will allow you to claim a credit for taxes paid to another state while you were working there, says Dina Pyron, global leader of Ernst and Young’s TaxChat. And some states have said they won’t tax people who are working in their jurisdictions remotely due to the coronavirus.
But geography matters. Seven states (Arkansas, Connecticut, Delaware, Nebraska, Massachusetts, New York and Pennsylvania) currently impose what’s known as a “convenience rule,” which states that individuals may be taxed by the state where their office is located — even if they didn’t live or work in that state — if they telework for reasons of their own convenience rather than because of employer requirements. So far, these states haven’t issued guidance as to how those rules will apply to workers who worked remotely during the pandemic. New Hampshire has asked the Supreme Court to prevent Massachusetts from taxing people who have offices in Massachusetts but have been working from home in New Hampshire, which has no income tax.
If you worked in more than one state in 2020, figure out how many days you spent working in each state. That will help you, or your tax preparer, determine whether you’re obligated to file more than one state tax return, based on the jurisdictions in which you worked.
If you relocated temporarily to a state with low (or no) income taxes last year, you may be tempted to claim that state as your state of residence in order to lower your tax bill. That’s a risky move, as many snowbirds have already learned. As states search for ways to close budget shortfalls, they’re going to take a hard look at residents who relocate to a lower-tax jurisdiction, and they may require those people to prove that the move is permanent. For example, you may be required to show that you’ve changed your voter registration and driver’s license to your new state, Pyron says.
Fulfilling state tax obligations is sufficiently complex that you may want to consult with a tax preparer, even if you ordinarily do your own taxes. If you’re still in the DIY camp, be aware that some tax programs, such as Credit Karma Tax, won’t process multiple state tax returns. Others charge a premium for a state tax return, which could get pricey if you need to file more than one (see Best Values in Tax Software).
If your stimulus payment was too low
Millions of Americans received economic stimulus checks last year for $1,200, plus $500 for each dependent child. A second round of checks for $600 per person went out in early January. Eligibility for the first round of checks was based on your 2018 or 2019 tax returns, whichever was filed more recently; the second round was based on your 2019 tax return.
While the stimulus put billions of dollars into the economy, some taxpayers got smaller checks than they were eligible to receive, and some didn’t receive a check at all. For example, a college student who was claimed as a dependent on her parents’ 2019 return but was working for herself in 2020 wouldn’t have received a stimulus check even though she was eligible for one, says Lisa Greene-Lewis, a CPA and tax expert for TurboTax. Those taxpayers will have an opportunity to claim the difference when they file their 2020 tax return. If information from your 2020 tax return shows that you’re eligible for a stimulus payment, or a larger amount than you received, you’ll be able to claim it on a line labeled “Recovery Rebate Credit” (tax software will calculate this for you). Similarly, if you didn’t receive your $600 check in January — a possibility, because the IRS was required to send out those checks by January 15—you can claim the money on your 2020 tax return. And if it turns out you received more than you were entitled to, find something else to worry about, because the IRS won’t make you pay the money back.
If you took a hardship withdrawal
The CARES Act allowed taxpayers who suffered economic distress due to the pandemic to withdraw up to $100,000 from their 401(k)s or IRAs without paying the 10% early-withdrawal penalty if they’re younger than 59½. That money is still taxable, but the law allows taxpayers to spread the tax bill over three years or avoid taxes altogether if they repay the money.
If you took a pandemic withdrawal last year, you have two choices, says Greene-Lewis of TurboTax. You can pay the entire tax bill when you file your 2020 tax return or pay one-third of the balance in 2020, 2021 and 2022. If you recontribute the amount of the withdrawal after paying taxes on it, you can file an amended return and get a refund, she says.