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(From the Financial Literacy Blog) – Like many people across the U.S. and beyond, you probably never want to think about 2020 again. Before you can do that, however, you need to take care of an important task––filing your 2020 taxes. Due in large part to the coronavirus pandemic, the filing process may look different for some Mainers this year. Here are some answers to questions you may have before filing:
Are unemployment benefits considered taxable income?
Yes, unemployment benefits received in 2020 will count as taxable income. While you don’t have to pay Social Security or Medicare withholdings while collecting unemployment, the benefits are taxable on a federal level and in most states, including Maine. Federal tax is withheld from unemployment benefits at a flat rate of 10%. To opt into the voluntary withholding request at a flat rate of 10%, you would have needed to fill out this W-4V form. If you chose to not have taxes withheld from your benefits, then you should have been paying quarterly estimated taxes on that money. If you haven’t been, for whatever reason, you’ll need to set aside enough money from your unemployment benefits to pay your taxes by Tax Day (April 15). To get an idea of how much should be withheld, you can use this Tax Withholding Estimator tool on the IRS’ website.
Are stimulus payments considered taxable income?
No, the stimulus payments will not count as taxable income. Between the Coronavirus Aid, Relief, and Economic Security (CARES) Act and the COVID-Related Tax Relief Act, Americans were provided two waves of refundable tax credits. Instead of being treated like taxable income, it’s being treated like a refundable tax credit. A refundable tax credit is a credit that is refunded to the taxpayer no matter how much the taxpayer’s liability is. Essentially, it’s an advance on money you would have received anyway after filing your 2020 taxes. Additionally, when it’s time to file, there is an important detail related to the stimulus payments that new parents in 2020 should we aware of. New parents didn’t receive the additional payments for having dependents under the age of 17 during the first or second wave of stimulus payments. This is because the stimulus payments were based on 2019 filings, where there was no record of the dependent. By claiming a new dependent on your 2020 taxes, you will receive both a $500 and $600 payment with your return.
What should I expect if I withdrew money from a retirement plan?
Under the CARES Act, Americans under the age of 59 1/2 were allowed to take up to $100,000 out of their 401(k)s and IRAs through the end of 2020 without having to pay any early withdrawal penalties. However, if you took money out of either of those tax-deferred retirement accounts, the money will be taxed as ordinary income. If you’re facing a huge tax bill following the withdrawal of retirement funds, you have three years to put those funds back and get a refund on any taxes you paid on that money. While prematurely withdrawing funds from a 401(k) or IRA isn’t traditionally recommended, 2020 was anything but traditional. Looking ahead to future years, try to avoid prematurely withdrawing funds to avoid paying penalties.
What should I expect if I withdrew money from an educational account?
With many colleges and universities across the state shifting their classes to a virtual format and sending students home, many students and parents received a refund for room and board, and even some partial tuition refunds. However, if any of the money that was refunded was originally from a 529 plan or Education Savings Account (ESA), you needed to have put the money back in that account within 60 days of the refund. Money from a 529 plan or ESA must be used for qualified education expenses in order to be tax-free. If the refund wasn’t returned to an educational-specific account, you’ll have to pay income taxes on it and face a potential 10% penalty from the IRS.
For more questions on how tax filings may be impacted by the pandemic or to learn what to do if you can’t pay your taxes in 2021, Coronavirus Aid, Relief, and Economic Security (CARES) Act. Otherwise, reach out to your local credit union to see how they can help.