By Steve Doster
COVID-19 brought major changes to our lives. With so much happening this past year, the last thing on most minds is taxes. Things are already depressing enough. Why make it worse by talking about everyone’s least favorite topic? Well, there could be some unhappy tax surprises come April 15th. To help you prepare for Tax Day, let us look at some potential traps.
Did you know that unemployment benefits are taxable? If you have collected these benefits, it’s likely no Federal tax withholding was taken out of them. (Some good news: Although most states tax unemployment benefits, California does not.) You might owe some Federal tax if you’ve been collecting unemployment for most of 2020.
Our U.S. Congress has introduced a bill to exempt up to $10,200 of unemployment benefits in 2020. This bill is still in the early stages and April 15th is fast approaching. It’s something to keep an eye on, but not something to count on.
As a side note, the stimulus checks sent out in 2020 are not taxable.
Businesses that received PPP loans (Payroll Protection Program) can exclude the amount forgiven from Federal taxable income without having to eliminate deductions for expenses paid with the loan proceeds. By receiving the loan proceeds as nontaxable without reducing deductions, businesses truly get a full tax-free benefit from PPP loans. As nice as this is, some states — like California — disallow the deduction of expenses paid with forgiven PPP proceeds— in essence, making the forgiven portion of the loan taxable. If you benefitted from a PPP loan, having to pay unexpected state income taxes could be a tough pill to swallow.
Like many people, you might have been forced to work from home during 2020. So, does that mean you can deduct home office expenses? The answer depends on whether you are an employee or an independent contractor (self-employed). For employees, there is no Federal tax deduction but there might be a California deduction. In the past, unreimbursed employee business expenses were deductible as a miscellaneous itemized deduction. Unfortunately, for Federal purposes, since 2018, miscellaneous itemized deductions were no longer allowed. For those that are self-employed, a home office deduction might be possible for both Federal and California taxes.
To qualify for a home office deduction, the office (room or part of a room) must:
Be your primary place of business, and
Be used regularly and exclusively for your work or business.
If you think you might qualify to claim home office expenses, be sure to keep proper records and be sure to work with a qualified CPA. The complex rules can be quite daunting.
The IRS requires at least 90% of your tax liability be paid ratably throughout the year. So, if you owe more than 10% of your total taxes come April 15th (and you don’t qualify for an exception), you will owe a penalty. If you are still collecting unemployment benefits, you might want to elect to withhold Federal taxes on this income to avoid penalties for 2021 income. Unfortunately, the withholding rate is only 10% and, thus, might not be enough to avoid penalties. Other options would be to pay quarterly tax payments or increase your withholding on other income.
Unfortunately, all this government assistance has a domino effect that makes taxes more complicated for 2020. You can’t control whether or not you end up owing taxes this April. However, you can get your tax returns prepared early so you have more time to come up with any tax owed. And, of course, make sure to work with a qualified CPA.
— Steve Doster, CFP® is the financial planning manager at Rowling & Associates – a fee-only wealth management and CPA firm helping individuals find their financial freedom. Rowling & Associates works to a fiduciary standard of care helping people with their taxes, investments, and financial planning. Read more articles at www.rowling.com/blog.