Before filing your income tax return for 2020, review some important information that you may not be aware of.

Are there any important COVID-related issues to consider for my 2020 tax return?

The pandemic has impacted nearly everyone—both personally and financially. Your 2020 tax return could also be impacted. You may have had a relatively straightforward tax return in the past, however, as a result of the pandemic, it might be necessary to adjust the way that you report income or you might have to pay additional income taxes that you had not planned for.  Here are a couple of important considerations:

Do I have to pay taxes on unemployment benefits?

Yes, unemployment benefits are taxable at the federal and Vermont state level. Benefits must be reported as gross income on your federal and state income tax returns.

Do I have to pay taxes on my economic stimulus payments?

No, the stimulus checks aren’t considered to be income and you do not have to pay taxes on them. There have been two rounds of stimulus payments made, and the amount received was based on the adjusted gross income reported on your most recent tax return (2018 or 2019).

With that said, there are some people who didn’t receive a check and others who did not receive a large enough payment resulting from income limits or an unexpected life event (unemployment, birth of a child). So, if you didn’t receive enough and are owed more money from those two rounds of stimulus, you can claim the full amount in your 2020 tax return, and the IRS will send it to you via your tax refunds.

Conversely, if your income was higher in 2019 or 2020 compared to the previous tax returns (used to calculate your payments), you may have received more than you were actually entitled to. If that is the case, the IRS cannot ask for any of that money back from you.

Is there anything that I can still do to maximize tax savings for the 2020 return? 

Consider a Health Savings Account (HSA) HSAs allow you to pay for certain medical expenses on a pretax basis. If you meet certain requirements for 2020, your HSA contribution can be up to $7,100 for family coverage and $3,550 for single coverage (plus an additional $1,000 if you’re 55 or older) and can be made regardless of your income level. These contributions are 100 percent tax deductible above-the-line, so you benefit even if you don’t itemize or are subject to high-income itemized deduction phaseouts. You can then take tax-free withdrawals to pay for uninsured medical expenses. A provision of the CARES Act now allows withdrawals to be made tax-free to pay for the cost of over-the-counter medications, retroactive to January 1 of 2021.

Retirement account contributions Consider increasing contributions to your Roth or traditional IRA. The maximum contribution limit is $6,000, or $7,000 if you are age 50 or older. You may also be eligible to still make contributions to other self-employed retirement savings account such as a SIMPLE or SEP. Contributions to these type accounts can be made through April 15, 2021. The SEP contribution can be made any time up through the extended filing deadline.

What can I do NOW to put myself in the best possible position for 2021?

There are certain actions that you can begin taking right now to prepare for your 2021 tax return.

Life events Consider the implications of expected life-changing events in the coming year. For instance, if you are planning on getting married or having a child in 2021, you should make the necessary adjustments to your withholdings.

Maximize your retirement account deferrals Contribute as much as possible to your employer’s retirement plan up to the allowed limits. If you are 50 or older by the end of 2021, your plan may allow you to make additional (catch-up) contributions. By doing so you can reduce your taxable income. In addition, you may qualify for the retirement savings contributions credit which could reduce your federal tax liability.

If available, maximize your flexible spending account contributions There are new rules for 2021 that will allow you to roll over any unused balance, so it is no longer a use it or lose it proposition.

Maximize contributions to and distributions from Section 529 Education Savings Plans Vermont allows a 10 percent tax credit on up to $2,500 contributed to a beneficiary’s 529 plan. For a married couple the credit is maxed at $5,000 in contributions or a $500 credit per beneficiary. 

Tax savvy charitable giving With the much higher threshold for the standard deduction, it may make sense to bunch your charitable contributions for a two-year timeframe all in one year. Alternatively, you may want to look at other options such as qualified charitable distributions from your required minimum IRA distributions if you have them or through the use of a Donor-Advised Fund (DAF).

John W. Davis, CPA, CFP®, CEPA, CVA has over 40 years of public accounting experience focused largely in the areas of taxation, financial planning, mergers and acquisitions, succession planning, and business consulting. In 1990, John founded what is now Davis & Hodgdon Associates CPAs. Davis & Hodgdon assists individuals and businesses throughout Vermont and New England. You may reach out to the firm to talk with a tax professional and create a strategy to fit your specific needs.