COVID-19 Relief Law Boosts Temporary Tax Deductions and CreditsTax Planning
Embedded in the COVID-19 relief law is $900 billion for financial assistance.
As you would expect in these unusual times, some of the relief is in the form of direct government financial assistance and some is from tax benefits that can impact both tax year 2020 and tax year 2021.
Most of the provisions create extra deductions or credits where Uncle Sam puts cash directly into your wallet.
We’ll review the ones that most likely will impact you, your tax return, and your wallet over the next year.
Recovery Rebate Payments and Credits
Remember those $1,200 checks from the IRS that many people got earlier in 2020?
Well, there’s another round of payments coming, with rules very similar to the first round.1
Take a look at COVID-19 Important Tax Breaks from the CARES Act for more information about the first round of payments.
The cash you’re about to receive in this second payment is an advance payment of another new refundable tax credit that you will finalize on your 2020 Form 1040.
You may have already received your new advanced tax credit in the form of a check, debit card, or electronic deposit. The amount is based on your 2019 tax return. If your income qualifies for the full payment, you will receive
- $600, or $1,200 if you filed a joint return, plus
- $600 for each dependent who was age 16 or younger on December 31, 2020.
Your check in the mail goes down by 5 percent of the amount by which your 2019 adjusted gross income (AGI) exceeds
- $150,000 on a joint return,
- $112,500 on a head of household return, or
- $75,000 for all other filing statuses.
The advance tax payment is based on
- 2019 AGI; or
- 2019 Social Security or retirement benefits if you did not file a 2019 tax return.
You will be able to “true up” your advance tax credit payment on your 2020 Form 1040 (which you file this year).
- If the advance payment (the cash you are about to receive) is less than the credit you qualify for based on your 2020 AGI, then you’ll get the difference as a refundable tax credit in 2021 after you file your 2020 tax return.
- If the cash amount you receive this year is greater than the credit you qualify for based on 2020 AGI, you have a windfall. You don’t have to pay back the excess cash to the IRS.
Example. You are single with tax year 2019 AGI of $85,000. You are over the $75,000 threshold. Your original advance tax credit from the federal government was a payment of $700 ($1,200 less $500 (5 percent of $10,000)).
Now, with the new relief, you have or are about to receive an additional payment of $100 ($600 less $500 (5 percent of $10,000)).
Fast-forward to your 2020 tax return: your AGI has gone down to $75,000. Since your income is not in the phaseout range anymore, you’ll get total additional refundable tax credits of $1,000:
- $500 from 2020 recovery rebate credit ($1,200 less the $700 you already received), plus
- $500 from the additional 2020 recovery rebate credit ($600 less the $100 you already received).
Paid Sick and Family Leave Credits
As we described in COVID-19: Significant Payroll and Self-Employment Tax Relief, Congress provided two ways to give workers paid sick and family leave:
- Employers received refundable payroll tax credits to fully offset the cost of the government mandate that employers provide paid sick and family leave to their employees.
- Self-employed persons also qualify for paid sick and family leave. They claim a refundable tax credit against their 2020 self-employment tax.
The tax credits require that the self-employed person or the employee was unable to work due to a qualifying
situation between April 1, 2020, and December 31, 2020. The maximum non-working days eligible for the tax credits are
- 10 days for paid sick leave, and
- 50 days for paid family leave.
Under the new law, you now can claim these tax credits for qualifying days through March 31, 2021. The maximum creditable days did not increase.
There is one other major change: to maximize your potential self-employment tax credits, you can elect to use your 2019 rather than 2020 net earnings from self-employment to calculate your credit amount.
Under the original law, if you had a 2020 net loss from self-employment, you would have a zero paid sick or family
leave tax credit.
Example. You were unable to work for five days due to COVID-19 symptoms in October 2020. Your net earnings from self-employment were
- $70,000 in tax year 2019, and
- $50,000 in tax year 2020.
Your average daily self-employment income to compute the credit is
- $269 in tax year 2019, and
- $192 in tax year 2020.
Since these amounts are below the $511 daily tax credit maximum for the paid sick leave credit, your 2020 tax credit is
- $1,345 if you elect to use the 2019 net earnings, or
- $960 if you use the 2020 net earnings.
Therefore, the election to use your 2019 net earnings from self-employment enables you to pocket an additional $385.
100 Percent Business Meal Deduction
The tax law generally limits your ability to deduct your business-related food and beverage expenses to 50 percent of the total amount (with some exceptions).
But because of an effort to help the restaurant industry, you can now deduct 100 percent of your business-related expenses for food and beverages provided by a restaurant for amounts paid or incurred after December 31, 2020, and before January 1, 2023.
Example. You take a prospect to lunch at a restaurant to discuss a business contract. The meal costs $100. Normally, you can deduct only $50 of that expense. For tax years 2021 and 2022, you can deduct the full $100 expense.
In COVID-19 Important Tax Breaks from the CARES Act, we discussed three major changes to charitable contribution deductions for tax year 2020:
- For individuals, there is no AGI limit for contributions normally subject to the 50 percent and 60 percent limitations. The 2020 no-limit rule does not apply to donor-advised funds.
- For corporations, the 10 percent limitation goes up to 25 percent of taxable income.
- If you are a non-itemizer, you may now deduct above-the-line up to $300 of cash charitable contributions for tax year 2020 only.
The new law extends the increased charitable contribution deduction limits for individuals and corporations to tax year 2021.
In addition, in tax year 2021, non-itemizers can deduct cash charitable contributions up to $600 on a married filing joint return ($300 for singles), but the deduction is now below-the-line.
Example. You are married and file jointly, take the standard deduction, and make total cash charitable contributions of $500 in tax year 2020 and $500 in tax year 2021.
- In tax year 2020, you can deduct $300 above-the-line.
- In tax year 2021, you can deduct $500 below-the-line.
For most taxpayers, the charitable deduction of $600 or less that’s below-the-line makes very little, if any, difference in tax when compared to having it above-the-line (before adjusted gross income).
Refundable Tax Credits
You can get refundable tax credits—i.e., cash in your hand even if you don’t owe federal tax—from the
- earned income credit, and
- child tax credit.
Good news. Thanks to the new law, when filing your 2020 tax return, you can elect to use your 2019 earned income to compute your earned income and child tax credits.
As part of the COVID-19 relief law enacted on December 27, 2020, you have additional tax deductions and credits that you can use to your benefit:
- Recovery rebate credits and advance payments for tax year 2020
- Paid sick and family leave tax credits for employers and the self-employed for tax years 2020 and 2021
- 100 percent deduction for certain business meals provided by a restaurant for tax years 2021 and 2022
- Increased ability to deduct cash charitable contributions for tax years 2020 and 2021
- Increased access to refundable tax credits in tax year 2020