How coronavirus legislation benefits affect your clients’ 2020 tax returns

This content is for the first stimulus relief package, The Coronavirus Aid, Relief and Economic Security Act (CARES Act), which was signed into law in March 2020. For information on the second stimulus relief package, the Coronavirus Response and Relief Supplemental Appropriations Act of 2021, please visit the second post here.

The stimulus check is an Economic Impact Payment authorized by the Coronavirus, Aid, Relief and Economic Security (CARES) Act, signed into law on March 27, 2020. Starting in mid-April, the IRS began sending out millions of stimulus payments. Here’s what you need to know to advise your clients on the potential impact on their 2020 tax returns.

The first round of payments was based on adjusted gross income (AGI) from the 2019 federal tax return, or if the taxpayer had not filed a 2019 federal tax return, the information from the 2018 federal tax return. A single U.S. resident must have had an AGI under $75,000 to receive the full payment amount of $1,200, and any stimulus payment was completely phased out once an AGI reached $99,000. Taxpayers filing as head of household received the full $1,200 payment if their AGI was $112,500 or less, and was completely phased out at $136,500. Married couples without children who file jointly received the full $2,400 payment if their AGI was below $150,000, and was completely phased out at $198,000. Recipients of Social Security, Social Security disability insurance, and railroad retirees automatically received the payment.

When the government hands out “free” money, it raises a few questions for a lot of people. Many become a little leery when they hear the government is giving them a benefit with no mention of wanting anything in return. One question your clients may be asking is, “Is this really free money, or will I be taxed on it in 2020?” Another question is, “Should I set aside some of my stimulus payment to pay the IRS when I file my 2020 federal income tax return?”

The short answer to both of these questions is no; the stimulus payment is not taxable, and your clients will not pay taxes next year on the payment received in 2020.

The IRS doesn’t consider a stimulus payment to be income, and a payment received in 2020 will not reduce a refund or increase the amount owed when clients file their 2020 tax returns next year. They also won’t have to repay anything if they qualify for a lower amount in 2021.

It’s understandable that there is confusion around the taxation of the stimulus payment. The term “stimulus payment” doesn’t lend itself to the fact that the payments are actually a type of tax credit. The payments are advances on a tax credit for 2020 based on a taxpayer’s 2019 or 2018 AGI. The credit will be applied to 2020 tax returns using 2020’s AGI, and taxpayers will receive the difference of the credit if it is in their favor.

Here’s an example. If a single taxpayer with no children had an AGI of $250,000 in 2019, they would not receive the stimulus payment based on their 2019 income. However, if they had an AGI of $40,000 in 2020, they will receive a $1,200 refundable tax credit on their 2020 federal income tax return. On the other hand, if a single taxpayer with no children had an AGI of $40,000 in 2019, and an AGI of $250,000 in 2020, they would receive a $1,200 payment and would not have to repay it on their 2020 federal income tax return.

Tax implications of other benefits from the CARES Act

The stimulus check isn’t the only benefit that has come out of the CARES Act. A few additional benefits that taxpayers could receive include the unemployment stimulus payment and the payroll tax deferral. Unlike the stimulus check, these will have an impact to 2020 federal income tax returns.

Although unemployment payments may sound like they are tax free since the government is calling them “stimulus payments,” unemployment income is actually considered taxable income.

The payroll tax deferral under the CARES Act as well as under the August 2020 executive orders are not considered tax forgiveness or tax cut. Each of these benefits works as a loan, and if the employee portion of payroll taxes are not withheld by the employer, the employee will be required to repay them the following year.