Preparing Your 2020 Taxes: Special Tax Issues that May Apply to You in the Year of COVID

How can we put a positive spin on the year 2020?  Perhaps we can characterize it as… unique?  Unforgettable?  However one describes it, this year presented several new challenges, and depending on your circumstances, you may need to add your 2020 tax return to that list.  Below are a few significant tax issues that may apply to you this year as a result of the pandemic.

Working in a Different State.  Many individuals working remotely during the pandemic chose to work in a different state than their principal residence and/or usual place of business for various reasons.  Whether they relocated temporarily to be closer to family, enjoy a vacation home, avoid paying unnecessary rent, or otherwise, this change may impact their state tax liability this year. 

Each state has its own definition of residency.  In Virginia, for example, any person who lived in Virginia or maintained an abode in the state for more than 183 days during the year is considered a resident—and therefore is subject to state income taxes.  Virginia does have reciprocity agreements with nearby states (DC, Maryland, Pennsylvania, West Virginia, and Kentucky), which could eliminate the need to file a Virginia return, but those who relocated from other states might not be as fortunate. 

At the very least, if you worked from a different state, you may have to incur the cost of filing an additional state tax return and paying the tax liability for that state out of pocket, unless you planned ahead and changed your state tax withholdings with your employer.  Your usual state of residence will generally give a credit for taxes paid to another state, but you will still have to file a return there too.  If this situation applies to you and you do not already have a tax preparer, this may be the year to hire one.

Working from Home.  Obviously, during the pandemic, millions of Americans turned into remote workers overnight.  Unfortunately, employees (those who earn W-2 income from an employer) are not eligible to take a home office deduction.  However, self-employed workers who had a dedicated workspace in their home and used that space as their principal place of business this year are eligible for that deduction. 

Receiving Unemployment Benefits.  Unemployment benefits, including any Pandemic Unemployment Assistance received this year, count as taxable income on your federal taxes.  Most states tax unemployment benefits as well, though Virginia is one of 6 states that exclude unemployment from taxable income.

Taking Coronavirus Distribution from IRA.  The CARES Act permitted individuals under age 59 ½ to take withdrawals from their IRAs this year of up to $100k without incurring the 10% early withdrawal penalty if the pandemic impacted their health or financial situation.  Those individuals still owe income tax on any withdrawals, but the tax can be spread over three years—or they can avoid the tax by putting the funds back into their IRAs within three years.  If this situation applies to you, think carefully about your expected income in the coming years as compared with this year.  If you were unemployed this year but expect to have significant income in future years, you may want to consider claiming more than one-third of the withdrawal on your 2020 taxes while in a relatively lower tax bracket.  If you are able to repay those funds into your IRA in the future, you can always amend your 2020 taxes.

Reversing RMDs.  The CARES Act also waived the obligation to take Required Minimum Distributions (RMDs) from IRAs and retirement accounts this year.  Some individuals had already taken their RMD by the time the CARES Act was passed, so Congress allowed them to reverse the RMD and put funds back into their retirement accounts (if they did not need the money).  If this applies to you, ensure that the custodian of your retirement accounts correctly reports no taxable distributions for the year on your 1099-R.  Also, if you generally use tax withholding from your RMD to cover your federal or state tax liability from other sources of income, note that the amount you owe on your tax returns might increase this year, even though your overall tax liability decreased.

Recontributing 529 Funds.  If your college-age child was sent home from college in the spring and you received a refund for any of their college expenses, hopefully you recontributed back to their 529 account (within 60 days) any funds that had been withdrawn from the 529 originally.  If not—and that beneficiary is still in college—you can use those funds for their tuition payment this month and still avoid penalty (since it is the same tax year), or you can use the funds to pay down their student loans.  If none of these options are viable, the funds will be considered a non-qualified distribution, and you will face a 10% penalty and tax on the growth in those funds on your tax return.

Harvesting Tax Losses.  If you have taxable account assets, you may have taken advantage of the market volatility in the spring to harvest some tax losses.  Note that any capital losses will first be used to cancel out capital gains for the year (including capital gains distributions from mutual funds this year).  If you still have net capital losses after that, up to $3,000 can be used to reduce your taxable income from other sources.  The remainder will be carried forward to future tax years.

In addition to these pandemic-related tax issues, 2020 is the first year in which the SECURE Act took effect, which could impact your taxes.  New tax provisions included in the CARES Act—in addition to those mentioned above—could affect you too, such as the $300 charitable giving deduction for those who do not itemize deductions.  Please reach out if you have any questions on how these changes in 2020 may affect your taxes or if you need a referral to a trusted tax preparer this year.