Last April, the government sent the first round of direct payments to Americans as part of a larger coronavirus stimulus package. In January, the second round of stimulus checks began, and Congress is currently working out the details of the third payment.
While people who have lost income as a result of the pandemic are in dire need of money, many are wondering if there is a catch. Will the money be taxed later? Is this just a tax refund advance that will need to be paid back next year?
If you’re confused about how stimulus payments affect your taxes, you’re not alone. Here’s what you need to know.
Are incentive checks taxable?
According to Mark Jagger, director of tax development for TaxAct, stimulus payments are actually a new type of refundable tax credit that will eventually be calculated based on your 2020 tax return information.
Technically known as an “economic impact payment” in IRS parlance, the value of the first stimulus checks received in 2020 was up to $1,200 per eligible adult and up to $500 per eligible dependent child under age 17 .
Tax credits are not actually income. Instead, it is a specific amount that taxpayers are allowed to deduct from the total outstanding taxes. Unlike a tax deduction, which reduces your taxable income, a credit is a dollar-for-dollar reduction in your overall tax bill. And since tax credits are not income, they cannot be taxed as such.
So why are these tax credits being given in the form of cheques?
“Instead of waiting for Americans to file their 2020 tax returns to claim this credit, the CARES Act allows the Treasury Department to pass these credits on to the American people,” said a certified public accountant and personal finance manager. Founder Logan Alec explained. Money Done Right Blog. Similarly, the value of the second round of checks is $600 per eligible adult and child, dependent on your 2021 taxes.
Does getting a stimulus payment mean a lower tax refund next year?
You may have seen some claims circulating on social media that the stimulus payment is a refund advance only, and will be “excluded” from your tax return for 2020. It’s not like this. “The incentive payment is an advance of an entirely new credit,” Alec said.
He shared this example: Let’s say the stimulus payment didn’t exist and you’d be eligible for a $1,000 refund on your 2020 tax return.
Now let’s get back to the reality where the incentive exists and you were eligible for a payment of $1,200 in 2020. In this case, the refund that appears on your 2020 tax return will be $2,200 (your original $1,000 refund + $1,200 thanks to the new credit). ) However, the government has already sent you an additional $1,200 as a stimulus check.
So now, all else being equal, you’ll receive the same $1,000 refund on your tax return that you would have received if the new tax credit (and the associated incentive payment) had never been created.
In other words, if you qualified for stimulus payments in 2020, your refund this year will actually be larger than usual, but you got that extra portion last year. Alternatively, if you owe tax, your tax liability will be reduced in the same way. And the same is true for 2021 taxes: If you received stimulus payments this year, you’ll officially claim that credit when you file taxes in 2022.
Your stimulus check amount may change based on 2020 tax information.
Even though you won’t have to pay income tax on your stimulus checks, you will still need to report that you received them. Jagger noted that since the first two stimulus payments were calculated against a prior year’s tax return (2018 or 2019, whichever is more recent available to the IRS), the amount you ultimately receive when you When you file, it will be reconciled with your 2020 tax information. this tax season, There are three scenarios that could potentially come up, he said.
For most tax filers, the credit will equal the stimulus payment they received, which leads to a net $0 on their 2020 tax return. “This scenario includes tax filers whose tax status hasn’t changed much from the prior year to 2020,” Jagger said.
In some cases, the tax credit will exceed the incentive payment you received. Tax filers in this situation include anyone who receives a new dependent child in 2020 or whose AGI was above the incentive limit in 2019 but fell below it in 2020. If this happens, the difference will either be added to your refund or further reduced. Your total tax bill. Additionally, the IRS has Having said That if you didn’t get the full credit amount you should have already received—for example, you received $1,200 for yourself, but not $500 for each of your eligible children—will be paid to you on your 2020 tax return.
On the other hand, it may turn out that your incentive payment was higher than the credit when it was matched on your tax return. “The tax filer in this scenario would be anyone whose dependent turned 17 in 2020 or whose income exceeded the threshold in 2020 but was below the threshold in 2019,” Jagger said.
What remains to be seen, Alec said, is whether the IRS will require people who received more stimulus money than they are entitled to pay more on their 2020 tax returns. Although the CARES Act states that Americans whose stimulus payments have become too high should not pay the difference, the IRS has not issued official guidance on this point.
One scenario in which the IRS has already pushed back is Incentive payments sent to dead people, The IRS mistakenly sent payments to deceased individuals and is now advising survivors to return the money. It is not clear what the consequences would be for failing to do so.