Why You Should Start on Your Taxes Sooner Than Later
While it’s never a good idea to procrastinate on your taxes, this year it’s especially prudent to get a head start as your tax situation may be more complex than usual. Perhaps a job loss or job change landed you in a new income bracket, maybe you became a contract worker for the first time if you picked up a side gig, or maybe you collected unemployment income that you now owe taxes on. Even if your employment situation didn’t change, there are new tax stipulations in effect this year outlined in the CARES Act, the Families First Coronavirus Response Act and the Consolidated Appropriates Act that may affect your filing.
“Believe it or not, there are more words in the IRS tax code than the Bible,” said Pam Krueger, founder and CEO of Wealthramp. “Taxes are always frustrating, but this year, in particular, will be challenging.”
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Here are a few reasons filing taxes may be extra complicated for you this year.
You Received a Stimulus Payment
“You’ll need to report any stimulus payments you’ve received during 2020,” said Tim Yoder, tax and accounting analyst at FitSmallBusiness.com. “If you received the incorrect amount, any needed adjustments will be made on your 2020 tax return.”
However, you do not need to pay taxes on any stimulus payments you received.
You Received Unemployment Compensation
“Unemployment benefits are taxable and must be reported on your federal income tax return,” Yoder said.
Although you may owe taxes on your unemployment income if they were not automatically deducted, if you lost your job, you may now qualify for new tax credits and deductions that you hadn’t in previous years.
“The loss of income due to unemployment means that some households could qualify for the Child and Dependent Care Credit and the Earned Income Tax Credit,” said Michael Benninger, personal finance writer for Finder.
You Took an Early Distribution From a Retirement Account
“Normally, distributions from your retirement account are subject to a 10% penalty if taken prior to turning 59½ . However, premature distributions in 2020 are not subject to the 10% penalty if you or a family member has tested positive for COVID-19, or experienced a financial hardship related to COVID-19,” Yoder said. “A financial hardship is broadly defined to include many things, like being quarantined, laid-off, having your hours reduced or being unable to work because of a lack of available child care.”
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This applies to distributions up to $100,000. And while you don’t have to pay the early withdrawal penalty for tax year 2020, it’s important to note that that doesn’t mean the distribution itself is tax-free: “The exception is only for the penalty — any income from the distribution will be taxed as normal,” Yoder said.
You Became Self-Employed
If you’re one of the many Americans who turned to freelance and other self-employed opportunities during the pandemic, you need to understand the tax implications of this.
“You must pay both self-employment tax and income tax on your self-employed earnings,” Yoder said. “If you have self-employed income, there is a high likelihood of owing federal tax with your return, so prepare your return early to know what you’ll need to pay by April 15.”
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Things may be even more complicated if you worked in different states over the course of 2020.
“If you left the big city to work remotely from a different state for a few months during the pandemic, you may end up having to file two separate 2020 tax returns — one for your home state and another for the state where you temporarily resided,” said Eric Bronnenkant, head of tax at Betterment.
Filing Early Is Always a Good Idea
Even if none of the above applies to you, it’s still a good idea to get a head start on your taxes this year.
“This is a complicated year to file taxes, which makes it even more likely that there may be small issues that delay your tax return,” Bronnenkant said. “Filing early gives you the time cushion you’ll need to correct any mistakes and still receive your tax return on time. Another reason to file your taxes as early as possible is to avoid falling victim to tax fraud. Unfortunately, thousands of taxpayers lose millions of dollars each year to fraudulent tax refunds, and these crimes tend to spike in times of economic stress, which we’re experiencing right now. The sooner that you file, the less risk you have that someone has illegally filed ahead of you.”
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