What is normally a reliable estimate of your taxes – the amount of money withheld from your paychecks by your employer – may be an unreliable estimate this year thanks to the current pandemic. Even worse, using the safety net of paying in what you did last year may not be practical if your financial situation changed due to the coronavirus.
Many taxpayers wrote a large check to the IRS this year for the very first time to pay a portion of their taxes as the 1st and 2nd quarter estimated tax payments for 2020 were both due on July 15. Because of this it may be beneficial to review whether you need to make a 3rd quarter or 4th quarter estimated tax payment in the coming months.
Here’s how to ensure you are not faced with an unpleasant tax surprise – because either not enough money was withheld from your paychecks for income tax purposes or your estimated tax payments were too small – when you file your 2020 tax return next April.
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Step 1: Estimate your 2020 income. Add up your anticipated income for 2020 – W-2 paychecks, unemployment compensation, business income, interest and dividend income and any other form of income.
- Step 2: Estimate your 2020 deductions. Add up your anticipated deductions for 2020, including retirement and health savings account contributions, student loan interest you paid and itemized deductions. If you’re not sure, take a look at last year’s tax return and use that figure.
- Step 3: Calculate your tax. Subtract your deductions from your income to calculate your taxable income. Then calculate the tax you owe based on your taxable income using the IRS tax tables. Use last year’s table until the new one is published later this year. Here is a link to the IRS publication: IRS tax table
- Step 4: Calculate your remaining estimated tax payments. Take the tax calculated in Step 3 and subtract any 1st and/or 2nd quarter estimated tax payments you made, and any paycheck withholdings so far this year. If you owe more than you have paid in or have had withheld so far this year, you have two more quarters to make up the difference through estimated tax payments.
- Step 5: Mail your payment to the IRS. The due date to make a 3rd quarter estimated tax payment is September 15, 2020. The 4th quarter deadline is January 15, 2021.
Sound complicated? It definitely can be. If you get stuck trying to figure out if you should make estimated tax payments or have any other questions, please call. Remember, it is better to plan now than to face the unpleasant surprise of an unwanted tax bill on April 15th.
More than 70% of small businesses in America now have loan proceeds from the Paycheck Protection Program (PPP) to help retain employees during the current pandemic. The entire amount of a PPP loan is eligible to be forgiven if the funds are used for qualified expenses. Recent legislation liberalizes the terms of loan forgiveness for funds used for payroll, utilities and rent. It is now based on a 24-week period, not just eight weeks.
But how can you best position your company to fully benefit from PPP loan forgiveness? Here are five tips to help meet the challenge.
- Restore your staff. If possible, restore the number of full-time equivalent (FTE) employees to previous levels by the safe-harbor due date of December 31 (extended from June 30). Bring back furloughed FTEs as soon as you can. Of course, this should fit into your overall business plan. If an employee does not return, document the refusal. All these actions will help when the forgiveness formula is applied to your loan.
- Pile on payroll costs. Run payroll and other remaining qualified expenses—including mortgage interest, rent and utilities—on the last day of the 24-week period. This will enable your business to maximize the amount of loan forgiveness allowed under the calculation.
- Reward employees. Consider paying out reasonable incentive amounts to maximize the forgiveness of payroll costs. The bonuses can even go to family members like your spouse or children. But remember that you can only count up to $100,000 of wages per person, pro-rated for the covered year, and you must be able to defend these payments as reasonable.
- Use the simplified application form. There are two loan forgiveness forms – the regular form (Form 3508) and a simplified version called Form 3508EZ. Review both forms before deciding which one is right for your situation. For instance, there are fewer calculations on the simplified form with less documentation required. To qualify for the simplified form, you must meet at least one of these requirements:
- You’re self-employed and have no other employees.
- You didn’t reduce employee hours or reduce their wages and salaries by more than 25%.
- You lost business due to health directives relating to COVID-19 and didn’t reduce employee wages and salaries by more than 25%.
- Document everything. Once you receive PPP loan funds, keep supporting documentation on everything related to the loan. Document when you receive the loan, each time you spend part of the loan and accrued interest expense on the loan. Also keep copies of receipts and invoices to document all loan expenditures, including bank account statements and journal entries.
Here are several new tax laws passed this year to consider as you start planning your 2020 tax obligation.
- Make up to $300 of charitable contributions. For the 2020 tax year only, an above-the-line deduction of $300 is available to all Americans ($600 for married filing jointly returns) who want to make a charitable contribution. You can donate to more than one charity, but the total amount of contributions must be $300 or less to be able to take an above-the-line deduction. While you will still need to itemize your deductions if you want a tax break for donations greater than $300, this above-the-line deduction for $300 or less helps alleviate the elimination of the charitable deduction for most taxpayers.
What you need to do. Donate $300 to your favorite charitable organization(s) by December 31, 2020. You must receive a written acknowledgment from the charitable organization(s) to which you made the $300 contribution before filing your 2020 tax return.
- Donate up to 100% of your income. The normal contribution limit of 60% of your income is suspended for 2020, allowing you to contribute as much of your income as you want to various charities.
What you need to do. While only a tax break for a few taxpayers, this initiative is meant to help struggling charities during the pandemic. If you are considering additional giving, you must make your charitable contributions by December 31, 2020. Remember to obtain written acknowledgment from each charity you made a donation to before filing your 2020 tax return.
- Use retirement savings to pay for birth or adoption expenses. Adding a child to your family is very expensive. To help with these costs, you can now cash out up to $5,000 per parent from your retirement accounts to pay for birth and/or adoption expenses. While the withdrawal won’t be hit with the 10% early withdrawal penalty, you’ll still have to pay income taxes.
What you need to do. Consult your financial advisor or benefits coordinator to find out how to withdraw the funds from your retirement accounts. Since this withdrawal will deplete your retirement savings, first consider whether you have other sources of cash to cover expenses.
- No age limit for contributing to IRAs. You can now contribute to an IRA regardless of your age as long as you have earned income. The old rule prevented you from contributing to an IRA past age 70½. The IRA contribution limit for 2020 is $6,000 if you’re under age 50 and $7,000 if you’re over age 50.
What you need to do. Consider getting a part-time job or doing some consulting work if you project that you won’t have earned income by the end of 2020. You can then use this earned income to fund your traditional or Roth IRA.
Numerous new laws provide economic relief to individuals and businesses hardest hit by this year’s pandemic. This much-needed financial assistance, however, comes with a few strings attached.
Here are three potential surprises if you use the available economic relief packages:
- Getting a tax bill for unemployment benefits. While the $1,200 economic impact payments most Americans received does not have to be reported as taxable income on your 2020 tax return, there is currently no such luck with unemployment benefits. In addition to paying federal taxes on your unemployment compensation, more than half of states also impose a tax on unemployment benefits.
- What you need to do: See if your unemployment compensation check withholds a portion of your pay for taxes. Even if your check does have withholding for income tax purposes, the withholding amount may not be enough. If possible, talk to your state unemployment office and try to get withholding amounts revised.
- Paying estimated tax payments. If you normally receive a paycheck from your employer, you may have never needed to write a check to the IRS to pay estimated future taxes. Your employer withholds your taxes from your paychecks and sends it to the IRS for you. If you’re collecting unemployment benefits, however, you may be required to pay tax on the unemployment benefits received during the first six months of 2020 by July 15, 2020.
- What you need to do: Estimate the amount of tax you owe for all sources of income, then compare that number with the amount of money withheld from your income to pay these taxes. If necessary, send in quarterly estimated tax payments to the U.S. Treasury and, in some cases, state revenue departments. This must be done each quarter with the next payment due July 15. You may need to send money in on September 15, 2020 and January 15, 2021 as well.
- Reporting emergency distributions from retirement accounts: You may withdraw up to $100,000 in 2020 from various retirement accounts to help cover pandemic-related emergency expenses without incurring penalties. While you will not be required to pay an early withdrawal penalty, you will still be subject to income tax when filing your 2020 tax return.
- What you need to do: If you plan to withdraw funds from your retirement account, reserve enough of the money to pay the tax! The amount you reserve depends on your potential tax situation so call for a tax review before taking money out of the account.
Do you need a quick infusion of cash?
Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, you may be able to take money out of a qualified plan, like a 401(k), or an IRA, with favorable tax consequences. But should you do it? You might view withdrawing money from a retirement account as a last resort.
Among other changes in the CARES Act relating to qualified plans and IRAs, a participant can withdraw up to $100,000 of funds without paying the usual 10% tax penalty on distributions before age 59½. Plus, you can take as long as three years to pay the resulting tax bill, spread out evenly over the three years. If you repay the full amount within three years, you owe no tax.
To qualify for this program, you or your spouse must be diagnosed with COVID-19 or experience adverse financial consequences due to the virus such as being laid off, having work hours reduced or being quarantined or furloughed.
What are the pitfalls?
There are several reasons why you may want to avoid taking money out of your retirement accounts unless it’s an absolute emergency:
You’re diluting your retirement savings. Although the money comes in handy now, you’re chipping away at your nest egg and forfeiting growth. For example, if you withdraw the maximum amount of $100,000 that would have earned 6% annually tax-deferred for ten years, the value would have been $179,000.
It may be bad timing. Experts say it is difficult to time the markets in the current volatile environment. If you sell some holdings right now, you may be locking in losses that would miss the recovery in the next few months or years.
You still owe income tax. Income tax is due unless you replace the full amount within three years. Also, depending on your situation, you could end up paying tax at higher rates than you would in your retirement years.
Better options might exist. Arranging a hardship loan from your 401(k) might be a better alternative for your situation. You avoid the taxable event of the withdrawal and you pay back yourself with interest. Other options include refinancing a mortgage with lower interest rates, taking advantage of payment relief from mortgage, rent or student loan payments or deferred credit card billing.
While it is an option, retirement plan withdrawals are not always the best choice. Think through all scenarios before withdrawing from retirement funds to cover emergency expenses.
Coronavirus uncertainty abounds. Thankfully, by monitoring tax changes on your behalf, we can work together to navigate the right path for you and your family. Here is a round-up of tax-related laws and information to help with tax planning for 2020.
- Early distribution penalty waived The 10% early distribution penalty on up to $100,000 of retirement withdrawals for coronavirus-related reasons is waived during 2020. New tax rules allow tax liabilities on these distributions to be paid over a three-year period. So if you need the funds, you won’t see your tax bill skyrocket in one year. Even better, you can return these distributions back into your retirement account over a three-year period and not be subject to the annual contribution limits. Action: This could be a great way to handle emergency payments until you receive a stimulus check, unemployment payments, or a pending small business loan.
- Required minimum distributions (RMDs) waived for 2020 Required minimum distributions (RMDs) in the year 2020 for various retirement plans is suspended. The corresponding 50% penalty associated with not taking an RMD is also suspended in 2020.Action: Taking out distributions when the market takes a tumble can hurt retirement income for many years. This change allows you to wait to let the value in your retirement account rebound before you withdraw funds.
- IRS installment agreement suspension The IRS is suspending payments of all amounts due from April 1 through July 15, 2020. If you do not pay your IRS installment payment during this time your installment agreement will not be in default. Interest will continue to accrue on these installment agreements. Action: Being on the bad side of the IRS is never fun. If you currently have an IRS installment agreement, look to take advantage of this delay.
- Offers-in-compromise The IRS will allow you until July 15, 2020 to provide additional requested information for any pending offers-in-compromise (OIC) and will not close out the OIC during this time without your consent. The IRS is also suspending any payments due under an OIC until July 15, 2020.
- Enforcement activities suspended? Not so fast…The filing and enforcement of liens and levies will generally be suspended. However, IRS Revenue Officers will continue to pursue high income non-filers and initiate other actions when warranted.
- No new audits The IRS will not initiate new audits during this time, but will act to protect the statute of limitations.