Since March, millions of individuals and small businesses have taken advantage of government programs to stay afloat during a pandemic that has badly damaged the economy and claimed the lives of more than 400,000 Americans. No doubt these programs have helped prevent a terrible situation from getting worse. With W-2 forms and other tax information now arriving, here are some things to consider:
Q. Are my stimulus checks taxable?
A. No. Technically, the money you received in stimulus checks isn’t income (which is almost always taxable). The money the federal government paid to you is actually a tax credit, known as a recovery rebate credit. It’s a reduction in your federal income taxes. So, you didn’t get money; you got a tax reduction, paid well in advance of the due date for taxes (April 15).
Q. What else should I know about taxes and stimulus checks?
A. If you didn’t get the full amount because your income was too high (or you got nothing because it was too high), you may be eligible for a recovery rebate credit on your 2020 tax return, which means money in your pocket. That’s because the stimulus checks sent last year were based on your 2019 adjusted gross income, while the recovery rebate credit is based on your 2020 adjusted gross income.
If your income decreased significantly in 2020 (perhaps due to the pandemic) you may get a tax reduction that reflects your lower income. Remember, the government linked the amount received by taxpayers to level of income. Below a certain level, you got the full amount; above a certain level, you got nothing; and in between, a phased approach.
Besides decreased income, be mindful of a couple of other year-to-year changes that almost always lower tax liability: You had a child; you got married; or you were claimed as a dependent in 2019 but not in 2020.
Q. I received unemployment insurance benefits in 2020. Are they taxable?
A. Yes, unemployment benefits are considered taxable income by both the federal and state governments. And it doesn’t matter if the benefit was funded by the federal or state government. (Unemployment benefits, however, are not subject to Social Security or Medicare taxes.) The state, which administers the benefits, provides an option for withholding taxes from weekly benefits. If you did not opt for withholding, you now may be liable for a sizable lump sum in owed taxes.
Q. My business received a federal Paycheck Protection Program loan. Is it taxable?
A. First, let’s recall that PPP loans are 100 percent forgivable. Recipients need not pay back principle or interest, so long as they follow the guidelines, such as paying workers at their usual, pre-pandemic rates. As such, PPP loans resemble grants, which are generally taxable. And under usual circumstances canceled debts of this sort are taxable.
But not in this case. Your PPP loan is not taxable. That has been firmly established since day one, when Congress passed the $2.2 trillion CARES Act and President Trump signed it into law in March. (Businesses that used PPP money for unpermitted purposes are supposed to be denied forgiveness on the loans and must repay them with interest.)
The purpose of the program was to keep businesses affected by the pandemic open and able to pay their workers. However, since March, the government has altered some of the basic rules, which may affect your tax liability.
Q. What are the rules and how have they changed?
A. One basic rule has to do with how much of the loan money must go to payroll to qualify for forgiveness. Originally, at least 75 percent had to be used to pay workers, with the remaining amount allowed to go for overhead costs, such as rent, mortgage interest, utilities, and personal protective equipment. That was later revised to require at least 60 percent for worker wages.
Q. What are the rules on business owners deducting overhead costs as business expenses?
A. Originally, the government said businesses could not deduct expenses such as rent and mortgage interest if those expenses were paid with forgivable PPP dollars. That was viewed by some as “double-dipping.” But last month, when the latest stimulus bill became law, Congress changed the rules so business expenses paid with PPP funds can be written off as business expenses. That provides a boost to small businesses, many of which are struggling.
Q. What if I didn’t apply for forgiveness of my PPP loan by the end of 2020?
A. The loan amount remains nontaxable, pending approval. Business borrowers have up to 10 months after spending the loan proceeds to apply for forgiveness.
Q. What about sole proprietorships, independent contractors, and the self-employed?
A. The same rules regarding PPP loans apply to them as to other small business. And to nonprofits, too.
Q. What is the employee retention tax credit?
A. It is another federal program designed to encourage employers to keep employees on the payroll by providing a refundable tax credit. For 2020, the maximum credit is $5,000 per employee, but Congress recently expanded it to $14,000 per employee through June 30, 2021. But businesses cannot claim an employee retention tax credit for wages paid with PPP money.