Filing your taxes soon? Here’s how COVID-19 stimulus could affect what you owe

Sarah Foster
Bankrate.com (TNS)

Even in 2022, millions of Americans will feel an impact from the coronavirus pandemic when they file their taxes.

The federal government in 2021 approved stimulus checks, scaled-up unemployment benefits, federal student loan forbearance and advance child tax credit payments to bridge hard-hit Americans through the crisis — and that direct aid has major implications during the 2022 tax season that could ultimately end up impacting the size of your refund.

Meanwhile, Americans who took hardship distributions from their retirement accounts in 2020 are coming up on the deadline for when they need to pay back all of the money without having to pay income taxes on what they withdrew.

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“There is no question whatsoever that your 2021 tax return will be the most complicated tax return put forth in decades, if not since the inception of the tax code in 1913,” says Mark Steber, chief tax officer at Jackson Hewitt.

Here’s six key things you need to know about COVID-19 relief measures and how they could impact your taxes.

1. Coronavirus stimulus checks

Individuals living in the U.S. were eligible for a third stimulus check in 2021 worth up to $1,400 — the third and largest Economic Impact Payment (EIP) of the pandemic era.

Taxpayers who didn’t receive all or part of the third stimulus payment can reconcile it by claiming the 2021 Recovery Rebate Credit on Line 30 of Form 1040 or 1040-SR” for seniors.

Income tax filers might already be familiar with the process from last year, when taxpayers could claim the 2020 Recovery Rebate Credit to reconcile the first and second stimulus checks worth up to $1,200 and $600, respectively.

Start by calculating how much stimulus money you already received. The IRS should have sent you a Letter 6475 to help you keep track.

FILE - In this April 23, 2020, file photo, President Donald Trump's name is seen on a stimulus check issued by the IRS to help combat the adverse economic effects of the COVID-19 outbreak, in San Antonio. A number of taxpayers who use tax preparation services, such as H&R Block and TurboTax, say their second relief payments were sent to the incorrect bank account. The IRS and the Treasury Department began issuing the Economic Impact Payments last week of Jan. 1, 2021. (AP Photo/Eric Gay, File)

Compare that amount with your own eligibility calculations. Single filers were eligible for the full $1,400 credit so long as their adjusted gross income (AGI) didn’t surpass $75,000, while married filers couldn’t make more than $150,000 and heads of households had to earn less than $112,500. Payments phased out by $28 for every $100 over the income thresholds. Dependents were also eligible for a $1,400 payment, though they aren’t eligible for a partial credit if your income is over the eligibility threshold.

If the numbers don’t match up, it might be because your income or personal situation changed from the last time you filed taxes. Individuals who didn’t receive the full amount might’ve had a baby or adopted a child in 2021, or their income could’ve been disrupted. If you received more than you should have, perhaps one of your dependents aged out or your income improved.

Taxpayers won’t have to pay back any extra stimulus money, but they will have to claim the Recovery Rebate Credit if they want to get their hands on any missing cash.

2. Child tax credit (CTC)

Among the most notable aid from 2021, U.S. families with dependent children were eligible for a dramatically enhanced child tax credit (CTC) worth up to $3,600 for each child ages 5 and younger and $3,000 per child for those 6 to 17. Originally, that credit was worth $2,000 for all dependents age 17 or younger.

Unless you opted out, half of that money was already distributed to you in the form of six advance monthly payments from July through December 2021. That means you can expect a child tax credit worth up to $1,800 or $1,500 on your 2021 tax return, slightly smaller than the original amount.

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Families in the lowest income-tax bracket, however, might receive an even bigger credit than what they’re used to because the credit was made fully refundable for 2021, meaning the full amount is disbursed to everyone, regardless of how much income they earned in the tax year.

Similar to stimulus checks, families that had a baby, adopted a child or whose incomes fell in 2021 will be able to recover any missing child tax credit money for which they’re eligible, if they didn’t already report those changes to the IRS.

To be eligible for the original $2,000 credit, the AGI of married couples filing jointly can’t surpass $400,000, while single filers and heads of household must earn less than $200,000.

To be eligible for the remaining $1,000 or $1,600, single filers must earn less than $75,000, heads of households can’t earn more than $112,500 and married couples can’t make more than $150,000. After that, the credit falls by $50 per every $1,000 over the income threshold.

The IRS took its eligibility information from 2020 tax returns, the most recent tax season. Unlike with stimulus checks, U.S. families will be expected to pay any extra child tax credit money back to the IRS, meaning you’ll want to pay close attention if you have fewer dependents or more income for 2021 as compared to 2020. Most of the time, the agency will reconcile that amount by dipping into your tax refund.

3. Unemployment insurance (UI)

State unemployment agencies saw a massive 24.6 million new claims for unemployment insurance (UI) in 2021. Those offices were also paying out an extra $300 each week up until September, in accordance with President Joe Biden’s American Rescue Plan.

The entire amount that you received counts as taxable income for 2021, unlike in the year prior when Democrats’ relief package made the first $10,400 of those payments tax exempt. That means any benefits you received last year are subject to full taxation.

Most of the time, Americans automatically end up withholding taxes from their checks. Yet, if you withheld too little, you could be slapped with a tax bill on your return.

4. Federal student loan forbearance

Federal student loans spent the entirety of 2021 in a forbearance period, with interest and payments on pause. That was a prime money-saving opportunity for many borrowers who’ve endured job or income loss during the coronavirus crisis.

But it all circles back come tax season. A special tax deduction lets federal student loan borrowers deduct up to $2,500 from their top-line income for every dollar that they paid in interest, a ceiling that’s typically easy to hit in a normal year of making payments. Even if you made at least some payments toward your federal student loans in 2021, taxpayers might have to brace for a smaller deduction than normal simply because the government paused interest collection.

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Financial experts, however, say making payments still offers a major financial benefit in the long run: Your payments will go toward your principal debt; therefore you’ll chip away at your balance faster.

If you’re a private student loan borrower, however, you can still likely claim the full credit because the federal student loan forbearance program didn’t apply to you.

5. Earned Income Tax Credit (EITC)

For 2021, the American Rescue Plan expanded income eligibility requirements for the popular Earned Income Tax Credit (EITC), while also increasing the maximum amount taxpayers can claim. The most generous new rules come for childless workers, who can claim a tax credit nearly three times bigger than in previous years. To be a qualifying child for the EITC, your dependent must be 18 or younger at the end of the specific tax year or under 24 if they’re a full-time student, according to the IRS.

To claim the credit, taxpayers must have earned income, whether that’s from wages, salaries, gig work or self-employment. Your AGI must also fall within the eligibility threshold for the current, previous and upcoming tax year to receive the full amount. Another change for 2021, however, the IRS will let taxpayers use 2019 income to qualify for the credit if it was higher than their 2021 earnings. In some instances, this option will give them a larger credit, the IRS says.

If your child doesn’t have a social security number (SSN), taxpayers can also now qualify for the zero-children version of the credit.

6. CARES Act-backed penalty-free hardship distributions

Individuals in 2020 could withdraw up to $100,000 — or 100 percent of their vested account balance if it’s less than that amount — from their retirement accounts without incurring the typical 10 percent early withdrawal penalty through a Coronavirus Aid Relief and Economic Security Act (CARES)-backed “hardship distribution.”

Individuals still had to pay income taxes on that money, though they could stretch it out over three years. Taxpayers also have the option to pay back the entire balance that they withdrew — after which, they’d have to amend their previous tax returns and the IRS would issue them an income tax refund. Taxpayers also wouldn’t be required to report that distribution as income on their 2022 return, if they take care of it now.

Experts say it’s now time to start thinking about your strategy.

“It can strap you if you’re not handling it correctly,” Jackson Hewitt’s Steber says. “That provision to borrow in 2020 has repercussions — you have to pay that money back. The IRS will find out if you don’t do what you have to do eventually.”

When taxpayers amend a return, it goes to the IRS’ paper backlog, which already stretches into the millions and could lead to delays. But it’s a route still worth considering, especially factoring in that time in the market matters when it comes to saving for major life events such as retirement. The bigger your retirement contributions, the more time your savings has to compound.

If you instead decide to pay income taxes on that balance, how that works depends on how much you’ve paid already. Some U.S. taxpayers might have chosen to report the entire distribution in their income in 2020. Another common strategy is dividing your distribution into three and reporting each chunk on your tax return for 2020, 2021 and 2022.

Bottom line

Given just how complicated this year’s tax season is, tax experts and the IRS itself stress the importance of filing early — and carefully. Making a mistake or filing incorrectly could subject your return to more scrutiny, meaning processing delays and a longer wait for your refund.

Taxpayers who file their tax returns electronically and without errors can expect to see a refund within 21 days of filing, so long as they choose direct deposit.

“We urge extra attention to those who received an Economic Impact Payment or an advance Child Tax Credit last year. People should make sure they report the correct amount on their tax return to avoid delays,” says IRS Commissioner Chuck Rettig. “The pandemic continues to create challenges, but the IRS reminds people there are important steps they can take to help ensure their tax return and refund don’t face processing delays.”