COVID-19 has touched nearly every aspect of the lives of every American, affecting finances and creating waves of economic stress. Unfortunately, in the midst of all this chaos, it will create some tax implications that you may have not considered. For some, it can mean simply reporting income or expenses differently. For others, it may mean having to pay additional income taxes that they had not planned.
Regardless of the situation, this year might be the year that you need to bring in a tax professional to help address some of the tax challenges that COVID-19 has caused.
Unemployment and Retirement Plan Withdrawals
As individuals are losing their jobs or had to decrease work because of COVID-19, they are turning to other sources of income such as unemployment benefits and dipping into their retirement savings plans.
For those who are tapping into these funds for the first time, they might have questions about taxation—and they may not realize that they may have to pay taxes on these additional income sources.
Are unemployment benefits taxable?
Your unemployment benefits will be fully taxable at the federal level. In general, unemployment benefits might be taxed by the state as well, depending on where you live. For example, Alabama and California do not impose any taxes on unemployment benefits, but the benefits are fully taxable as regular income in Iowa. Some states will only tax part of your benefits.
Are retirement benefit withdrawals taxable?
If you take out retirement benefits early, there is a 10% penalty imposed on any funds you remove. However, tax changes because of COVID-19 allowed individuals to take out funds from retirement without paying the 10% penalty as long as the withdraw took place during 2020. You must also meet certain requirements that indicate you have a stressful financial situation because of COVID-19. Even if you meet the qualifications, avoiding the 10% penalty is not the only tax that you must pay. Instead, the money you take out is often taxed as income, depending on how your retirement plan was established.
Many people may not realize that they will face this additional tax hit after January 1, so they have not been planning for it over the past few months.
Dealing with the IRS and Unique Tax Problems After COVID-19
The best way to ensure that you are addressing tax issues appropriately is to get professional tax help. If you will owe taxes from 2020, you might be able to work out a deal with the IRS to decrease your tax obligations, for example.
If you get a notice from the IRS about taxes that you owe, you have a few options that you can use to address it.
- Make a full payment. You can pay the amount demanded in full by the due date noted on the notice. However, this might not be the best course of action, as the amount that the IRS says is due might not actually be accurate. Check with a tax professional before you make any additional payments.
- Create an installment agreement. You can work with your tax professional and the IRS to create an installment agreement to pay the tax obligation over time. If you work with the taxing authority directly, they will often demand a large monthly payment. Using a professional to help you negotiate will usually decrease this payment and help you create a plan that works for you.
- Suggest an offer in compromise. An offer in compromise is a technical term that means you are offering to settle your debt with the IRS for a lesser amount than what the IRS is demanding. Using this compromise method often requires a showing that you cannot afford to pay the full amount, even if you created an installment plan. A tax professional will be able to help you develop this type of offer and present it in a way that is most likely to be accepted.
Having a professional on your side to help you deal with tax preparation, back taxes, tax problems, and negotiations with the IRS can be invaluable. Do not work through this process alone, especially if COVID-19 has created some unique tax issues for you in 2020.
If you have questions, contact the Experts at Henssler Financial:
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