The U.S. federal tax system is a pay-as-you-go arrangement. Taxpayers are supposed to pay the IRS relatively soon after they receive any income. Ideally, you’ll pay toward your tax obligation throughout 2020 by one means or another, but this can be challenging enough under normal circumstances, especially for the self-employed.
Throw in a pandemic and unemployment, and you could easily find yourself unable to come up with the cash you need to pay your taxes when it’s time to file your 2020 return. Perhaps this bumpy year caused you to forget to make an estimated payment. Whatever the case, it’s not too late to salvage the situation if you can.
Adjust Your Withholding
Taxpayers who work for employers and who were able to continue to do so during the pandemic might fare better than others when it comes time to file that tax return in May 2021. The IRS has extended the year's tax-filing deadline in response to the ongoing pandemic, from April 15 to May 17, 2021.
These individuals have already paid as they've earned, because taxes have been withheld from each of their paychecks based on the information they provided to their employers on their Forms W-4. Their employers have been forwarding that money to the IRS on their behalf all along.
Your withholding should come pretty close to covering what you’ll owe if you completed your Form W-4 correctly and if you didn’t have any additional sources of income that you haven’t accounted for.
Form W-4 can be changed as needed. The IRS recommends reviewing and updating it from time to time to ensure that the information you initially provided to your employer is still correct. This includes your filing status, the number of your dependents, and any tax credits you’re likely to claim—or that you won’t be able to claim again this year.
You can request that more money be withheld from your pay to cover the extra income from a side gig that’s been generating some much-needed cash during difficult times—there’s a special line on the 2020 Form W-4 for this purpose. And you should definitely update your withholding if you married, divorced, had a child, or had a child “age out” of dependent status at any time in 2020.
The IRS provides a handy tax withholding estimator on its website to help you get your withholding just right.
Make Estimated Quarterly Payments
If you are self-employed or prefer to leave your employer out of the process rather than request extra withholding, you can make estimated quarterly income tax payments based on what you think you'll probably owe on all taxable income at year’s end.
IRS Form 1040-ES includes a worksheet to help you make an accurate prediction of what you’re likely to owe.
Sole proprietors and independent contractors must make estimated payments because their clients and customers don’t typically withhold taxes from their payments to them. The IRS charges penalties if they don’t do so and they come up short at filing time. But other taxpayers are free to pay in this way as well.
The key to avoiding an estimated tax penalty is to pay at least 90% of your total tax bill by year’s end if you suspect that you’ll owe the IRS $1,000 or more in income tax for the year.
The “quarterly” part of this option derives from the fact that estimated payments are due to the IRS four times a year. January 15, 2021, was the final quarterly payment date for the 2020 tax year.
In future years, “If you know your tax bracket, you can send a quarterly payment on September 15 for the third quarter, and January 15 for the fourth quarter,” according to Michael Merlino, president and CEO of Atlantic Accounting Services in Northfield, N.J.
The other quarterly payments are typically due on April 15 and June 15, but they were pushed back to July 15 in 2020 in response to the coronavirus pandemic. As of April 2021, the first three deadlines for 2021 should be April 15, June 15, and September 15, based on customary procedure. The April 15 deadline has not been pushed back to May 17, 2021 for estimated tax payments.
Residents of Texas and surrounding states have had their regular April 15 tax deadline extended through June 15, 2021, due to February's severe winter storms.
Did You Collect Unemployment?
Of course, nothing has been simple in tax year 2020. Many Americans were out of work during the coronavirus pandemic—9.7 million as of April 2021. They received a $600-per-week increase in their unemployment checks under the terms of the Coronavirus Aid, Relief, and Economic Security (CARES) Act through July 31, 2020. This evolved into a $300 increase, and the American Rescue Plan Act (ARPA) signed in March 2021 extended the $300 through September 6, 2021.
Taxpayers who would not normally be eligible to collect unemployment, such as sole proprietors and independent contractors, could collect during this same period as well if they lost their jobs due to the pandemic. These unemployment checks were considered to be taxable income.
Then the American Rescue Plan Act (ARPA) was signed into law in March 2021. The Act allows for up to $10,200 of unemployment compensation in 2020 to be tax-free for anyone earning up to $150,000. The IRS indicates that you should not file an amended tax return if you filed your 2020 return before the ARPA was passed. It will recalculate all returns reporting unemployment income and will issue any resulting refunds in spring and summer of 2021.
You can expect to receive a Form 1099-G detailing how much you received in the way of unemployment benefits and how much you had withheld for taxes, if you were able to arrange for withholding. Unfortunately, you’ll get the form after the close of the 2020 tax year, and that doesn’t leave you a lot of time to catch up if you’re short and you're one of those taxpayers who's not affected by the ARPA. You had until January 15, 2021, to make estimated tax payments to cover as much of this income as possible without incurring a penalty.
The IRS offers an interactive tool on its website to help you determine whether your unemployment benefits are taxable, but they typically are except for the special provisions of the ARPA.
Did You Get a Stimulus Check?
The good news here is that the stimulus check provided by the federal government to help many Americans during the 2020 coronavirus economic crisis is not taxable income. Officially called the “Economic Impact Payment” (EIP), you might even have a little more coming to you if the check you received was less than you think you qualified for because you didn’t receive payment for one or more of your children or for other reasons.
The EIP is technically an advance on a refundable tax credit for the 2020 tax year. The IRS distributed the checks rather than make you wait until you file your 2020 tax return in the 2021 filing season to claim the money. You can claim any extra that you think you might be entitled to as the Recovery Rebate Credit on your 2020 return, for reasons such as not receiving an extra $500 for your dependent child.
Information and instructions for this procedure are available on IRS Notice 1444.
The Bottom Line
It’s been an unusual year that might have affected the amount of your income and how you earned that money, so it’s important to make sure as soon as possible that you've estimated how much you’ll be taxed on, including any unemployment payments received that haven't been exempted from taxation by the ARPA.