Didn’t Qualify for the Stimulus Payment? Capture it on your 2020 Taxes

Didn’t Qualify for the Stimulus Payment? Capture it on your 2020 Taxes

The Coronavirus Aid, Relief, and Economic Security (CARES) Act provided a recovery rebate credit of $1,200 for individuals or $2,400 for couples and $500 per child under the age of 17 against the tax imposed in the tax year 2020.  This is also referred to as a Stimulus Payment.  Tax filers with adjusted gross income (AGI) up to $75,000 for individuals and up to $150,000 for married couples filing joint returns will receive the full payment. For filers with income above those amounts, the payment amount is reduced by $5 for each $100 above the $75,000/$150,000 thresholds. Single filers with income exceeding $99,000 and $198,000 for joint filers with no children are not eligible. Eligible taxpayers who filed tax returns for either 2019 or 2018 will automatically receive an economic impact payment of up to $1,200 for individuals or $2,400 for married couples. Parents also receive $500 for each qualifying child.

To help with the current COVID-19 crisis and expedite the delivery of rebate credits to people, an advanced refund amount is calculated based on taxpayers’ AGI for 2019 or for 2018 if 2019 amounts are not yet available. Many of you may have already received this advanced payment if you were eligible.

If you did not receive a payment, or only a part of the maximum payment, you may still become eligible for the credit or the balance of the credit, if your AGI for 2020 can be reduced below the amounts noted above.  The prepaid amount paid during 2020 is an estimate of the credit and will be calculated and reconciled on your 2020 tax return.  Generally if the estimated amount received is more than is calculated on the 2020 tax return, you will not have to refund the difference.

Tax Planning Opportunities:

If your 2020 AGI can be reduce below the amount listed above, and that is less than your 2019 or 2018 tax return’s AGI, you may become eligible for part or all of the credit on your 2020 tax return.

  • Can you defer 2020 income to 2021
  • Can you increase any of the following deductions (Subject to limitations):
    • Health Savings Account Contributions
    • Flex Spending Account Contributions (125 Plans)
    • Tax-favored Retirement Account Contributions (Qualified plans such as 401(k)s or IRA contributions)

Below is an example how increasing a 401(k) contribution, might help you qualify for more of the Stimulus Payment not previously received, which in turn reduces your out of pocket amount necessary for the increased 401(k) contribution

Many taxpayers are not able to max out their 401(k) contributions. However, taxpayers who are in jeopardy of losing part of their credit due to the phaseout might want to use any advanced refund that they receive to increase their 401(k) contributions. Since 401(k) contributions are pretax contributions, taxpayers should be able to increase their 401(k) contribution more than the advanced refund amount without revising their personal budgets.

For example, assume there is a family of four with 2 qualifying children.  Also assume the family is in a 22% marginal federal tax bracket and an 8% marginal state income tax bracket for a combined marginal tax rate of 30%. This family could use the advanced refund of $3,400 to increase their 401(k) contribution to $3,400 ÷ (1 – 0.30) = $4,850 (all numbers are rounded) without affecting their after-tax take-home pay. (See the table “Increased 401(k) Contribution When Family AGI Is Less Than $150,000,” below, which in this example also assumes the employer match would add $290 to the 401(k) contribution.)

However, assume the couple’s income is currently above the $150,000 phaseout of the advanced refund and the couple received only a $2,000 advanced refund. If they expect approximately the same amount of income in 2020, then the 5% phaseout rate acts as an additional marginal tax. In that situation, the combined marginal tax rate for the family is 35% (30% + 5% phaseout rate). In that case, the couple could increase their 401(k) contribution by $2,000 ÷ (1 – 0.35) = $3,075 without decreasing the net after-tax income available to the family.

Increased 401(k) contribution when family AGI is less than $150,000
Increased 401(k) contribution$4,850Increased 401(k) contribution$4,850
Federal & State Tax Savings$1,450Assumed company match of the increased contribution$290
Increase in 401(k)$5,140
Net cost of increased 401(k) contribution$3,400
Less advanced refund$3,400
Net cost to couple of increased 401(k) contribution net of advanced refund$0

As an additional example, assume the couple currently have AGI of $160,000, their advanced refund would be reduced by $500 ([$160,000 – $150,000] × 5% = $500) (see the table “Increased 401(k) Contribution When Family AGI Is Over $150,000”, below). The 5% phaseout of the advanced refund acts as an additional marginal tax in this instance so the marginal tax rate becomes 35% (30% combined federal and state marginal rates plus the 5% phaseout). If this couple were able to increase their 401(k) contributions by $10,000 (gross), they could maximize the recovery rebate credit. The couple would save $3,000 in federal and state taxes and would increase their advanced refund by $500 for a total of $3,500 in savings/refund leaving an after-tax cost of the increased contribution of $6,500. Since the family of four would have already received $3,000 as part of the advanced refund, the couple would need to reduce their take-home pay by only $4,500 during the year. Assume the employer matches some percentage of 401(k) contributions9 and that, in this case, the employee would receive an additional $600 matching contribution. In total, the employee would be increasing his or her 401(k) contributions by $10,600, at an after tax cost of $6,500.

Increased 401(k) contribution when family AGI is over than $150,000
Increased 401(k) contribution$10,000Increased 401(k) contribution$10,000
Federal & State Tax Savings$3,000Assumed company match of the increased contribution$600
Increase in advanced refund$500Increase in 401(k)$10,600
Net cost of increased 401(k) contribution$6,500
Less advanced refund assuming no increase in 401(k) contribution$2,000
Net cost to couple of increased 401(k) contribution net of advanced refund$4,500

Each taxpayer’s situation is different and as a result will have different outcomes.  If you would like us to prepare a tax projection for you using hypothetical adjustments, please contact us.