Filing your taxes may look a little different this year. But if you’re worried the extra boost in funds you received as stimulus payments will negatively impact your tax refund, rest assured that is not the case.
That’s because the stimulus payments are not considered taxable income; they are advances on a tax credit created to provide relief to the many Americans impacted by the COVID-19 pandemic. That credit is called the Recovery Rebate Credit.
Tax Credit Definition
In order to understand how the stimulus payments don’t negatively impact your tax refund, let’s first start with the definition of a tax credit.
Tax credits reduce the amount of income tax you owe to the federal and state governments. They are a dollar-for-dollar reduction on your tax liability. That means if you owe $1,000 in federal taxes but are eligible for a $1,000 tax credit, your $1,000 tax bill will drop to zero once the credit is applied.
There are two different categorizations of tax credits – a nonrefundable tax credit and a refundable tax credit. When claimed on your tax return, nonrefundable tax credits reduce your tax liability until you no longer owe any money. Refundable credits, however, go beyond that $0 balance. Any amount of the refundable tax credit that remains after your tax bill is reduced to $0 will be sent to you as a tax refund, as is the case with the Recovery Rebate Credit.
Rather than automatically being applied to tax bills, the Recovery Rebate Credit was sent to eligible individuals as a form of relief in response to the financial hardships many Americans experienced during 2020.
Credits are generally designed to encourage or reward certain types of behavior that are considered beneficial to the economy, the environment or to further any purpose the government deems important. In most cases, credits are focused on helping with specific expenses you pay during the year and have requirements you must satisfy before you can claim them. The government deemed providing some financial support to Americans in response to the pandemic a high priority, and that’s why the Recovery Rebate Credit was created for the 2020 tax year.
How TaxAct helps filers claim the Recovery Rebate Credit
If you complete your tax return using TaxAct, you will be asked if you received both stimulus payments and what the dollar values were for each. The product asks about your payments in an effort to reconcile the credit on your return based on your 2020 tax situation.
As you may already know, the stimulus payments were originally calculated based on your 2018 or 2019 tax data (whichever tax return was filed most recently before you received the payments). Technically, however, the payments are supposed to be reflective of your 2020 tax situation. Because 2020 tax returns had not yet been filed before the stimulus payments went out, the IRS had no way of knowing how much money you qualified to receive based on that year. Therefore, they resorted to prior year tax data.
Now that you are filing your 2020 return, you have the opportunity to reconcile that payment on your return to ensure you received the correct amount of stimulus money. The good news is if you were overpaid in stimulus funds, you will not have to pay any of that money back. It’s yours to keep.
If you were underpaid, however, filing your return gives you the chance to see if you qualify for more. In the event that you do, you’ll receive that money as part of your tax refund since the Recovery Rebate Credit is a refundable tax credit.
After entering your stimulus payment information into TaxAct, the product calculates your credit eligibility and lets you know if you qualify for more or if you received the right amount. You will not see the refund amount you were owed prior to inputting your stimulus payment information decrease. It will only increase if you are due more.
To learn how to add your stimulus payments to your return and claim the Recovery Rebate Credit, visit our FAQ page titled Form 1040 – Recovery Rebate Credit.
Why some filers see their refunds get smaller
Some DIY tax software providers automatically factor the Recovery Rebate Credit into a filer’s refund from the moment they start completing their return. Unfortunately, that method creates a false – or higher than normal – refund amount. Once the filer gets to the point of letting the software know they already received their stimulus payments, the software then removes the Recovery Rebate Credit value from the refund which dramatically reduces the amount of refund dollars the filer thought they were receiving. At that point, many filers begin to believe the Recovery Rebate Credit negatively impacted their refund when, in fact, the negative reduction was purely due to the way the software provider handled the credit.
To avoid that scenario and to not put a false refund dollar amount in front of filers, TaxAct chooses to handle the credit differently. The Recovery Rebate Credit will not be calculated or added to your refund until you let the product know the values of what you received as stimulus payments. That includes indicating that you didn’t receive a payment at all. And that is why you should not see a reduction in your refund amount from your stimulus payments otherwise known as the Recovery Rebate Credit.
Your refund could increase after claiming Recovery Rebate Credit
While the Recovery Rebate Credit will never negatively impact your refund, it certainly can increase the amount you receive. There are several scenarios in which you may receive a higher refund because of the credit. And these are good reasons to file as soon as possible so you get the money owed to you. A few of the more common situations include:
- A change in income between 2019 and 2020: If you previously did not qualify for the full stimulus payment because your 2019 income put you above the stimulus income limits, but your income in 2020 was reduced due to a job loss or decrease in pay, you may now qualify to receive the full credit amount.
- The addition of a dependent: Many individuals will qualify for additional stimulus funds when they file their 2020 returns because they had a baby or adopted a child in 2020, which gave them a new dependent to add to their tax return. Parents who claim qualifying children under the age of 17 on their return are eligible to receive extra stimulus funds. For the first stimulus payment, $500 was given for every qualifying dependent. With the second stimulus payment, an additional $600 was given for every qualifying dependent.
- Sharing joint custody of a child: If you rotate the responsibility of claiming your child on your tax return with your child’s other parent, you both may be eligible for the Recovery Rebate Credit. For instance, let’s say you filed your 2019 return claiming your child as a dependent and received stimulus funds for that child, but in 2020 it’s the child’s other parent’s turn to claim him or her, that parent would then also qualify to claim the Recovery Rebate Credit.
Additionally, maybe you got married or divorced. Perhaps you graduated college and started working, meaning you’re no longer considered a dependent on someone else’s return. Both scenarios would qualify you to claim the credit on your 2020 return. Even individuals who were working in 2019 but retired in 2020 could now be eligible for the credit if they previously weren’t due to income limitations.
TaxAct Xpert Help can guide you
No matter which TaxAct product you choose to file your 2020 return, claiming the Recovery Rebate Credit is a simple process. But if you have questions or want some extra advice on how to best complete your return based on the life changes you experienced in 2020, you can always take advantage of TaxAct Xpert Help when filing.
Xpert Help offers unlimited access, seven days a week, to CPAs, EAs and other tax experts. When using the service, you can choose to connect directly with an expert in the moment or schedule a call back when it’s most convenient for you. No matter which method you choose, you have access to experts at your fingertips to help you navigate your tax situation and file your return with confidence.
All TaxAct offers, products and services are subject to applicable terms and conditions.
TaxAct Xpert Help: Available to certain users of TaxAct’s online, consumer 1040 product for an additional charge. Service hours limited to designated scheduling times and by expert availability. Some tax topics or situations may not be included as part of this service. View full TaxAct Xpert Help Terms and Conditions.