Recovery rebates: Tax planning pitfalls and opportunities.

• Author: Gross, Andrew

The Coronavirus Aid, Relief, and Economic Security (CARES) Act (1) provides for a recovery rebate credit of $1,200 for individuals or $2,400 for couples and $500 per child against the tax imposed in the first tax year beginning in 2020. (2) The credit is phased out at a rate of 5% of a taxpayer's adjusted gross income (AGI) exceeding $150,000 for joint filers, $112,500 for a head of household, and $75,000 for everyone else. (3)

To help with the current COV1D-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. (4) This prepaid amount is an estimate of the credit that the taxpayer should receive based on the 2020 tax year and does not necessarily reflect the actual amount of the credit.

Potential Issues

Since a taxpayer's advanced refund is just an approximation of the credit to be received as part of the 2020 tax return, changes in the taxpayer's AGI in 2020 can make a significant difference in determining whether a taxpayer will ultimately qualify for the recovery rebate credit. Given the economic uncertainty of 2020, many taxpayers will have significant changes in income. Some taxpayers such as nurses or paramedics may work more and be in greater demand, resulting in higher income in 2020 than in previous years, while other taxpayers may lose jobs, be temporarily laid off, or have substantial decreases to their income.

For example, if a married couple with two children receive the full advanced refund of $3,400 based on 2019 s AGI, but their income increases to over $150,000 this year, they may be concerned that they will receive a surprise bill when filing their taxes next year, as the credit they already received begins to phase out. While the wording in the CARES Act is somewhat ambiguous, a Congressional Research Service report clarifies that the CARES Act does not require taxpayers to repay any advanced refund payments if their 2020 AGI exceeds the income limits for the refund credit as calculated on a 2020 return. (5) Therefore, this couple would be allowed to keep the entire $3,400 refund without increasing their tax liability when filing their 2020 return. This also means people may benefit from delaying their 2019 filing until after receiving the refund payment if their 2018 income was lower.

On the other hand, if the advanced credit is less than the actual credit, then taxpayers will be able to claim the difference (as an increased refund) on their 2020 income tax returns. For example, another married couple with two children may not receive an advanced refund at all if they had high income in 2018 or 2019. However, due to the current crisis, their income may be substantially lower in 2020, which would allow them to qualify for part or all of the credit on their 2020 return. Furthermore, if children are born or adopted in 2020 (and possibly 2019 if the recovery rebate is based on 2018), taxpayers will be eligible for an additional $500 for each new child, further increasing their credit. In that case, they may want to consider the increased credit when setting their withholding or making estimated payments. This is especially true if one spouse continues to work while the other has lost his or her job due to the crisis.

Since the tax credit is only valid for 2020, taxpayers have more of an incentive to push income to subsequent years, increase their 2020 deductions before AGI, or take advantage of other tax planning strategies to keep the recovery credit from being phased out in 2020. This could mean using the advanced refund to increase pretax retirement contributions, giving more to charity to take advantage of the AG J charitable contribution provision, or even choosing to file married filing separately to preserve the recovery rebate credit for at least one spouse.

Using the advanced refund to increase retirement contributions and maximize the recovery refund

Since taxpayers have an incentive...