The pandemic’s economic fallout is putting people’s tax knowledge to the test, and they’re not passing with flying colors.
A new survey indicates that many U.S. adults are in the dark about critical questions this tax season, such as how the Internal Revenue Service treats stimulus checks and whether remote workers can claim a home office tax deduction.
Just 5% of more than 1,000 people polled by NORC at the University of Chicago correctly answered five true-or-false questions about the tax code. People, on average, answered almost three (2.89) of the five questions correctly.
Here are the questions.
- People don’t have to pay taxes if they didn’t earn any income. True or false?
- If someone worked from home instead of their usual place of employment last year, they can claim their home office as a deduction on their taxes. True or false?
- People don’t have to pay taxes on what they received in their stimulus checks. True or false?
- People don’t have to pay taxes on unemployment benefits. True or false?
- Income earned from gig economy jobs is still taxed. True or false?
(The answers are given below.)
Let’s face it: Even in normal times, understanding the mass of rules and regulations is a taxing task. In 2018, almost half of the people in one survey did not know which tax bracket they fell in. That reflects America’s wider challenges with financial literacy.
Layer on all the COVID-19 complications for taxes, and getting through the tax code thicket becomes even trickier — and the stakes are higher now for people who don’t know the ins and outs.
2020’s CARES Act and a $900 billion relief bill in December introduced significant changes to the federal tax code. So did the $1.9 trillion American Rescue Plan enacted in March.
As a result, there’s a lot riding on the 2020 tax return. It’s the last chance to claim missed-out stimulus check money from last year, though people can also try to rely on parts of their 2019 return to maximize their payout under certain credits.
Additionally, the IRS pushed the 2020 income-tax filing deadline to May 17 from April 15 — but it kept the April 15 payment deadline on estimated payments, which is a key point for gig workers.
It’s no wonder a person’s head might be spinning.
Still, the extent of incorrect answers surprised Angela Fontes, the poll’s principal investigator and vice president of NORC’s Economics, Justice, and Society Department.
“This is a year that, for many folks, a refund is going to be critically important,” she said, adding, “If we have folks not potentially understanding the tax code, at worst, the IRS will consider the error willful. At best, refund checks could be delayed.”
As of March 26, the IRS had received 85 million returns and issued 56.4 million refunds. The average refund check by that date was $2,902.
Higher-income survey participants typically fared better on the quiz, even though Fontes said lower-income participants could least afford the lack of knowledge on how to get every last tax dollar coming to them. “It’s these folks who are probably most at risk for financial insecurity who also have the least knowledge about tax topics.”
Here are the answers to the quiz:
1. The answer is false. The IRS will certainly tax earned income, but it says types of non-earned income are taxable. This includes child support, alimony, interest and dividends.
The fewest people got this right in the survey. 21% of people making less than $30,000 answered this correctly. Around 30% of the people in each of the other three income groups — $30,000 to $60,000, $60,000 to $100,000 and over $100,000 — answered correctly.
2. The answer is false. The tax code does offer a tax break for work from home expenses, but the deduction does not currently apply to people who are employees. It applies to people such as self-employed taxpayers and independent contractors who, according to the IRS, have to show they are using part of their home “exclusively and regularly as a principal place of business for a trade or business.”
Correct answers ranged from roughly one quarter of participants making less than $30,000 to 41% of people making above $100,000.
3. The answer is true. Stimulus checks, whether it’s the first, second or third round, do not count as taxable income. This is one of the many myths that swirled around on the economic impact payments.
In the quiz, it’s also the exception to the rule of higher-income participants having more tax savvy than lower income participants. 65% of people making more than $100,000 answered the question correctly. 76% of people making less than $30,000 answered correctly.
Wealthier survey participants might have been less likely to receive the checks, Fontes pointed out. The full checks went to individuals making up to $75,000 and married couples filing jointly that earned $150,000.
Lower-income participants might also know the stimulus check rule intricacies because “they are probably the folks who are counting every cent of those stimulus checks,” Fontes said.
4. The answer is false. Taxpayers do have to pay taxes on the unemployment benefits they receive in a year.
The American Rescue Plan modified the federal rules on that, fueled in part by the worry of some lawmakers that many people would be blindsided by this tax rule after a year of massive job losses.
The American Rescue Plan waives federal income tax on the first $10,200 in jobless benefits a person receives and the first $20,400 in benefits a married couple receives, so long as the household makes less than $150,000. If a taxpayer already filed their return before the exclusion became law, the IRS will automatically readjust the return. State income tax rules may differ.
NORC noted it conducted the survey before the $10,200 exclusion became law.
5. The answer is false. Yes, taxpayers do have to pay tax on their “side hustle,” and this was the question most people answered correctly. Correct answer rates ranged from 64% of people making less than $30,000 to 91% of people making more than $100,000.
A paycheck from an employer has income tax and Social Security taxes already taken out. A person who’s their own boss still has to pay taxes, but they’ve got to do it themselves. Gig workers can make those payments in four installments through the tax year.
Though May 17 is the deadline to file 2020 federal income taxes and pay any taxes owed, April 15 marks the first of four deadlines for estimated payments during the 2021 tax year.
“Talk about confusing, for not only the tax professional community, but also for individual taxpayers,” Barbara Weltman, founder of Big Ideas for Small Business and the author of “J.K. Lasser’s Guide to Self-Employment,” previously told MarketWatch.