New FAQs cover interplay of unemployment income exclusion and credits

Taxpayers whose 2020 income tax returns were revised by the IRS to exclude unemployment benefits from gross income may be eligible for the additional child tax credit or earned income tax credit as a result, the IRS advised in two frequently asked questions (FAQs) it added Friday to its 2020 Unemployment Compensation Exclusion FAQs webpage. The IRS also addressed a possible complication for FAFSA applicants.

Notices CP08 and CP09: The two tax credit FAQs were added to the page’s Topic G: Receiving a Refund, Letter, or Notice. FAQs G8 and G9 note that taxpayers might receive a CP08 or CP09 notice from the IRS advising that they did not claim the additional child tax credit or earned income tax credit, respectively, but may now be eligible for one of those credits as a result of the IRS’s exclusion of unemployment benefits from their income. Taxpayers must reply to the notices to receive the credit or credits (although the notice is not confirmation they are eligible for them) but do not have to file an amended return.

The unemployment exclusion was enacted as part of the American Rescue Plan Act, P.L. 117-2, on March 11, 2021, with respect to the 2020 tax year. By that date, some taxpayers had already filed 2020 tax returns including the unemployment benefits, or did so afterward. In either case, the IRS recalculated those returns applying the exclusion of up to $10,200 of unemployment benefits paid in 2020, if the taxpayer’s modified adjusted gross income was less than $150,000. Married taxpayers could receive the exclusion with respect to benefits paid both spouses.

FAFSA applications: The IRS also on Friday added new FAQ 3 to Topic I: Post Unemployment Compensation Exclusion Adjustment, advising that, based on information from the Department of Education, applicants filing a Free Application for Federal Student Aid (FAFSA) should do so according to its instructions and afterward check with their school’s financial aid office regarding any financial changes, including an exclusion of unemployment benefits, that may have affected their financial aid.

Taxpayers who need updated account information and received an IRS Notice CP21 stating their tax account was changed as a result of the unemployment exclusion can use a combination of the information in the notice and their tax return, the IRS stated in the FAQ, which also advises how to obtain an IRS tax return or account transcript.

Amended returns: In addition, the IRS revised FAQ 2 for Topic D: Amended Return (Form 1040-X), which states that if taxpayers know they were eligible to exclude unemployment benefits but did not do so on their return, they should file an amended return to claim any credit or deduction that the exclusion makes them eligible for. If they filed their original return electronically, they may file the amended return electronically as well. However, they do not need to file an amended return to claim a recovery rebate credit, earned income tax credit with no qualifying children, or the premium tax credit. The IRS will automatically calculate those credits and include them in any overpayment.

Also, the IRS says taxpayers should not file an amended return to claim the additional child tax credit or earned income tax credit if they reply to a CP08 or CP09 notice stating they may be eligible for one of these credits and they are not requesting any other changes be made to their 2020 tax return, as noted in FAQs G8 and G9, described above.

— Paul Bonner (Paul.Bonner@aicpa-cima.com), is a JofA senior editor.