Should stimulus checks be reported on tax returns?
Q: My wife and I just received our second stimulus payment. It was transferred directly into our checking account. The deposit date is Jan. 4, 2021. Should we report this on our 2020 or 2021 tax return?
A: Stimulus payments are not taxable, so you don’t have to report it as taxable income on either your 2020 or 2021 return. That said, even though the deposit was made in 2021, you will need to factor in the amount you received to calculate your Recovery Rebate Credit, which is a special credit that only applies to the 2020 tax year. Like the first one, the second stimulus payment is considered an advance on that tax credit. The IRS estimated how much stimulus you were owed based on your 2019 adjusted gross income (2018 AGI was used for first-round payments if you didn’t file a 2019 return). If you are owed more money based on your 2020 income, you will get it as part of your tax refund. If you received more than you should have, you do not have to return the difference.
Q: Some time ago, you wrote about converting traditional IRAs to a Roth. Then I saw that the IRS refers to something called a Roth recharacterization, which is no longer allowed. What is the difference between a Roth conversion and a Roth recharacterization?
A: A Roth conversion is transferring existing funds from a traditional IRA to a Roth, a move the IRS allows, though there are tax consequences to consider. You’ll get the benefit of withdrawing that money tax free in retirement, but the downside is that you will owe taxes on the conversion amount now.
The recharacterization you refer to is reversing that conversion. For example, if you converted traditional IRA money to a Roth but then changed your mind, you can’t undo that conversion by “recharacterizing” the funds, something that was permitted before 2018. Now, when you convert the funds to a Roth, the decision and the tax consequences are final. The IRS, however, does still permit an annual IRA contribution to be recharacterized. Recharacterizing in this instance means redesignating some or all of the contribution, plus earnings, as either a Roth or a traditional IRA deposit, with the transfer completed by that year’s tax-filing deadline, including extensions. The recharacterization is nontaxable, though you will need to report it and perhaps file an amended return.