Sleep well, we’re looking out for you

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People often ask me what value CPAs provide in these days of technology. One way we provide value is by letting you sleep when we can’t because Congress is coming up with new legislation, and we must know the impact of this impending law. My after-hours research is driven by the question: If this passes, what will it mean for my clients and their businesses? I don’t sleep so you can…. although I certainly want to sleep.

Take, for example, the proposed $10,200 unemployment income exemption in the latest stimulus package as a perfect example.  It contains what is believed to be a cliff $150,000 threshold to where if you make under $150,000, then the first $10,200 of unemployment is non-taxable, but if you make over that amount, you pay tax on the $10,200 that otherwise is exempted.

As a tax pro, we know to avoid cliffs. Don’t go near them. We like rolling hills. But, if we have a cliff before us, we better know the consequences. Good tax pros everywhere are lying in bed thinking about this, so you don’t have to.

Some hills are steeper than others while not quite a cliff. A hill like the phaseouts on the next round of economic recovery rebates, for example, is steep. Not a cliff, but steep. The $1,400 rebates have a phaseout range of just $10,000. Guess where it starts for married filing joint couples? You guessed it…$150,000. Math is fun–you see a common $150,000 income threshold and the relationship between a $10,000 phaseout for rebates and approximately $10,000 of unemployment exclusion? Yes, this dream is what keeps us tossing and turning at times when we need sleep the most.

There is a very real possibility that someone could have an effective tax rate in excess of 100% when you combine taxes and economic rebates or stimulus payments. But wait, how can that be? We should not have higher taxes or lower benefits by more than we make? Well, here is a scenario where that happens:

Our hypothetical taxpayer is a married family with three young kids. Combined income in 2019 is $250,000+ while in 2020, they had $150,000 of wages and $10,000 of unemployment benefit income while in 2021, they will be back up at the $250,000+ income level.

There are three major items at play here that create tax/benefit changes because of the $150,000 limits referenced above:

  • Tax on the Unemployment: The tax cost of the $10,000 of unemployment is $2,200. This is because their other income is above the $150,000 cliff, so the entire amount is taxable.
  • 2020 Stimulus: With income at $150,000 (if the unemployment was not taxable), they would get the full $6,900 of stimulus payments on their 2020 filings ($3,600 for parents and $3,300 for kids). However, at $160,000 of income with the $10,000 of unemployment included, their stimulus drops due to the gradual phaseout by $1,000.  Since they were high income in 2019, they would not have received their advance payment, by the way.
  • 2021 Stimulus: At an income level of $150,000, again if the income was excluded from their 2020 income, this family would get advance economic rebate payments of $7,000 ($1,400 x 5 family members) while at $160,000, they would get none as an advance due to that steep phaseout. Further, since their income is high again in 2021, they get none when they file 2021 either, so the cost is $7,000, although I have heard there may be a clawback of the advance payment for those whose income accelerates in 2021 but have not confirmed this.

So, in this “perfect nightmare,” a family received $10,000 of unemployment, and it actually costs them $10,200 through increased taxes and reduced pandemic benefits. That unemployment income actually costs this family $200. I don’t think this was intended, but that is how I see it right now.

Value is not provided though just in doing the math. It is the workaround that keeps me awake at night–even if it is just working up a hypothetical in my head. So how can we reduce AGI? When there are cliffs involved, this is so very important.

The answer: the old forgotten Individual Retirement Account. For some, an IRA is an afterthought, while for others, it is something they do every April once prodded by their CPA or financial advisor. In this situation, it may be worth quite a bit of tax savings.  The IRA may be our way down the cliff.

For a married couple that is not covered by an employer-sponsored retirement plan, they each can contribute $6,000 to an IRA by April 15th for the 2020 tax year. So, in this case, a total of $12,000 may be contributed as long as neither spouse is covered by a retirement plan at work. This may be our chance out of this nightmare. Stay with me here.

Our hypothetical family with $150,000 of wages, no company-sponsored retirement plan, $10,000 of unemployment, and 3 young kids in 2020 each contribute $5,000 to their IRA accounts, and therefore their income is below the $150,000 mark. What does that get them in return?

In normal years, the $10,000 IRA contribution would be worth a reduced federal tax of $2,200. However, in these times, it would be $2,200 PLUS the $10,200 “lost” when their income was higher than $150,000 due to the above…the $10,000 of unemployment is no longer taxable, they get 100% of their 2020 stimulus payments, and they should qualify for their full 2021 stimulus payments (fingers crossed).  Follow me…that $10,000 IRA contribution results in $12,400 of tax benefits. A whopping tax benefit of 124%. Remember, the IRA is still their money; it is part of their future retirement. The benefit is even larger if you are in a state like California that provides a similar IRA deduction.

This nightmare can turn into a dream by flipping the script and thinking of the alternatives. We don’t know how this will all play out, but the takeaways are important here, which is that we want to consider these scenarios for our clients and plan for them.  We also must consider filing status in this equation. Further, who knows if Congress will double the $150,000 for married filers or add a phaseout range into the final package.

Now, obviously, we likely do not have a single client whose situation aligns with this scenario, but we can learn lessons from it.  This is why we can’t sleep at night. This is what keeps us driving day in and day out. We want to find our way around the cliffs without jumping off them. This is why clients work with us. I hope you can sleep better at night knowing that someone is looking after you.


If you have questions about how this might apply to you, feel free to reach out to me at or click here.