The following is from the AARP website:
The Internal Revenue Service (IRS) sent out more than 160 million stimulus payments since the CARES Act was signed into law on March 27. Now it’s sending out millions more checks in the second round of stimulus payments. As people start to spend their money, some wonder: Is my stimulus payment taxable?
The short answer: No. In the somewhat longer words of the IRS: “No, the payment is not income and taxpayers will not owe tax on it. The payment will not reduce a taxpayer’s refund or increase the amount they owe when they file their 2020 or 2021 tax return next year. A payment also will not affect income for purposes of determining eligibility for federal government assistance or benefit programs.”
Not your average tax credit
The stimulus payment — or economic impact payment, as the IRS calls it — is technically a tax credit for 2020. But this isn’t widely understood. Some people assume that the IRS will add the amount to your income, generating a bigger tax bill, or reduce your future tax refund when you file your tax return next year. Neither is the case, but this bears some explaining.
In the tax world, a tax deduction is a good thing. It reduces your income, which reduces the amount of tax you owe. If you had $50,000 in income and had a $5,000 tax deduction, your deduction would reduce your taxable income by $5,000. If you were in the 12 percent tax bracket, you’d reduce your taxes owed by $600 (12 percent of $5,000).
A tax deduction is good, but a tax credit is very good. A tax credit reduces your tax bill dollar for dollar. If you owe $1,500 in federal income taxes and you get a $1,000 tax credit, your tax bill sinks to $500.
A refundable tax credit is a thing of wonder. A garden-variety tax credit can reduce your tax bill to zero, but it can’t turn a tax bill into a tax refund. Refundable tax credits can. For example, if you owed $1,000 in taxes but had a refundable tax credit of $1,200, you’d get a $200 tax refund check from Uncle Sam.
Because you’re getting what amounts to a refundable tax credit now in the form of a stimulus payment, rather than waiting to get the money from the credit in 2021 when you actually file your 2020 tax return, you’re in effect getting an advanced refundable tax credit.