On Dec. 27, 2020, President Trump signed into law the Consolidated Appropriations Act (the Act) that had been passed with overwhelming majorities in both Houses of Congress on December 21. Trump delayed the signing as he pursued, with the approval of Democratic members of Congress, an increase in the amount of Recovery Rebate checks from $600 to $2,000. Without explanation or fanfare, the President signed the bill to the surprise of members of both parties. On Dec. 28, the House passed a stand-alone bill to increase the stimulus payments to $2,000, but with voting along party lines it is expected to die in the Senate.
In addition to many other provisions, such as a new round of Paycheck Protection Program (PPP) loans, the new law has many tax or tax-related provisions that will impact businesses and individuals, alike. In this article, we explore some of the key changes and how they may affect you.
For presentation and simplicity, we have used an edited summary of each relevant provision released by the House of Representatives, followed by our perspective on the treatment and impact of the provision. We will begin with the substantive provisions intended to provide relief from the COVID-19 pandemic, and finish with the explanation of what expiring provisions were extended.
Additional 2020 Recovery Rebates for Individuals
The Act provides a refundable tax credit in the amount of $600 per eligible family member. The credit is $600 per taxpayer ($1,200 for married filing jointly), in addition to $600 per qualifying child. The credit phases out starting at $75,000 of modified adjusted gross income ($112,500 for heads of household and $150,000 for married filing jointly) at a rate of $5 per $100 of additional income.
Eligibility criteria generally are the same for this round of recovery rebate payments as the first round provided by the Coronavirus, Aid, Relief, and Economic Security (CARES) Act. Advance payments of the recovery rebates will be based on the information on 2019 tax returns. Eligible taxpayers treated as providing returns through the non-filer portal provided for by the CARES Act, will also receive payments.
Taxpayers receiving an advance payment that exceeds the amount of their eligible credit will not be required to repay any amount of the advance payment. If the amount of the credit determined on the taxpayer’s 2020 tax return exceeds the amount of the advance payment, taxpayers will receive the difference as a refundable tax credit when the 2020 tax return is filed.
For a single filer with no qualifying children, the $600 additional recovery rebate payment is completely phased out when adjusted gross income exceeds $87,000. For a married couple with two qualifying children, the $2,400 additional recovery rebate payment is completely phased out when adjusted gross income exceeds $198,000.
Expansion of eligible expenses for educator expense tax deduction
The Act provides that personal protective equipment and other supplies used for the prevention of the spread of COVID-19 are treated as eligible expenses for purposes of the educator expense deduction. This provision is made retroactive to March 12, 2020.
Clarification of Tax Treatment of PPP loans
The Act reiterates any amount of PPP loan that is forgiven will not result in taxable income. The Act also clarifies that deductions are allowed for otherwise deductible expenses paid with the proceeds of a PPP loan that is forgiven. Further, the Act clarifies that the tax basis and other attributes of the borrower’s assets will not be reduced as a result of the loan forgiveness. These clarifications are effective as of the date of enactment of the CARES Act, and apply to any PPP loans from this round, as well.
These clarifications arguably are the headline tax feature of the Act for business taxpayers. Forgiven PPP loans are now akin to “free money” with no strings attached from a tax perspective. Because businesses are not taxed on the loan forgiveness income, and can still deduct expenditures paid out of PPP loan proceeds, there is a clear double benefit. Further, owners of S corporations and partnerships will increase the basis of their ownership interests by the amount of the tax-exempt loan forgiveness income, providing capacity to take tax-free distributions from their businesses. Because the expenses are deductible, however, the net effect on basis is essentially zeroed out.
Additionally, the Act makes obsolete the recent IRS guidance under Notice 2020-32 and Rev. Rul. 2020-27. The previous IRS guidance had provided that expenses paid out of forgiven PPP loan proceeds were nondeductible, whether or not the loan was forgiven during the same year that the expenses were incurred. While this is a very favorable development, it does create a complexity for fiscal year filers. Many fiscal year filers have already filed tax returns by following the IRS guidance. Because the clarifications under the Act are retroactive, these fiscal year filers must request adjustments to previously-filed returns. While most taxpayers make this request by filing amended returns, many partnerships must instead file an administrative adjustment request. This procedure often is different in that the tax decrease is taken into account by the partners as a nonrefundable credit during a different tax year, which creates a risk that there will be insufficient tax to offset this nonrefundable credit.
Employee Retention Tax Credit Modifications
The Act extends and expands the CARES Act employee retention tax credit (ERTC). It also contains some technical corrections to the CARES Act.
Beginning on Jan. 1, 2021 and through June 30, 2021, the Act:
- Increases the credit rate from 50 percent to 70 percent of qualified wages;
- Expands eligibility for the credit by reducing the required year-over-year gross receipts decline from 50 percent to 20 percent and provides a safe harbor allowing employers to use prior quarter gross receipts to determine eligibility;
- Increases the limit on per-employee creditable wages from $10,000 for the year to $10,000 for each quarter;
- Increases the 100-employee delineation for determining the relevant qualified wage base to employers with 500 or fewer employees;
- Allows certain public instrumentalities to claim the credit;
- Removes the 30-day wage limitation, allowing employers to, for example, claim the credit for bonus pay to essential workers;
- Allows businesses with 500 or fewer employees to advance the credit at any point during the quarter based on wages paid in the same quarter in a previous year; and
- Provides rules to allow new employers who were not in existence for all or part of 2019 to be able to claim the credit
The Act also extends the credit to employers who claimed PPP loans. However, to the extent that wages were used in the calculation of forgiveness of any PPP loan, they may not be used again in the calculation of the ERTC. This stipulation limits the potential benefit for recipients of PPP loans.
Extension of Payback Period for Employees’ Shares of Deferred Payroll Taxes
On Aug. 8, 2020, the President issued a memorandum to allow employers to defer withholding employees’ shares of social security taxes (or the railroad retirement tax equivalent) from Sep. 1, 2020 through Dec. 31, 2020. Because this is only a deferral, employers are required to subsequently increase withholding beyond the normal baseline level, and to remit the deferred taxes ratably from wages and compensation paid between Jan. 1, 2021 and April 30, 2021. Beginning on May 1, 2021, penalties and interest on deferred unpaid tax liability will begin to accrue.
The Act extends the repayment period through Dec. 31, 2021. Penalties and interest on deferred unpaid tax liability will not begin to accrue until Jan. 1, 2022.
Due to the administrative complexity of this program and the hardship it places on employees during the payback period, most employers did not offer this program to their workforce.
Extension of Credits for Paid Sick and Family Leave
The Act extends the refundable payroll tax credits for paid sick and family leave, enacted in the Families First Coronavirus Response Act (FFCRA), through the end of March 2021. It also modifies the tax credits so that they apply as if the corresponding employer mandates were extended through the end of March 2021. This provision is effective as if included in FFCRA.
Only private sector employers with fewer than 500 employees (and government entities) are subject to the paid sick and family leave program. This includes not-for-profit employers. Small businesses with fewer than 50 employees may be exempt if the program would jeopardize the viability of the business as a going concern.
Additional eligibility for paid sick and family leave credits by self-employed individuals
Allows self-employed individuals to elect to use their average daily self-employment income from 2019 rather than 2020 to compute the credit for paid sick and family leave. This provision is effective as if included in FFCRA.
Other Provisions for Businesses: PPP Loans
Changes to Original Paycheck Protection Program Loans
The Act retroactively expands the list of allowable and forgivable expenses paid out of Paycheck Protection Program loan proceeds, to include:
- Covered operations expenditures. Payment for any software, cloud computing, and other human resources and accounting needs
- Covered property damage costs. Costs related to property damage due to public disturbances that occurred during 2020 that are not covered by insurance
- Covered supplier costs. Expenditures to a supplier pursuant to a contract, purchase order, or order for goods in effect prior to taking out the loan that are essential to the recipient’s operations at the time at which the expenditure was made (supplier costs of perishable goods can be made before or during the life of the loan)
- Covered worker protection expenditure. Personal protective equipment and adaptive investments to help a loan recipient comply with federal health and safety guidelines or any equivalent State and local guidance related to COVID-19 during the period between March 1, 2020, and the end of the national emergency declaration
Borrowers who already received forgiveness are not eligible for these retroactive changes, however. The Act also makes changes to the “covered period” that borrowers use to determine loan forgiveness eligibility. Specifically, the Act retroactively allows a borrower to elect a covered period ending at the point of the borrower’s choosing between 8 and 24 weeks after origination (instead of absolute periods equaling 8 or 24 weeks). Again, borrowers who already received forgiveness are not eligible for these retroactive changes.
Additionally, the Act creates a simplified application process for loans under $150,000 such that:
- A borrower shall receive forgiveness if a borrower signs and submits to the lender a certification that is not more than one page in length, includes a description of the number of employees the borrower was able to retain because of the covered loan, the estimated total amount of the loan spent on payroll costs, and the total loan amount
- Borrowers are required to retain relevant records related to employment for four years and other records for three years
- Borrowers must attest that they accurately provided the required certification and complied with Paycheck Protection Program loan requirements
This simplified application process applies to loans made or forgiven before, on, or after the Act.
Paycheck Protection Program Second Draw Loans
The Act creates a second loan from the Paycheck Protection Program, called a “PPP second draw” loan for smaller and harder-hit businesses, with a maximum amount of $2 million.
In order to receive a PPP second draw loan, eligible entities must:
- Employ not more than 300 employees;
- Have used or will use the full amount of their first PPP; and
- Demonstrate at least a 25 percent reduction in gross receipts in the first, second, or third quarter of 2020 relative to the same 2019 quarter.
Eligible entities must be businesses, certain not-for-profit organizations, housing cooperatives, veterans’ organizations, tribal businesses, self-employed individuals, sole proprietors, independent contractors, and small agricultural co-operatives. Ineligible entities include entities involved in political and lobbying activities, entities affiliated with entities in the People’s Republic of China, registrants under the Foreign Agents Registration Act, and entities that receive a grant under the Shuttered Venue Operator Grant program.
In general, borrowers may receive a second draw loan amount of up to 2.5 times the average monthly payroll costs in the one year prior to the loan or the calendar year. No loan can be greater than $2 million, and only one second draw loan may be received. Seasonal employers may calculate their maximum loan amount based on a 12-week period beginning Feb. 15, 2019 through Feb. 15, 2020. Further, new entities may receive second draw loans of up to 2.5 times the sum of average monthly payroll costs, and entities in industries assigned to NAICS code 72 (Accommodation and Food Services) may receive second draw loans of up to 3.5 times average monthly payroll costs.
Businesses with multiple locations that are eligible entities under the initial PPP requirements may employ not more than 300 employees per physical location. A waiver of affiliation rules that applied to original PPP loans also apply to a second draw loan.
Certain Charitable Contributions Deductible by Non-Itemizers
The Act extends and modifies the non-itemizer charitable deduction for 2021. The provision increases the maximum amount that may be deducted such that married couples filing a joint return may deduct up to $600 (while non-married filers or married filers who file separately are limited to $300). Additionally, the provision restructures the deduction such that, although it may be claimed only by non-itemizers, the deduction does not reduce adjusted gross income (AGI).
These changes are only applicable to tax years beginning in 2021. There are also increased penalties for overstating the deduction in 2021.
Modification of Limitations on Charitable Contributions
The Act extends for one year the increased limit from the CARES Act on deductible charitable contributions for corporations and taxpayers who itemize.
Individuals may continue to plan for fully-deductible cash contributions to public charities as itemized deductions in 2021, without regard to the AGI limitations that would otherwise apply.
Reduction in Medical Expense Deduction Floor
Between 2013 and 2017, individuals under 65 years old could claim an itemized deduction for unreimbursed medical expenses to the extent that such expenses exceeded 10 percent of AGI, while for individuals 65 or older, the threshold was 7.5 percent of AGI. Prior to this period, the 7.5 percent threshold generally applied regardless of age. The Act makes permanent the lower threshold of 7.5 percent for all taxpayers, originally restored for 2017 and 2018 and then extended for 2019 and 2020.
Temporary FSA Rule
- Allows plans to permit health and dependent care flexible spending arrangements (FSAs) to carryover unused benefits up to the full annual amount from 2020 to 2021 and 2021 to 2022;
- Allows plans to permit a 12-month grace period for unused benefits or contributions in health and dependent care FSAs for plan years ending in 2020 or 2021;
- Allows plans to extend the maximum age of eligible dependents from 12 to 13 for dependent care FSAs for the 2020 plan year and unused amounts from the 2020 plan year carried over into the 2021 plan year; and
- Allows plans to permit a prospective change in election amounts for health and dependent care FSAs for plan years ending in 2021.
This may have a limited impact on taxpayers for 2020, as many will have already used their FSA benefits to avoid losing them. However, for 2021 taxpayers anticipating substantial future medical expenses may benefit from a rollover of FSA funds to 2022.
Transition from Deduction for Qualified Tuition and Related Expenses to Increased Income Limitation for Lifetime Learning Credit
The qualified tuition deduction is capped at $4,000 for an individual whose AGI does not exceed $65,000 ($130,000 for joint filers) or $2,000 for an individual whose AGI does not exceed $80,000 ($160,000 for joint filers). After 2020, the Act repeals the qualified tuition deduction and replaces it by increasing the phase-out limits on the Lifetime Learning credit from $58,000 ($116,000 for joint filers) to $80,000 ($160,000 for joint filers).
Section 114: Exclusion From Gross Income of Discharge of Qualified Principal Residence Indebtedness
The Act extends, through 2025, the exclusion from gross income for a discharge of qualified principal residence indebtedness. The provision reduces the maximum amount that may be excluded from $2,000,000 to $750,000. Generally, indebtedness must be the result of acquisition, construction, or substantial improvement of primary residence.
Treatment of Mortgage Insurance Premiums as Qualified Residence Interest
The Act extends, through 2021, a rule treating qualified mortgage insurance premiums as interest for purposes of the mortgage interest deduction. This deduction phases out for taxpayers with adjusted gross income (AGI) over $100,000 ($50,000 if married filing separately).
Nonbusiness Energy Property
The Act extends through 2021, a credit for purchases of nonbusiness energy property. Further, the Act allows a credit of 10 percent of the amounts paid or incurred by the taxpayer for qualified energy improvements to the building envelope (windows, doors, skylights, and roofs) of principal residences. Also, the Act allows credits of fixed dollar amounts ranging from $50 to $300 for energy-efficient property including furnaces, boilers, biomass stoves, heat pumps, water heaters, central air conditioners, and circulating fans, and is subject to a lifetime cap of $500.
Extension of Residential Energy-Efficient Property Credit and Inclusion of Biomass Fuel Property Expenditures
The Act extends, through 2022, the credit for residential energy efficiency property at the current 26 percent rate for property placed in service through 2022, with the rate reduced to 22 percent for property placed in service in 2023. Starting in 2021, the Act expands the definition of eligible property to include qualified energy efficient biomass fuel property.
Qualifying properties for the residential energy efficient property credit are solar electric property, solar water heaters, geothermal heat pumps, small wind turbines and fuel cell property. The credit percentage was scheduled to phase down to 22% for property placed in service during 2021, and was scheduled to expire after 2021.
Employer Tax Credit for Paid Family and Medical Leave
The Act extends, through 2025, the employer credit for paid family and medical leave, which permits eligible employers to claim an elective general business credit based on eligible wages paid to qualifying employees with respect to family and medical leave. The credit is equal to 12.5% of eligible wages if the rate of payment is 50% of such wages, and is increased by 0.25 percentage points (but not above 25%) for each percentage point that the rate of payment exceeds 50%. The maximum amount of family and medical leave that may be taken into account with respect to any qualifying employee is 12 weeks per taxable year.
This is a separate general business credit from the credit created by the FFCRA. Taxpayers who claim the credit provided by the FFCRA, described above, may not count those wages for purposes of calculating the employer tax credit for paid family and medical leave.
Temporary Allowance of Full Deduction for Business Meals
The Act provides a 100% deduction for business meal food and beverage expenses, including any carry-out or delivery meals, provided by a restaurant that are paid or incurred in 2021 and 2022. Currently, the deduction is available for only 50% of such expenses.
President Trump strongly advocated for the expansion of the meals deduction as a “stimulus” provision for business, however with continued restrictions on indoor dining in many areas of the country, it is unclear whether this change will have a significant effect.
Depreciation of Certain Residential Rental Property over 30-Year Period
The Act provides that the recovery period applicable to residential rental property placed in service before Jan. 1, 2018, and held by an electing real property trade or business (as defined in Section 163(j)) is 30 years. This provision applies only if the alternative depreciation system did not apply with respect to such property prior to Jan. 1, 2018.
This provision brings residential rental property placed into service by an electing real property trade or business prior to Jan. 1, 2018 into parity with property placed into service after Jan. 1, 2018. Previously the tax reform law known as the Tax Cuts and Jobs Act (TCJA) applied the 30-year recovery period only to property placed into service after Jan. 1, 2018; a 40-year recovery period applied to all other property of this type.
Energy-Efficient Commercial Buildings Deduction
The Act makes permanent the Section 179D deduction for energy efficiency improvements to a building envelope, lighting, heating, cooling, ventilation, and hot water systems of commercial buildings. The provision additionally indexes for inflation the amount of the $1.80-per-square-foot limitation.
New Markets Tax Credit
The Act extends annual $5 billion allocations of the New Markets Tax Credit for years 2021 through 2025. The Act also extends through 2030 the carryover period for unused New Markets Tax Credits.
Work Opportunity Tax Credit
The Act extends, through 2025, an elective general business credit to employers hiring individuals who are members of one or more of ten targeted groups under the Work Opportunity Tax Credit (WOTC) program.
The WOTC is particularly important to industries that employ young individuals and veterans, among other targeted groups. It does not appear that the bar from claiming the WOTC and the
ERTC created by the FFCRA has been eliminated. Thus, an employer may not claim both credits for the same employee.
Expensing Rules for Certain Productions
The Act extends, through 2025, a deduction of up to $15 million of the aggregate cost ($20 million for certain areas) of a qualifying film, television, or theatrical production in the year the expenditure was incurred.
Empowerment Zone Tax Incentives
The Act extends, through 2025, tax benefits for certain businesses and employers operating in empowerment zones. The Act modifies the tax incentives available by terminating the increased expensing on qualifying equipment under section 179 and the deferral of capital gains tax on the sale of certain qualified assets, effective for taxable years beginning after Dec. 31, 2020.
Exclusion for Certain Employer Payments of Student Loans
The Act extends, through 2025, the allowance for employers to provide a student loan repayment benefit to employees on a tax-free basis. Under the provision, an employer may contribute up to $5,250 annually toward an employee’s student loans, and such payment would be excluded from the employee’s income. The $5,250 cap applies to both the student loan repayment benefit as well as other educational assistance (I., tuition, fees, books) provided by the employer under current law. The provision applies to any student loan payments made by an employer on behalf of an employee through 2025.
Credit for Electricity Produced From Certain Renewable Resources
The Act extends the production tax credit for renewable power facilities that begin construction by the end of 2021. For wind facilities that begin construction by the end of 2021, the credit continues to be reduced by 40 percent.
Extension and Phaseout of Energy Credit
The Act extends the current 26% investment tax credit for solar energy property, fiber-optic solar equipment, fuel cell property, and small wind energy property that begin construction by the end of 2022, and at a 22% rate for property that begin construction by the end of 2023, after which the credit is reduced to 10% or 0%. The Act also extends the 10% investment credit for microturbine property, geothermal heat pumps, and combined heat and power property that begins construction through 2023.
The effects of the Consolidated Appropriations Act will be wide ranging. Democrats, hoping for a sweep in the Georgia Senatorial runoff elections, are pledging that this is only Step 1. Stay tuned for more Stimulus legislation and the introduction of President-Elect Biden’s tax proposals as we move into the new Administration’s early tenure.
For questions about new legislation or any other tax related topic, please contact us.