Recovery rebates

Under the ARPA, many people will receive a third round of direct payments (which the law calls recovery rebates). It provides for direct payments of $1,400 — plus $1,400 per dependent — for single tax filers with adjusted gross income (AGI) up to $75,000 per year, heads of households with AGI up to $112,500 and married couples with AGI up to $150,000. The rebates phase out when AGI exceeds $80,000, $120,000 and $160,000, respectively. Dependents include adult dependents, such as college students and qualifying family members.

The payments will be based on your 2019 or 2020 income, depending on whether you’ve filed your 2020 tax return. If you haven’t filed and expect your 2020 AGI to be at or near the applicable phaseout threshold, you might want to consider the timing of your 2020 filing.

Payments will be reconciled on your 2021 tax return. If you qualify for a rebate based on your 2020 income but didn’t receive a check because the government based your eligibility on your 2019 tax return, you can claim a credit on your 2021 return. But, if you receive a payment based on your 2019 AGI even though you don’t actually qualify based on your 2020 AGI, you won’t be required to return it.

Unemployment benefits

The ARPA extends the extra $300 per week in unemployment benefits, over and above state unemployment benefits, through September 6, 2021. It also increases the maximum period of benefits from 50 weeks to 79 weeks.

In addition, the law spares unemployment beneficiaries an unwelcome surprise tax bill by making the first $10,200 in unemployment benefits received in 2020 nontaxable for households with incomes less than $150,000. If you qualify for this tax break and have already filed your 2020 returns, you’ll want to await IRS guidance as to how to proceed. The IRS is reviewing the possibility that they’ll be able to make the adjustments automatically.

Child tax credits

The new law temporarily expands the $2,000 Child Tax Credit (CTC) significantly. For 2021 only, eligible taxpayers will receive a $3,000 credit for each child ages 6 to 17 and a $3,600 credit for each child under age 6.

The $2,000 credit is subject to a phaseout when income exceeds $400,000 for joint filers and $200,000 for other filers. The ARPA continues this treatment for the first $2,000 of the credit in 2021, but it applies a separate phaseout for the increased amount — $75,000 for single filers, $112,500 for heads of household and $150,000 for joint filers. So, in other words, for 2021, the credit is subject to two sets of phaseout rules.

The ARPA directs the U.S. Treasury Department to create a program to make monthly advance payments for the increased CTC beginning in July, based on taxpayers’ most recently filed tax returns. That means eligible taxpayers will receive half of the credit before year end. If the advance payments end up exceeding the amount of the credit due on the 2021 tax return, the excess amount must be repaid. The IRS will establish an online portal where you can opt out of advance payments or enter information that modifies the amount of your monthly payments, if you’re eligible.

Child and dependent care tax credit

The ARPA expands the child and dependent care tax credit substantially, albeit again temporarily. For 2021, taxpayers can claim a refundable 50% credit for up to $8,000 in care expenses for one child or dependent and up to $16,000 in expenses for two or more children or dependents — so the credit ultimately is worth up to $4,000 or $8,000. It begins phasing out when household income levels exceed $125,000; for households with income over $400,000, the credit can be reduced below 20%.

For comparison, the 2020 expense limits were $3,000 and $6,000, and the credit topped out at 35% of the expenses. The phaseout began when household income exceeded $15,000, though the credit is no less than 20% of the allowable expenses regardless of household income.

The ARPA also increases the limit on tax-free employer-provided dependent care assistance for 2021 to $10,500 (50% for married couples filing separately). That’s more than double the current limit of $5,000.

Student loan forgiveness

The ARPA doesn’t forgive student loan debt, but it anticipates a possible development may occur in the near future. For now, it ensures the tax-free treatment of student loan debt forgiven between December 31, 2020, and January 1, 2026. Forgiven debt typically is treated as taxable income.

Health care insurance

Health insurance will become more affordable for some insured individuals in 2021 and 2022 because of two provisions in the ARPA. The provisions relate to the Affordable Care Act (ACA) and continuation coverage that may be available under the Consolidated Omnibus Budget Reconciliation Act, better known as COBRA.

The law increases both the availability and the amount of ACA subsidies, retroactive to January 1, 2021. It extends cost-sharing support to anyone who receives, or was approved to receive, unemployment benefits in 2021. It also limits the amount that anyone who obtains insurance through the federal or state marketplaces must pay for premiums to 8.5% of their modified adjusted gross income — regardless of their income.

And the ARPA provides a 100% premium subsidy for qualified beneficiaries who are 1) currently enrolled in COBRA or 2) either eligible but didn’t enroll previously or enrolled but dropped out. The subsidy is available only to employees who lost group coverage because they were involuntarily terminated or their hours were reduced. It covers the period of April 2021 through September 2021.

Housing relief

Like the CARES Act and the Consolidated Appropriations Act (CAA) before it, the ARPA includes assistance for those struggling to keep their homes due to the pandemic. For example, it provides rental assistance that eligible families can use for past-due rent, future rent, and utility and energy bills.

The law also provides additional funding to the Homeowner Assistance Fund. The fund is intended to prevent mortgage delinquencies, defaults, foreclosures, the loss of utility or home energy services, and the displacement of homeowners experiencing financial hardship after January 21, 2020.

Business-related provisions

The ARPA contains numerous provisions affecting businesses, too. For example, it provides an additional $7.25 billion in funding for the Paycheck Protection Program (PPP). However, the new law didn’t extend the current March 31 deadline for PPP loans to be approved but Congress is discussing another bill to extend it.

The ARPA also provides another $15 billion for Economic Injury Disaster Loan (EIDL) Advance Grants. Small businesses in low-income communities are eligible for EIDL grants of up to $10,000; $5 billion is reserved for $5,000 grants to businesses that experienced a revenue loss of more than 50% and have no more than 10 employees.

The law also includes targeted relief for some of the industries hit hardest by the COVID-19 pandemic. It establishes a $28.6 billion fund for businesses that primarily serve food or drinks, with $5 billion earmarked for restaurants with 2019 gross receipts under $500,000. In addition, the ARPA directs an additional $1.25 billion to the “shuttered venue operators” grant program that was created by the CAA and expands eligibility to include operators that received a PPP loan after December 27, 2020. These operators include live performing arts organizations and movie theaters.

Additional guidance to come

The ARPA is a sweeping piece of legislation, with substantial implementation guidance on certain provisions sure to come from regulators. We’ll keep you apprised of the developments most likely to affect you, your family and your business.

The ARPA extends and expands some of the critical provisions in the CARES Act and the Consolidated Appropriations Act (CAA). It also includes some new provisions that should come as welcome news to many families and businesses.

Key provisions for individuals, businesses and other employers

Here’s a broad overview of some of the provisions that may affect you:

Individuals

• Additional direct payments (or recovery rebates) of $1,400 — plus $1,400 per dependent (including adult dependents) will be made to eligible individuals. To qualify, individuals must have an adjusted gross income (AGI) of up to $75,000 per year, ($150,000 for married couples filing jointly and $112,500 for heads of households). The payments phase out and are no longer made when AGI exceeds $80,000 for individuals, $160,000 for married joint filers and $120,000 for heads of household.
• For eligible individuals, the Child Tax Credit (CTC) increases to $3,000 for each child age six to 17 and $3,600 per year for children under age six. To be eligible for the full payment, you must have a modified AGI of under $75,000 for singles, $112,500 for heads-of-households and $150,000 for joint filers and surviving spouses. The credit phases out at a rate of $50 for each $1,000 (or fraction thereof) of modified AGI over the applicable threshold.
• Parents will begin receiving advance payments of part of the CTC later this year. Under the ARPA, the IRS must establish a program to make monthly payments (generally by direct deposits) equal to 50% of eligible taxpayers’ 2021 CTCs, from July 2021 through December 2021.
• Some taxpayers who aren’t eligible to claim an increased CTC in 2021, because their income is too high, may be able to claim the regular CTC of up to $2,000, subject to the existing phaseout rules.
• For 2021, there’s an expanded child and dependent care tax credit of up to $4,000 for childcare expenses for one child and up to $8,000 for two or more children for households making up to $125,000.
• Any student loan debt forgiven between December 31, 2020, and January 1, 2026, will receive tax-free treatment.
• An additional $300 per week in unemployment benefits will be paid through September 6, 2021. In addition, the first $10,200 in unemployment benefits received beginning in 2020 isn’t included in gross income for taxpayers with AGIs under $150,000. (However, for joint filers below the AGI limit, the $10,200 exclusion applies separately to each spouse.)
• There’s expanded availability of and increased Affordable Care Act (ACA) subsidies for those who obtain insurance in the ACA marketplaces, for 2021 and 2022.
• Federal rental assistance is included for families affected by COVID-19, applicable to past due rent, future rent payments, and utility and energy bills.
• There’s expanded eligibility for low-income individuals with no qualifying children to claim the Earned Income Tax Credit.

Businesses and other employers

• Pandemic assistance grants will be made to eligible businesses serving food or drinks, including restaurants and food trucks.
• There will be additional funding for forgivable loans to eligible businesses under the Paycheck Protection Program (PPP), which is currently scheduled to expire on March 31, 2021.
• Nonprofit organizations and online news services will receive expanded PPP eligibility.
• New targeted Economic Injury Disaster Loan grants will be available for eligible small businesses in low-income communities.
• The Employee Retention Tax Credit is extended for eligible employers that continue to pay employee wages during COVID-19-related closures or experience reduced revenue through December 31, 2021. This includes “recovery startup businesses” (those businesses that launched after February 15, 2020, with average annual gross receipts of $1 million or less).
• Tax credits for paid sick and family leave are modified and extended to September 30, 2021.
• The excess business loss limitation is extended through December 31, 2026.
• The Section 162(m) limits on the tax deduction that public companies can take for executive compensation is extended to cover the CEO, the CFO and the five next highest paid employees, beginning in 2027.

Make the most of the benefits

With vaccination rates climbing, the ARPA may be the last of the major legislative relief packages addressing the effects of the pandemic. We’d be pleased to provide you with more information on how you can make the most of the benefits available to you, your family or your business.

Paycheck Protection Program

The CAA includes another $284 billion in funding for forgivable loans through the Paycheck Protection Program (PPP), for both first-time and so called “second draw” borrowers. New loans can be made through March 31, 2021, or until the funding is exhausted. The new law expands the allowable uses for PPP funds, provides a simplified forgiveness process for smaller loans, and clarifies the proper tax treatment of loan proceeds and forgiven amounts.

The second draw loans are intended for smaller and harder hit businesses. Eligible borrowers include businesses, certain nonprofits, self-employed individuals, sole proprietors and independent contractors.

To qualify for a second draw, a borrower must have no more than 300 employees and have used (or will use) all of the proceeds of its first PPP loan. Borrowers generally also must demonstrate at least a 25% reduction in gross receipts in one quarter of 2020 compared with the same quarter in 2019. For loans of $150,000 or less, a borrower can submit a certification attesting that it meets the revenue loss requirements on or before the date it submits its loan forgiveness application.

Loans are limited to 2.5 times average monthly payroll costs in the year prior to the loan or the calendar year, up to $2 million. Accommodation and food service businesses may receive loans for up to 3.5 times their average monthly payroll. Businesses can obtain only a single second draw loan, and businesses with multiple locations that are eligible under the initial PPP requirements can have no more than 300 employees per physical location.

The CARES Act, which created the PPP, limited the funds to payroll, mortgage, rent and utility payments. The CAA allows businesses to also apply the funds to:

• Covered operating expenses, including software or cloud computing services that facilitate business operations, product and service delivery, payroll processing, human resources, sales and billing, accounting or tracking supplies, inventory, records, and expenses,
• Uninsured costs related to property damage, vandalism or looting during 2020 public disturbances,
• Supplier costs according to a contract, purchase order or order for goods, in effect before taking out the loan, that are essential to the borrower’s operations, and
• Worker protection expenses incurred to comply with federal or state health and safety guidelines related to COVID-19 (for example, personal protective equipment, ventilation systems and drive-through windows).

As with the first round of PPP loans, full forgiveness requires a 60/40 cost allocation between payroll and nonpayroll costs. In other words, you must spend at least 60% of the funds on payroll over your covered period, which may range from eight to 24 weeks.

The CAA creates a simplified forgiveness application for loans up to $150,000. Such loans will be forgiven if the borrower signs and submits to the lender a one-page certification form from the Small Business Administration (SBA). The certification requires a description of the number of employees retained due to the loan, the estimated total amount of funds spent on payroll and the total loan amount. Borrowers must retain relevant records regarding employment for four years and other records for three years.

The CAA also eliminates the previous requirement that borrowers deduct the amount of any SBA Economic Injury Disaster Loan (EIDL) advances from their PPP forgiveness amount.

Additionally, the CAA addresses some of the confusion that had arisen regarding PPP tax issues. It specifies that a borrower need not include any forgiven amounts in its gross income. And — contrary to the position taken earlier by the IRS — it states that borrowers can deduct otherwise deductible expenses paid with forgiven PPP proceeds. The CAA also provides that tax basis and other attributes aren’t reduced by loan forgiveness (special rules apply to partnerships and S corporations). These tax provisions apply to second draw loans, too.

Other financial assistance

The CAA provides $20 billion for new EIDL grants for businesses in low-income communities and $15 billion for live venues, independent movie theaters and cultural institutions.

On the tax front, it states that a borrower’s gross income doesn’t include forgiveness of certain loans, emergency EIDL grants and certain loan repayment assistance provided by the CARES Act. As with PPP loans, you can deduct your otherwise deductible expenses paid with such forgiven amounts, and forgiveness won’t reduce your tax basis and other attributes (special rules apply to partnerships and S corporations). Similar treatment applies to targeted EIDL advances and Grants for Shuttered Venues.

Employee Retention Credit

To encourage businesses to maintain their workforces, the CARES Act created the Employee Retention Credit, a refundable credit against payroll tax for employers whose:

• Operations were fully or partially suspended due to a COVID-19-related governmental shutdown order, or
• Gross receipts dropped more than 50% compared to the same quarter in the previous year (until gross receipts exceed 80% of gross receipts in the earlier quarter).

Employers with more than 100 employees could receive the credit if they closed due to COVID-19. Those with 100 or fewer employees received the credit regardless of whether they were open for business.

The credit equaled 50% of up to $10,000 in compensation — including health care benefits — paid to an eligible employee from March 13, 2020, through December 31, 2020. The CAA extends the credit for eligible employers that continue to pay wages during COVID-19 closures or reduced revenue through June 30, 2021.

Notably, as of January 1, 2021, the CAA hikes the credit from 50% of qualified wages to 70%. It also expands eligibility by reducing the requisite year-over-year gross receipt reduction from 50% to only 20% and raises the limit on per-employee creditable wages from $10,000 for the year to $10,000 per quarter.

In addition, the threshold for a business to be deemed a “large employer” — and thus subject to a tighter standard when determining the qualified wage base — is lifted from 100 to 500 employees.

The CAA includes some retroactive clarifications and technical improvements regarding the original credit, as well. For example, it provides that employers that receive PPP loans still qualify for the credit for wages not paid with forgiven PPP funds.

Deferred payroll taxes

Businesses were given the option to withhold their employees’ share of Social Security taxes from September 1, 2020, through December 31, 2020. Those that did were originally directed to increase the withholding and pay the deferred amounts on a prorated basis from wages and compensation paid between January 1, 2021, and April 30, 2021.

Under the CAA, such employers now have all of 2021 to withhold and pay the deferred taxes.

Non-COVID-19 disaster relief

The CAA also acknowledges the recent disasters not related to the pandemic (for example, wildfires). Among other things, it provides a tax credit of up to $2,400 (40% of up to $6,000 of wages) per employee, to employers in qualified disaster zones.

The credit applies to wages paid, regardless of whether services were actually performed in exchange for those wages. The CAA also modifies the CARES Act to allow corporations to make qualified disaster relief contributions of up to 100% of their 2020 taxable income.

Business meals deduction

For 2021 and 2022, you can deduct 100% (up from 50%) for food and beverages as long as they’re “provided by a restaurant.” The IRS will likely issue guidance on the deduction, particularly the meaning of the term “provided by a restaurant.”

Retirement plans

The tax code allows “qualified future transfers” of up to 10 years of retiree health and life costs from a company’s pension plan to a retiree’s health benefits or life insurance account within the plan. These transfers must meet certain requirements (for example, the plan must be 120% funded) that pandemic-related market volatility has made too difficult to meet in some cases.

In response, the CAA allows employers to make a one-time election on or before December 31, 2021, to end any existing transfer period for any taxable year beginning after the election in certain circumstances.

The law also includes a partial termination safe harbor for retirement plans in light of 2020’s pandemic-related workforce fluctuations. Plans won’t be treated as having a partial termination (which would trigger 100% vesting for affected participants) if the number of active participants on March 31, 2021, is at least 80% of the number covered by the plan on March 13, 2020. The safe harbor applies to plan years that include the period beginning on March 13, 2020, and ending on March 31, 2021.

Charitable deductions

The CAA extends, through 2021, the CARES Act provision that increases the limitation on corporations’ cash charitable contributions from 10% of taxable income to 25%. Any excess corporate cash contributions will be carried forward to subsequent tax years. The limitation on deductions for donations of food inventory, which the CARES Act increased to 25% for 2020, is similarly extended through 2021.

Tax extenders

The CAA incorporates several “extenders” of tax breaks. For example, it extends both the New Markets Tax Credit and the Work Opportunity Tax Credit through 2025. The employer credit for paid family and medical leave is extended through 2025 for wages paid in tax years after 2020.

The law extends through 2025 the period for which an empowerment zone designation is in effect. But the enhanced expensing rules and nonrecognition of gain on rollover of empowerment zone investments are terminated for property placed in service in tax years beginning after December 31, 2020. Empowerment zone tax-exempt bonds and employment credits also weren’t extended beyond December 31, 2020.

A loaded law

At almost 5,600 pages, the CAA contains many more components that could impact your business and personal taxes. Please contact us if you have any questions about these or other provisions.

Recovery rebates

The most headline-grabbing component of the CAA is the second round of direct payments. The law calls for nontaxable “recovery rebates” of $600 per eligible taxpayer ($1,200 for married couples filing jointly) plus an additional $600 per qualifying child.

The payments begin phasing out at $75,000 of modified adjusted gross income (MAGI) for single filers, $112,500 for heads of household and $150,000 for married couples filing jointly. Payments are reduced by $5 for every $100 of income above these thresholds, and phaseouts reduce the total payment amount, including the amounts for qualifying children.

The CAA expands eligibility for the payments to so-called mixed-status households, meaning those where not every family member has a Social Security Number (SSN). This change is retroactive to the CARES Act. Eligible families who didn’t receive a payment in the first round because one spouse lacked an SSN can claim a credit for that payment on their 2020 federal tax returns.

Because the rebates are based on your 2019 tax returns, you could receive a payment that’s less than you’re entitled to under the law. If your income was lower in 2020 or your family grew, you may be able to claim an additional credit for the difference on your 2020 tax return. But, if you receive a payment and it turns out your actual 2020 income is high enough that your payment should have been phased out, you won’t have to repay the difference.

Unemployment benefits

The CAA provides an extra $300 per week in unemployment benefits, over and above state unemployment benefits, for 11 weeks. It also extends for 11 weeks the Pandemic Unemployment Assistance program, which makes unemployment benefits available to workers who typically don’t qualify, including the self-employed, gig economy workers and others in nontraditional employment.

Housing relief

The new law includes multiple types of relief for those struggling with their housing costs. For example, the federal eviction moratorium is extended through January 31, 2021. The CAA also offers rental assistance for families affected by COVID-19. Eligible households can apply the funds to rent, utilities and energy costs — including amounts in arrears. And mortgage insurance premiums remain deductible through 2021 (subject to phaseout limits).

Retirement relief

The CARES Act provides several forms of temporary relief related to retirement plan requirements. For example, it permits penalty-free withdrawals from certain retirement plans for expenses related to COVID-19 and lifts the limit on retirement plan loans. The CAA clarifies that money purchase pension plans are included among the retirement plans subject to the temporary relief measures under the CARES Act.

Unfortunately, the pandemic wasn’t the only disaster to befall taxpayers this year, and the CAA recognizes that. It includes tax relief for taxpayers in federally declared disaster areas for major disasters (not related to COVID-19) declared from January 1, 2020, through February 25, 2021.

The relief under the CAA mirrors some of the relief afforded under the CARES Act. For example, it provides that residents of qualified disaster areas can take distributions of up to $100,000 from retirement plans without the normal 10% early withdrawal penalty. A “qualified disaster distribution” must be made no later than June 25, 2021. The CAA also contains special rules for the recontribution of retirement plan distributions applied to a home purchase in a qualified disaster area and raises the limit for retirement plan loans made following a qualified disaster.

Be aware that the CAA doesn’t extend the CARES Act’s temporary waiver of required minimum distributions. Affected taxpayers should plan on resuming those distributions for 2021.

Earned income and child tax credits

The CAA includes a temporary change that could result in larger earned income tax credits (EITCs) and child tax credits (CTCs). It allows lower-income individuals to use their earned income from the 2019 tax year to determine their EITC and the refundable portion of their CTC for the 2020 tax year. This could produce larger credits for eligible taxpayers who earned lower wages in 2020 due to the pandemic.

Medical expense deductions

For tax years beginning before January 1, 2021, you could claim an itemized deduction for unreimbursed medical expenses that exceeded 7.5% of your adjusted gross income (AGI). The threshold was scheduled to jump to 10% of AGI for 2021, which would make it more difficult to qualify for a medical expense deduction. The CAA permanently sets the threshold at 7.5% of AGI for tax years beginning after December 31, 2020.

Charitable contributions

Under the CARES Act, taxpayers who don’t itemize their deductions on their tax returns can nonetheless claim a $300 “above-the-line” deduction for cash contributions to qualified charitable organizations in 2020. The CAA extends that deduction through 2021 and doubles the deduction for married filers to $600. Contributions to donor-advised funds and supporting organizations don’t qualify for the deduction.

The CARES Act also loosened the limitations on charitable deductions for cash contributions made in 2020, boosting it from 50% to 100% of AGI. The CAA carries that over for 2021. Cash contributions remain limited to the excess of AGI over the amount of all other charitable contributions. Any excess cash contributions are carried forward to later years.

Student loans

Under the CARES Act, employers can provide up to $5,250 annually toward employee student loan payments on a tax-free basis before January 1, 2021. The payment can be made to the employee or the lender. The CAA extends the exclusion through 2025. The longer term may make employers more willing to offer this benefit.

The CARES Act also temporarily halted collections on defaulted loans, suspended loan payments and reduced the interest rate to zero through September 30, 2020. Subsequent executive branch actions extended this relief through January 31, 2021. The CAA leaves in place that expiration date.

Education tax credits

Qualified taxpayers generally can claim an education tax break with the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC). Previously, though, the two credits were subject to different phaseout rules, with the AOTC available at a greater MAGI than the LLC. In addition, before the new law, taxpayers could claim a “higher education expense deduction” for qualified tuition and related expenses.

The CAA adopts a single phaseout for both the AOTC and the LLC, effective for tax years beginning after December 31, 2020. The credits will phase out beginning at $80,000 for single filers and ending at $90,000. For joint filers, they will begin to phase at $160,000 and disappear at $180,000.

The new law also repeals the higher education expense deduction. Instead, taxpayers can apply the LLC credit.

Discharged mortgage debt

The tax code provision allowing taxpayers to exclude the discharge of qualified debt on their principal residence up to $2 million (or $1 million for married individuals filing separately) from their gross income was scheduled to expire at the end of 2020. The CAA extends the exclusion to such debt discharged through 2025. But it also reduces the maximum acquisition debt limits to $750,000 for individuals — and $375,000 for married individuals filing separately — for debt discharged after 2020.

Flexible Spending Accounts

The CAA loosens certain rules related to health and dependent care Flexible Spending Accounts (FSAs) that could lead to taxpayers forfeiting unspent funds. It allows unused amounts from 2020 FSAs to roll over to 2021and unused amounts from 2021 FSAs to roll over to 2022. Grace periods for plan years ending in 2021 or 2022 may be extended to 12 months after the end of the plan year. For 2021, employees can make mid-year prospective changes in their FSA contribution amounts without a change in status.

These changes are voluntary for employers. If you have an FSA, check with your employer to see if it’s adopting the available relief.

There’s more

The CAA is one of the longest pieces of legislation in congressional history, and the provisions outlined above are only a sampling of those that could affect you. Contact us to make sure you make the most of the changes.

Liberalized rules for NOL carryforwards

The CARES Act includes favorable changes to the rules for deducting net operating losses (NOLs). First, it eases the taxable income limitation on deducting NOLs.

Under an unfavorable provision included in the 2017 Tax Cuts and Jobs Act (TCJA), an NOL arising in a tax year beginning in 2018 or beyond and carried forward to a later tax year couldn’t offset more than 80% of the taxable income for the carryforward year (the later tax year), calculated before the NOL deduction.

For tax years beginning before 2021, the CARES Act removes the TCJA taxable income limitation on deductions for prior-year NOLs carried forward into those years. So NOL carryforwards to tax years beginning before 2021 can be used to fully offset taxable income for those years.

For tax years beginning after 2020, the CARES Act allows NOL deductions equal to the sum of:

• 100% of NOL carryforwards from pre-2018 tax years, plus
• The lesser of 1) 100% of NOL carryforwards from post-2017 tax years, or 2) 80% of remaining taxable income (if any) after deducting NOL carryforwards from pre-2018 tax years.

As you can see, this is a complicated rule. But it’s more taxpayer-friendly than what the TCJA allowed. This favorable change is permanent.

Carrybacks allowed for certain NOLs

Under another unfavorable TCJA provision, NOLs arising in tax years ending after 2017 generally couldn’t be carried back to earlier tax years and used to offset taxable income in those earlier years. Instead, NOLs arising in tax years ending after 2017 could only be carried forward to later years. But they could be carried forward for an unlimited number of years.

Under the CARES Act, NOLs that arise in tax years beginning in 2018 through 2020 can be carried back for five years. For example, a taxpayer could carry back an NOL arising in 2020 to 2015 and recover federal income tax paid for that year. That could be very beneficial, because the federal income tax rates for both individuals and corporations were higher before the TCJA rate cuts took effect in 2018.

When advantageous, taxpayers can elect to waive the carryback privilege for an NOL and, instead, carry the NOL forward to future tax years. In addition, barring a further tax-law change, the no-carryback rule will come back into play for NOLs that arise in tax years beginning after 2020.

Excess business loss rules postponed

Another unfavorable TCJA provision disallowed current deductions for so-called “excess business losses” incurred by individuals and other noncorporate taxpayers in tax years beginning in 2018 through 2025.

An excess business loss is one that exceeds $250,000 ($500,000 for a married joint-filing couple). These limits are adjusted annually for inflation.

The CARES Act removes the excess business loss disallowance rule for losses arising in tax years beginning in 2018 through 2020.

Barring a further tax-law change, the excess business loss disallowance rule will come back into play for losses that arise in tax years beginning in 2021 through 2025. Any disallowed excess business loss for one of those years will be carried forward to the following year and can be deducted under the rules for NOL carryforwards.

Amended return opportunities

These taxpayer-friendly CARES Act changes can affect prior tax years for which you’ve already filed returns. Amended returns may be needed to benefit from the changes. Contact your tax professional for more information.

Note: This post comes directly from Edelstein’s 2020-2021 Tax Guide, which can be found here.

To provide tax relief to businesses suffering during the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security (CARES) Act temporarily relaxes the limitation on deductions for business interest expense. Here’s the story.

TCJA created new limitation

Before the Tax Cuts and Jobs Act (TCJA), some corporations were subject to the so-called “earnings stripping” rules. Those rules attempted to limit deductions by U.S. corporations for interest paid to related foreign entities that weren’t subject to U.S. income tax. Other taxpayers could generally fully deduct business interest expense (subject to other tax-law restrictions, such as the passive loss rules and the at-risk rules).

The TCJA shifted the business interest deduction playing field. For tax years beginning in 2018 and beyond, it limited a taxpayer’s deduction for business interest expense for the year to the sum of:

• Business interest income,
• 30% of adjusted taxable income (ATI), and
• Floor plan financing interest expense paid by certain vehicle dealers.

Business interest expense is defined as interest on debt that’s properly allocable to a trade or business. However, the term trade or business doesn’t include the following excepted activities:

• Performing services as an employee,
• Electing real property businesses,
• Electing farming businesses, and
• Selling electrical energy, water, sewage disposal services, gas or steam through a local distribution system, or transportation of gas or steam by pipeline, if the rates are established by a specified governing body.

Interest expense that’s disallowed under the limitation rules is carried forward to future tax years indefinitely and treated as business interest expense incurred in the carry-forward year.

Small business exception

Many businesses are exempt from the interest expense limitation rules under what we’ll call the small business exception. Under this exception, a taxpayer (other than a tax shelter) is exempt from the limitation if the taxpayer’s average annual gross receipts are $25 million or less for the three-tax-year period ending with the preceding tax year. Businesses that have fluctuating annual gross receipts may qualify for the small business exception for some years but not for others — depending on the average annual receipts amount for the preceding three-tax-year period.

For example, if your business has three good years, it may be subject to the interest expense limitation rules for the following year. But if your business has a bad year, it may qualify for the small business exception for the following year. If average annual receipts are typically over the $25 million threshold, but not by much, judicious planning may allow you to qualify for the small business exception for at least some years.

Special rules for partnerships and S corporations

The interest expense deduction limitation rules get more complicated for businesses operating as partnerships, limited liability companies (LLCs) treated as partnerships for tax purposes and S corporations.

Basically, the limitation is calculated at both the entity level and at the owner level. Special rules prevent double counting of income when calculating an owner’s ATI for purposes of applying the limitation rules at the owner level.

IRS proposed regs set forth the special rules for applying the business interest expense limitation to partnerships and S corporations and their owners. The rules are complex and present significant compliance challenges.

Favorable CARES Act changes

The CARES Act generally allows businesses, unless they elect otherwise, to increase the interest expense deduction limitation to 50% of ATI for tax years beginning in 2019 or 2020. Businesses can also elect to use 2019 ATI to calculate the 2020 ATI limitation, which can allow for a larger deduction if 2020 ATI is less, which may be the case for many businesses.

For partnerships (including LLCs treated as partnerships for tax purposes), the 30% of ATI limitation remains in place for tax years beginning in 2019 but is 50% for 2020. Disallowed partnership business interest expense from a partnership’s 2019 tax year is allocated to partners and carried over to their 2020 tax years.

Unless a partner elects otherwise, 50% of carried-over partnership business interest expense from 2019 is deductible in the partner’s 2020 tax year without regard to the business interest expense limitation rules. The remaining 50% is subject to the normal limitation rules, calculated at the partner level, for carried-over partnership business interest expense. Like other businesses, partnerships can elect to use 2019 ATI to calculate the 2020 ATI limitation.

Help is available

As you can see, the business interest expense limitation rules are complicated. The temporarily relaxed limitations can allow affected businesses to reduce their federal tax liabilities for 2019 and 2020. However, for partnerships and partners, limitation rules are relaxed only for 2020. Your tax advisor can help your business take advantage of the relaxed rules for business interest expense deductions and benefit from other tax relief measures made available by the CARES Act.

Note: This post comes directly from Edelstein’s 2020-2021 Tax Guide, which can be found here.

Quick refunds

Businesses facing cash flow crunches can take advantage of a provision in the CARES Act that accelerates the timeline for recovering unused alternative minimum tax (AMT) credits. The Tax Cuts and Jobs Act (TCJA) eliminated the corporate AMT but allowed businesses with unused credits to claim them incrementally in taxable years beginning in 2018 and through 2020.

Under the TCJA, for tax years beginning in 2018, 2019 and 2020, if AMT credit carryovers exceed regular tax liability, 50% of the excess is refundable, with any remaining credits fully refundable in 2021. But the CARES Act lets businesses claim all remaining credits in 2018 or 2019, opening the door to immediate 100% refunds for excess credits. Instead of amending a 2018 tax return to claim the credits, a business owner can file Form 1139, “Corporate Application for Tentative Refund,” by December 31, 2020.

The CARES Act also temporarily loosened the rules for net operating losses (NOLs). The TCJA limits the NOL deduction to 80% of taxable income and NOLs can’t be carried back. Now, NOLs arising in 2018, 2019 or 2020 can be carried back five years to claim refunds in previous tax years. No taxable income limitation applies for years beginning before 2021, meaning NOLs can completely offset income in those years.

Businesses can obtain even larger refunds by accelerating deductions into years when higher pre-TCJA tax rates were in effect (for example, a 35% corporate tax rate vs. 21% under the TCJA). Bear in mind, though, that carrying back NOLs can trigger a recalculation of other tax attributes and deductions, such as AMT credits and the research credit, often referred to as the “research and development,” “R&D,” or “research and experimentation” credit.

Capital assets purchases

Capital investments have long been a useful way to reduce income taxes, and the TCJA further juiced this technique by expanding bonus depreciation. And the CARES Act finally remedies a drafting error in the TCJA that left qualified improvement property (QIP), generally interior improvements to nonresidential real property, ineligible for bonus deprecation.

For qualified property purchased after September 27, 2017, and before January 1, 2023, businesses can deduct 100% of the cost of new and used (subject to certain conditions) qualified property in the first year the property is placed into service. Special rules apply to property with a longer production period.

Qualified property includes computer systems, purchased software, vehicles, machinery, equipment and office furniture. Beginning in 2023, the amount of the bonus depreciation deduction will fall 20% each year. Absent congressional action, the deduction will be eliminated in 2027.

Congress clearly intended for QIP that was placed in service after 2017 to qualify for 100% first-year bonus depreciation, but a drafting error prevented that favorable treatment. The CARES Act includes a technical correction to fix the problem. As a result, businesses that made qualified improvements in 2018 or 2019 can claim an immediate tax refund for the missed bonus depreciation.

Under the TCJA, Sec. 179 expensing (that is, deducting the entire cost) is available for several improvements to nonresidential real property, including roofs, HVAC, fire protection systems, alarm systems and security systems. The law also increases the maximum deduction for qualifying property. The 2020 limit is $1.04 million (the maximum deduction is limited to the amount of income from business activity). The expensing deduction begins phasing out on a dollar-for-dollar basis when qualifying property placed in service this year exceeds $2.59 million.

Business interest management

The TCJA generally has limited the deduction for business interest expense to 30% of adjusted taxable income (ATI). The CARES Act allows C- and S-corporations to deduct up to 50% of their ATI for the 2019 and 2020 tax years (special partnership rules apply for 2019).

It also permits businesses to elect to use their 2019 ATI, rather than 2020 ATI, for the calculation, which should increase the amount of the deduction for many businesses. Businesses should consider using accounting method changes to shift their business interest deductions from 2019 to 2020 to boost their 2019 ATI.

Income and expense timing

Businesses that haven’t expected to be in a higher tax bracket the following tax year have long deferred income and accelerated expenses to minimize taxable income. If the Democrats win the White House and the Senate, and retain the House of Representatives, tax rates could increase as soon as 2021. In that case, it could be advantageous to accelerate income into 2020, when it would be taxed at the lower current rates.

Even if tax rates don’t climb next year, companies of all kinds have seen downturns in business this year due to the far-reaching effects of the COVID-19 pandemic. Those that expect to be more profitable in 2021 may want to push their expense deductions past year-end to help offset profits.

Payroll tax deductions

A similar analysis applies to payroll tax deductions. The CARES Act allows businesses and self-employed individuals to delay their payments of the employer share (6.2% of wages) of the Social Security payroll tax. Such taxpayers can pay the tax over the next two years, with the first half due by December 31, 2021, and the second half due by December 31, 2022.

Sticking with those dates, however, will affect 2020 taxes. Businesses generally can’t deduct their share of payroll taxes until they actually make the payments. Certain businesses might find it more worthwhile to pay those taxes in 2020. This could, for example, increase the amount of NOLs they can carry back to higher tax-rate years.

Avoid missteps

Many of these taxing planning opportunities come with filing requirements, whether for amended tax returns, applications for changes in accounting method (IRS Form 3115) or applications for tentative refunds. In addition, some of these strategies could have a negative impact on taxpayers who claim the qualified business income deduction. Contact us and we can help determine your best course forward and ensure you don’t miss any critical deadlines.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act contains a variety of relief, notably the “economic impact payments” that will be made to people under a certain income threshold. But the law also makes some changes to retirement plan rules and provides a new tax break for some people who contribute to charity.

Waiver of 10% early distribution penalty

IRAs and employer sponsored retirement plans are established to be long-term retirement planning accounts. As such, the IRS imposes a penalty tax of an additional 10% if funds are distributed before reaching age 59½. (However, there are some exceptions to this rule.)

Under the CARES Act, the additional 10% tax on early distributions from IRAs and defined contribution plans (such as 401(k) plans) is waived for distributions made between January 1 and December 31, 2020 by a person who (or whose family) is infected with COVID-19 or is economically harmed by it. Penalty-free distributions are limited to $100,000, and may, subject to guidelines, be re-contributed to the plan or IRA. Income arising from the distributions is spread out over three years unless the employee elects to turn down the spread-out.

Employers may amend defined contribution plans to provide for these distributions. Additionally, defined contribution plans are permitted additional flexibility in the amount and repayment terms of loans to employees who are qualified individuals.

Waiver of required distribution rules

Depending on when you were born, you generally must begin taking annual required minimum distributions (RMDs) from tax-favored retirement accounts — including traditional IRAs, SEP accounts and 401(k)s — when you reach age 70½ or 72. These distributions also are subject to federal and state income taxes. (However, you don’t need to take RMDs from Roth IRAs.)

Under the CARES Act, RMDs that otherwise would have to be made in 2020 from defined contribution plans and IRAs are waived. This includes distributions that would have been required by April 1, 2020, due to the account owner’s having turned age 70½ in 2019.

New charitable deduction tax breaks

The CARES Act makes significant liberalizations to the rules governing charitable deductions including:

• Individuals can claim a $300 “above-the-line” deduction for cash contributions made, generally, to public charities in 2020. This rule means that taxpayers claiming the standard deduction and not itemizing deductions can claim a limited charitable deduction.
• The limit on charitable deductions for individuals that is generally 60% of modified adjusted gross income (the contribution base) doesn’t apply to cash contributions made, generally, to public charities in 2020. Instead, an individual’s eligible contributions, reduced by other contributions, can be as much as 100% of the contribution base. No connection between the contributions and COVID-19 is required.

Far beyond

The CARES Act goes far beyond what is described here. The new law contains many different types of tax and financial relief meant to help individuals and businesses cope with the fallout.

Employee retention tax credit

To encourage employers to keep their workforces intact, the CARES Act creates a new refundable credit against payroll tax. The credit is generally available to employers whose:

• Operations have been fully or partially suspended due to a COVID-19-related governmental shutdown order, or
• Gross receipts have dropped more than 50% compared to the same quarter in the previous year (until gross receipts exceed 80% of gross receipts in the earlier quarter).

Employers with more than 100 employees can receive the credit for employees who’ve been furloughed or who’ve had their hours reduced due to one of the reasons above. Those with 100 or fewer employees can receive the credit regardless of whether employees have been furloughed.

The credit equals 50% of up to $10,000 in compensation — including health care benefits — paid to an eligible employee from March 13, 2020, through December 31, 2020. Additional rules and limits apply.

Payroll tax deferral

The new law allows employers to delay their payment of the employer share (6.2% of wages) of the Social Security payroll tax. These taxpayers can pay the tax over the next two years, with the first half due by December 31, 2021, and the second half due by December 31, 2022.

Self-employed individuals receive similar relief under the law.

Relaxed restrictions on losses

Before the Tax Cuts and Jobs Act (TCJA), taxpayers could carry back net operating losses (NOLs) two years, and carry forward the losses 20 years, to offset taxable income. The TCJA limited the NOL deduction to 80% of taxable income for the year, eliminated the carryback of NOLs and removed the time limit on carryforwards.

The CARES Act loosens the TCJA restrictions. It allows NOLs arising in 2018, 2019 or 2020 to be carried back five years and temporarily removes the taxable income limitation for years beginning before 2021, so that NOLs can fully offset income.

The new law also amends the TCJA to temporarily eliminate the limitation on excess business losses for pass-through entities and sole proprietors. These taxpayers can now deduct excess business losses arising in 2018, 2019 and 2020.

Taxpayers may need to file amended tax returns to obtain the full benefits of these changes.

Modified limitation on business interest deductions

For tax years beginning after 2017, the TCJA amended the Internal Revenue Code to limit the deduction for business interest incurred by both corporate and noncorporate taxpayers. It generally limits the deduction to 30% of the taxpayer’s adjusted taxable income (ATI) for the year.

The CARES Act allows businesses to deduct up to 50% of their ATI for the 2019 and 2020 tax years. (Special partnership rules apply for 2019.) It also permits businesses to elect to use 2019 ATI, rather than ATI in 2020, for the calculation, which will increase the amount of the deduction for many businesses.

Expedited depreciation of qualified improvement property

Prior to the TCJA, qualified retail improvement property, restaurant property and leasehold improvement property were depreciated over 15 years under the modified accelerated cost recovery system (MACRS). The TCJA classifies all of these property types as qualified improvement property (QIP).

The legislative history of the TCJA is clear that Congress intended QIP placed in service after 2017 to have a 15-year MACRS recovery period and, in turn, qualify for 100% bonus depreciation through 2023, when the allowable deduction will begin to phase out. But, in what’s been called “the retail glitch,” the statutory language didn’t define QIP as 15-year property, so QIP defaulted to a 39-year recovery period, making it ineligible for bonus depreciation.

The CARES Act includes a technical correction to fix this drafting error. Hotels, restaurants and retailers that have made qualified improvements during the past two years can claim an immediate tax refund for the bonus depreciation they missed. They also can claim bonus depreciation going forward, according to the phaseout schedule.

Expanded SBA assistance for small businesses

The CARES Act expands the ways the Small Business Administration (SBA) can help small businesses remain open and meet payroll. For example, it temporarily doubles the maximum loan amount under its primary low-interest loan program from $5 million to $10 million (or 2.5 times the average total monthly payroll costs for the prior year, whichever is less).

The law expands the allowable use of the so-called “Section 7(a)” funds to include payroll support, including paid leave, mortgage payments, insurance premiums and debt obligations, and waives many of the usual requirements, such as collateral and personal guarantees. Moreover, if employers maintain their payrolls for eight weeks after the loan origination, the portion of the loan applied to payroll, mortgage interest, rent and utilities will be forgiven.

To qualify, businesses generally must have 500 or fewer employees and have been operational on February 15, 2020. Sole proprietors, independent contractors and other self-employed individuals may qualify.

Amendments to the new paid leave law

The CARES Act also makes some critical modifications to the Families First Coronavirus Response Act, which was signed into law on March 18. That law temporarily requires certain employers to provide expanded paid sick and family leave for certain employees affected by COVID-19.

The CARES Act provides a new rule that defines “eligible employee” for purposes of paid sick and family leave to include employees who:

• Were laid off by the employer March 1, 2020, or later,
• Had worked for the employer for at least 30 days in the 60 calendar days prior to the layoff, and
• Have been rehired by the employer.

And the CARES Act allows advances on anticipated tax credits for employers’ paid leave costs and provides penalty relief for employers that don’t deposit tax amounts because they expect credits.

More to come?

Several members of Congress have suggested that the CARES Act won’t be the end of the federal legislative relief in response to the COVID-19 pandemic. We’ll keep you informed of new developments that could affect your bottom line and help you navigate the best financial course forward during these uncertain times.