After months of debate about providing additional economic relief in response to the coronavirus pandemic, the latest “Coronavirus Stimulus 2.0” bill passed out of Congress on December 21, 2020, as an attachment to the larger 5,000+ page Consolidated Appropriations Act of 2021, which provides Federal funding through September 2021, extends and amends various expiring tax provisions, and addresses several other financial planning-related issues.
The relief legislation includes a fresh round of $600 stimulus checks and extensions to unemployment benefits (including another $300/week of unemployment insurance relief for 11 weeks). In addition, small businesses will also gain access to a greatly expanded Employee Retention Tax Credit (potentially up to $7,000/employee/quarter) if they experienced at least a 20% decline in quarterly revenue and a new forgivable Paycheck Protection Program (PPP2) loan opportunity if revenue was down by at least 25% in any quarter of 2020.
In addition, the Coronavirus Stimulus 2.0 legislation includes a wide range of Personal Income Tax planning relief provisions, from an extension of the 100%-of-AGI limit on cash contributions to a charity into 2021, the opportunity to carry forward unused Flexible Spending Account balances in 2021, a reduction in the hurdle for Medical Expense Deductions to ‘permanently’ return to 7.5%-of-AGI, the ability to deduct meals and entertainment expenses at restaurants for 100% of the expense, the elimination of the Tuition and Related Expenses deduction for education to be replaced with an expanded (and even more generous) Lifetime Learning Credit, and more.
On the other hand, it’s notable that some widely discussed potential changes were not included, from additional relief on Required Minimum Distributions, to further relief on student loan deferrals (though the legislation does authorize a substantive change to FAFSA forms for Financial Aid in the future!).
Fortunately, the Coronavirus Stimulus 2.0 legislation does not introduce a number of ultra-short-term end-of-year planning needs – as some prior end-of-year tax legislation has in the past – but does set the table for significant planning opportunities with clients (especially small business owner clients still suffering from the pandemic) as 2020 comes to a close and into 2021!
After nearly 6 months of back-and-forth negotiations and speculation over “Would they, or wouldn’t they?” Congress passed the much-anticipated latest ‘Stimulus Bill’ in the waning hours of the evening on Monday, December 21, 2020.
The bill was ultimately attached to a much larger piece of legislation, dubbed the Consolidated Appropriations Act of 2021, which provides funds for the Federal government through September 2021, extends and amends a substantial number of expiring tax provisions, and addresses a host of other financial planning-related issues from major changes to the Free Application for Federal Student Aid (FAFSA) to providing relief to taxpayers with unused Flexible Spending Account (FSA) funds.
The ‘bad’ news for financial advisors is that, all told, the legislation clocks in at a whopping 5,593 pages, which is monstrous, even by Washington standards. The ‘good’ news, however, is that few elements in the bill require prompt action before the end of 2020. In fact, if anything, various provisions included in the law reduce the need for actions that would have otherwise needed to occur before year-end.
Nevertheless, the passage of the bill, and the intense media coverage it has received, is sure to generate a barrage of questions from clients, business owners, and even friends and family. Accordingly, advisors should act promptly to develop a working understanding of the key provisions in the bill so that they can answer questions, allay concerns, and help clients and others create personalized action plans.
Additional Recovery Rebate Checks To Offset Economic Impact of COVID-19 On Taxpayers
After the passage of the CARES Act earlier this year, one of the most common questions from taxpayers was, “Will I be receiving a stimulus check?” Invariably, that’s likely to be the case this time around as well. So, answering that question seems like a good place for us to start.
The latest round of stimulus checks largely mirrors the rules and guidelines that were used for the first round of stimulus checks authorized by the CARES Act, with a few notable changes. The most significant change for most people is that the latest round of stimulus checks authorizes a ‘base’ credit of $600 per eligible individual. Eligible individuals include the taxpayer (or, in the case of a joint return, the taxpayers) filing the return as well as any children for whom a Child Tax Credit may be claimed (they must be younger than age 17).
Example #1a: Wayland is a single taxpayer and the parent of a 10-year-old child. Accordingly, his ‘base’ Additional Recovery Rebate is 2 (representing Wayland and the child) x $600 = $1,200.
Example #1b: Seymour and Edna are a married couple who file a joint return and have no children. Accordingly, their ‘basic’ Additional Recovery Rebate is 2 (representing Seymour and Edna) × $600 = $1,200.
Example #1c: Cletus and Brandine are married, file a joint return, and are the parents of nine children who are under the age of 17. Accordingly, their ‘base’ Additional Recovery Rebate is 11 (representing Cletus, Brandine, and their nine children) × $600 = $6,600.
As was the case under the CARES Act for the initial Recovery Rebate Credit, a taxpayer’s ‘base’ Additional Recovery Rebate under the latest stimulus bill begins to be phased out as their income exceeds an applicable threshold. More specifically, for every $100 of Adjusted Gross Income (AGI) a taxpayer exceeds their applicable threshold, $5 of Additional Recovery Rebate will be phased out. Thus, the phaseout range varies from taxpayer to taxpayer, depending upon the size of their ‘base’ Additional Recovery Rebate in the first place (i.e., the more eligible individuals, the larger the dollar amount to be phased out at $5 per $100 of AGI, and the more income it will take to fully phase out the rebate check).
The AGI thresholds (unchanged from the CARES Act) where a taxpayer’s ‘base’ Additional Recovery Rebate begins to be phased out are:
- Single Filer: $75,000
- Joint Filer: $150,000
- Head of Household Filer: $112,500
Example #2a: Wayland (single), from Example #1a, has a ‘base’ Additional Recovery Rebate of $1,200 and has $80,000 of AGI.
Since Wayland’s phaseout threshold is $75,000, he is $80,000 (Wayland’s AGI) – $75,000 (Single Filer phaseout threshold) = $5,000 over his applicable Additional Recovery Rebate threshold.
Accordingly, his ‘base’ Additional Recovery Rebate will be reduced by $5,000 (excess AGI over threshold) ÷ $100 × $5 = $250, since the reduction is $5 for every $100 of AGI exceeding the threshold.
Thus, Wayland’s actual Additional Recovery Rebate is $1,200 (base rebate amount) – $250 (reduction) = $950.
Example #2b: Seymour and Edna (joint filers), from Example #1b, have a ‘base’ Additional Recovery Rebate of $1,200 and have $200,000 of AGI.
Since Seymore and Edna’s phaseout threshold is $150,000, they are $200,000 (their AGI) – $150,000 (Joint Filer phaseout threshold) = $50,000 over their applicable Additional Recovery Rebate threshold.
Accordingly, their ‘base’ Additional Recovery Rebate will be reduced by $50,00 (excess AGI over threshold) ÷ $100 × $5 = $2,500, since the reduction is $5 for every $100 of AGI exceeding the threshold.
Since this exceeds their ‘base’ Additional Recovery Rebate of $1200, they are fully phased-out and will receive no Additional Recovery Rebate.
Example #2c: Cletus and Brandine (joint filers), from Example #1c, have a ‘base’ Additional Recovery Rebate of $6,600 and have $200,000 of AGI.
Since Cletus and Brandine’s phaseout threshold is $150,000, they are $200,000 (their AGI) - $150,000 (Joint Filer phaseout threshold) = $50,000 over their applicable Additional Recovery Rebate threshold.
Accordingly, their ‘base’ Additional Recovery Rebate will be reduced by $50,000 ÷ $100 × $5 = $2,500, since the reduction is $5 for every $100 of AGI exceeding their threshold.
Thus, Cletus and Brandine’s actual Additional Recovery Rebate is $6,600 – $2,500 = $4,100.
Note that while Seymour and Edna from Example #2b and Cletus and Brandine from Example #2c are both married couples filing a joint return and both have $200,000 AGI, only Seymour and Edna are fully phased out of the Additional Recovery Rebate. Cletus and Brandine, on the other hand, who started with a larger ‘base’ Additional Recovery Rebate, still receive a partial Additional Recovery Rebate due to their wider phaseout range because of the larger number of eligible individuals in the family to begin with.
Finally, it’s worth noting that while the Additional Recovery Rebate is a 2020 refundable credit, it will be paid to individuals as soon as possible based on the AGI report on their 2019 tax return.
If a taxpayer’s 2019 AGI was high enough to phase them out from some (or all) of their Additional Recovery Rebate, but their actual 2020 AGI is lower and produces a larger Additional Recovery Rebate, the difference between the two amounts will be added as a credit when the taxpayer files their 2020 tax returns.
By contrast, taxpayers whose 2019 income was low enough to receive a payment now, but whose actual 2020 is high enough that they ‘should’ have been phased out, will not have to repay such amounts. There will be no clawback on their 2020 tax return.
The Return And Enhancement Of The Paycheck Protection Program (PPP)
One of the centerpieces of the latest COVID-19 relief package is the introduction of a potential second loan under the Paycheck Protection Program, referred to as the Paycheck Protection Program Part 2, or “PPP2”, throughout the remainder of this article.
The Act reopens the ‘original’ Paycheck Protection Program (PPP), makes meaningful revisions to the PPP rules (applicable to both the original and PPP2 versions), and provides important clarifications. All of this additional relief comes as welcome news to the many small business owners whose revenues continue to suffer as a result of the COVID-19 pandemic.
For those businesses who have yet to receive a loan under the Paycheck Protection Program, the ability to apply for ‘round one’ financing will be reopened. The qualifications and the rules for that program remain largely the same, save for the additional changes authorized by the Act discussed below.
By contrast, those who have already received a loan under the ‘original’ Paycheck Protection Program, but need additional capital, may be able to receive a second loan under PPP2. PPP2, however, has more stringent qualification requirements than the original PPP.
Expenses Paid With Forgiven Paycheck Protection Program (PPP) Loan Funds Are Deductible
In general, when a taxpayer has debt that is forgiven, the forgiven debt becomes taxable income to the taxpayer. However, when the CARES Act first introduced Paycheck Protection Program loans, and more specifically, the possibility (and likelihood) that much of the loans provided by the program would ultimately be forgiven, it carved out forgiven PPP loans from future taxation by stating:
…any amount which (but for this subsection) would be includible in gross income of the eligible recipient by reason of forgiveness described in subsection (b) shall be excluded from gross income…
Despite the somewhat obvious intent from Congress, the IRS effectively nullified the tax-free nature of forgiven PPP debt by adopting the position that any expenses paid with such tax-free funds could not be claimed as a deductible expense on a borrower’s tax return; in other words, the loan forgiveness was not taxable, but the otherwise deductible expenses paid with the forgiven loan lost their deductibility. This left many small business owners with the potential of an ‘artificially inflated’ tax bill for 2020 (due to the loss of otherwise deductible expenses).
Much to the relief of such business owners, the latest stimulus bill ‘fixes’ this problem. Not only does it reinforce the initial IRS position on the matter, but it statutorily overrides the IRS’s initial take on the deductibility of expenses paid with forgiven PPP proceeds by explicitly authorizing deductions to be taken for such expenditures.
From Section 276 of the Additional Coronavirus Response and Relief Division of the Appropriations Act:
(1) no amount shall be included in the gross income of the eligible recipient by reason of forgiveness of indebtedness described in subsection (b)…
(2) no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of the exclusion from gross income provided by paragraph (1)…
Notably, this updated treatment for the deductibility of expenses paid with PPP loan proceeds will apply both to expenses already paid with original PPP loans that were forgiven, and with any new PPP2 loan proceeds that are forgiven.
Additional Expenses Authorized For Use With Paycheck Protection Program (PPP) Proceeds
Section 304 of the Additional Coronavirus Response and Relief Division of the Appropriations Act adds four new categories of expenses for which Paycheck Protection Program (PPP) proceeds (from both original PPP that haven't been used already, and PPP2 loans) can be used. The four new categories are as follows:
- Covered Operations Expenditures – payments “for any business software or cloud computing service that facilitates business operations, product or service delivery, the processing, payment, or tracking of payroll expenses, human resources, sales and billing functions, or accounting or tracking of supplies, inventory, records and expenses”
- Covered Property Damage Costs – expenses “related to property damage and vandalism or looting due to public disturbances that occurred during 2020 that was not covered by insurance or other compensation”
- Covered Supplier Costs – An expense of a business involving payment to a supplier of essential goods that is made pursuant to a contract, order, or purchase order that was in effect at any time before the Covered Period with respect to the applicable Covered Loan (or at any time during the Covered Period with respect to perishable goods).
- Covered Worker Protection Expenditures – Operating or capital expenditures related to complying “with requirements established or guidance issued by the Department of Health and Human Services, the Centers for Disease Control, or the Occupational Safety and Health Administration, or any equivalent requirements established or guidance issued by a State or local government, during the period beginning on March 1, 2020 and ending the date on which the national emergency declared by the President under the National Emergencies Act (50 U.S.C. 1601 et seq.) with respect to the Coronavirus Disease 2019 (COVID–19) expires related to the maintenance of standards for sanitation, social distancing, or any other worker or customer safety requirement related to COVID-19”
And of course, PPP funds spent on any of the above expenses will be eligible for forgiveness, subject to the still-applicable limitations on non-payroll expenses (no more than 40% of the forgiven amount of a PPP loan can be attributable to non-payroll expenses).
Flexibility In The Selection Of The Paycheck Protection Program (PPP) ‘Covered Period’ For All Borrowers
The Covered Period of a PPP loan is the period of time during which expenses that are “incurred” or for which there are “payments made” can be used in the calculation of determining how much of the PPP loan is forgivable.
Initially, the CARES Act set the Covered Period at eight weeks. Then, in June, the Paycheck Protection Program Flexibility Act of 2020 set the Covered Period to 24 weeks for loans funded on or after June 5, 2020, but allowed early (pre-June 5, 2020) borrowers to choose between either an 8-week or a 24-week Covered Period.
Thanks to this latest bit of legislation, borrowers who had their PPP loan funded on or after June 5, 2020, will also be able to choose between an 8-week or a 24-week Covered Period. That includes any businesses that receive a loan now under the newly reopened ‘original’ Paycheck Protection Program.
More simply put, all PPP borrowers will have the option of choosing either an 8-week or a 24-week Covered Period.
Other Notable Paycheck Protection Program Changes
In addition to the revisions to the Paycheck Protection Program rules outlined above, the Appropriations Act also makes several other changes that may benefit business owners, including the following:
- Simplified Forgiveness Application for Loans Up To $150,000 – PPP borrowers of up to $150,000 who are seeking forgiveness for all or a portion of their loan will find it a much easier process going forward. Specifically, the Act requires the Small Business Administration to create a new forgiveness certification that is no longer than one page! And notably, while borrowers are still obligated to follow all applicable PPP rules, they will not be required to submit any proof of doing so when they submit their forgiveness certification. In fact, the Act actually bars lenders from requesting substantiating documents!
- Additional Insurance Benefits Count As Payroll – Expenses related to group life insurance, group disability, vision, and/or group dental insurance all count towards “Payroll Expenses.” As a reminder, at least 60% (and up to 100%) of the forgivable amount of a PPP loan must be attributable to Payroll Expenses.
- Borrowers Who Returned Funds Can Reapply – Some borrowers who took PPP loans gave back some or all of their loans due to uncertainty regarding qualification, calculation, etc. Such borrowers are now allowed to reapply for the maximum allowable loan amount. In addition, lenders can recalculate loan amounts due to changes in regulations that have occurred since a borrower’s loan was initially funded.
Requirements For Paycheck Protection Program Second Draw (PPP2) Loans
Section 311 of the Additional Coronavirus Response and Relief division of the Appropriations Act introduces PPP2, referred to in the bill as “Second Draw Loans.” These “Second Draw Loans” under PPP2 are for borrowers who have already received and spent through loans received under the original PPP.
To repeat… In order to obtain a PPP2 loan, a business must have already received and spent its first PPP loan. (But again, businesses that did not take and use the original PPP loan will have the application period re-opened to be able to do so now.)
Operationally, PPP2 loans largely mirror original PPP loans. The criteria to be eligible to receive such a loan, however, are substantially different.
More specifically, the Appropriations Act limits PPP2 to businesses that have no more than 300 employees (down from 500 employees for the original PPP), with the exception of those businesses classified as providing “Accommodation and Food Services,” which retain their existing exception.
In addition, the business must have experienced a drop in revenue of more than 25% in any quarter in 2020, as compared to the same quarter in 2019, in order to be eligible for a PPP2 loan. Special rules apply to businesses that were in operation by February 15, 2020, but did not exist for all, or some portion, of 2019.
While the drop-in-revenue requirement will certainly pare down the number of eligible businesses somewhat, the 25% threshold is much more inclusive than many lawmakers have pushed for. Furthermore, even many businesses that are doing well overall for 2020 had at least one quarter where revenues suffered enough that they would qualify.
Another difference between the original PPP and new PPP2 loans is the cap on the maximum allowable loan amount. More specifically, while businesses under both programs are generally eligible to receive a loan equal to 2.5 times their average monthly payroll costs (with a small exception for businesses engaged in Accommodation and Food Services, discussed momentarily), PPP2 limits that amount to a maximum of $2 million (compared to $10 million under the original PPP).
Businesses engaged in Accommodation and Food Services (which have a NAICS code that begins with “72”) are eligible to receive PPP2 loans of up to 3.5 times their average monthly payroll costs, subject to the same $2 million maximum as other businesses.
Expansion And Extension Of The Employee Retention Credit
Initially, the CARES Act authorized eligible businesses to receive the Employee Retention Credit in 2020 only. The Appropriations Act, however, extends potential eligibility for affected employers through the first half of 2021.
The changes to the Employee Retention Credit made by the Appropriations Act can effectively be split into two categories: changes that are effective, retroactively, for 2020, and changes that are prospective, for 2021 only.
With respect to the former, the BIG change for 2020 is that the Appropriations Act eliminates the rule that prevented businesses who received a PPP loan from also taking advantage of the Employee Retention Credit. Instead, such businesses can now benefit from both a PPP loan and the Employee Retention Credit, though the same wages cannot be used to qualify for both the credit and for forgiveness.
The other significant change that is retroactive for 2020 is that healthcare expenses are now eligible to be treated as wages, regardless of whether or not an employee was receiving other wages (e.g., they were furloughed).
The Appropriations Act also makes a number of substantial enhancements to the Employee Retention Credit for 2021 only. For instance, effective January 1, 2020, the amount of wages, per employee, that are eligible for the credit from $10,000 (total), to $10,000 per quarter (up from the current $10,000 maximum amount for all of 2020). In addition, the credit rate on such wages is increased from 50% to 70%. Accordingly, qualifying businesses can receive a refundable Payroll Tax credit of up to $10,000 × 70% = $7,000 per quarter(!), per employee.
Notably, not only does the Appropriations Act dramatically increase the maximum benefit, but it also makes it easier to qualify to receive that benefit. The definition of a “small” employer also changes, increasing from 100 employees to 500 employees (small employers are eligible to include any wages paid to employees in this calculation, or as large employers are only eligible to include such wages if, essentially, their employees are being paid to stay home and not work). And, whereas the CARES Act initially required employers to have a reduction in 2020 year-over-year quarterly revenues of 50% in order to qualify for the credit (or if they were fully or partially shut down by government order), the Appropriations Act lowers that threshold for 2021 quarters (still compared to the same quarter in 2019) to ‘just’ 20%.
Example #3: Barney’s Bowl-A-Rama, a local bowling alley, has been experiencing a drop in revenue as compared to 2019. In 2019, the Bowl-A-Rama had revenues of $100,000 per quarter. Beginning in April 2020, however, in an effort to help mitigate the spread of the COVID-19 virus, Barney’s Bowl-A-Rama began closing some lanes to spread customers out. As such, its Q2, Q3, and Q4 quarterly revenues for 2020 are $70,000 per quarter.
Accordingly, the Bowl-A-Rama will not be eligible for any Employee Retention Credit for 2020 (because it’s 2020 quarterly revenues never dipped below $50,000, or 50% of its revenue from the same calendar quarter in 2019).
Now, however, suppose that Barney’s Bowl-A-Rama continues to limit lane availability in the first half of 2020, and therefore continues to have quarterly revenues of $70,000 per quarter. Here, since each of those quarters’ revenues represent a drop of more than 20% of revenue as compared to the same quarter in 2019 (i.e., less than $80,000 of revenue in any 2020 quarter, compared to $100,000/quarter in 2019), Barney’s Bowl-A-Rama will be eligible to receive the Employee Retention Credit for Q1 and Q2 2021.
Finally, it’s worth noting that the Appropriations Act allows businesses to opt into a so-called “Alternative Quarter Election,” enabling them to compare revenues to the immediately preceding calendar quarter, foregoing the standard year-over-year revenue comparisons, if that would be more favorable.
Extended Federally Subsidized Unemployment Benefits
When the CARES Act was passed in March, it created a host of out-of-the-ordinary unemployment benefits. Many of those benefits have been extended, or reinstated, via the Appropriations Act. Such changes include the following:
- ‘Regular’ Unemployment Compensation extended another eleven weeks – Prior to the passage of the Appropriations Act, Federally subsidized unemployment benefits were scheduled to end this week. Instead, they will now be extended by an additional 11 weeks, covering eligible unemployed individuals through the middle of March 2021.
- Pandemic Unemployment Assistance is extended 11 weeks – This fund, which provides unemployment benefits to individuals who are not normally eligible to receive such benefits, such as self-employed individuals, is also extended to provide benefits for individuals through as late as April 5, 2021.
- ‘Regular’ Unemployment Compensation increased by $300 for 11 weeks – When the CARES Act was passed, one of the most contentious elements was a Federally funded increase in weekly unemployment benefits for individuals of $600 for four months. That four-month period ended earlier this year, but the passage of the Appropriations Act brings back a reduced version of this benefit for a shorter period of time.
More specifically, individuals would receive an additional $300, on top of their ‘regular’ state-determined unemployment compensation benefit for 11 weeks. While not quite as ‘rich’ as the $600 bump in weekly benefits provided by the CARES Act, with the average state unemployment benefit nationwide being under $400, the $300 amount would still nearly double the check of the average recipient of unemployment compensation.
The additional $300 amount would also be paid to individuals receiving Employment Compensation via the Pandemic Unemployment Assistance program.
- Funding of the “waiting week” for 11 weeks – In general, individuals are ineligible to receive Employment Compensation benefits for the first week in which they are unemployed. The CARES Act initially provided Federal funds for states to waive this requirement, and the Appropriations Act would extend this relief for an additional 11 weeks.
With hundreds of thousands of individuals still applying for Unemployment Compensation each month, this first week of benefits remains quite valuable to many.
Personal Income Tax Changes And Extensions
Throughout various parts of the Consolidated Appropriations Act of 2021, changes were made to the Internal Revenue Code, and more specifically, to the rules governing personal income taxes. A handful of the changes can be found in a portion of the Act given the short title of COVID-related “Tax Relief Act of 2020,” while many others can be found in the “Taxpayer Certainty and Disaster Tax Relief Act of 2020,” which is just a fancy name for what is more commonly known as the Extenders Bill.
While, in fairness, it’s hard to look at any of the tax-related provisions in the Act as a true ‘game-changer,’ the sheer number of changes makes it likely that many clients will at least be able to benefit in some fashion. And saving even a small amount on taxes is generally welcome news to clients. We highlight the most substantive personal income tax changes below.
Deadline To Repay Deferred Payroll Taxes Extended To December 31st, 2021
On August 8, 2020, President Trump signed an executive order to allow employees to defer their share of Social Security taxes in an effort to temporarily increase workers’ cash flow. Roughly 3 weeks later, on August 28, 2020, the IRS issued Notice 2020-65, which allowed (but did not require) employers to suspend withholding and paying most employees’ Social Security taxes (6.2% on the first $137,700 in 2020) from September 1, 2020, through December 31, 2020.
Notably, while President Trump wanted to simply abate the aforementioned employment taxes, he lacked the statutory authority to do so unilaterally, and Congress opted not to pass such relief. Accordingly, IRS notice 2020-65 required that employees make up any previously deferred employment taxes ratably from January 1, 2021, through April 30, 2021 (in order to avoid interest, penalties, and or additions to tax).
The Appropriations Act, now with relief coming directly from Congress, updates the timing of the required repayments to be the entirety of 2021 (repayments are to be made ratably from January 1, 2021, through December 31, 2021). Accordingly, as compared to expectations prior to the passage of the Appropriations Act, affected employees will have modestly higher-than-expected cash flow from January 1, 2021, through April 30, 2021, and modestly less-than-expected cash flow from May 1, 2021, through December 31, 2021.
Example #4. Otto is a school bus driver who earns a salary of $96,000 per year and is paid bi-monthly. Thus, each of Otto’s bi-monthly paychecks is for a gross amount of $96,000 ÷ 24 equals $4,000. And as such, each time Otto is paid, his employer withholds 6.2% × $4,000 = $248 for Otto’s share of his Social Security taxes.
After President Trump’s Executive Order, and the subsequent IRS guidance in Notice 2020-65, Otto’s employer allowed him to opt in to deferring his Social Security taxes from September 1, 2020 through December 31, 2020. Otto opted to do so, receiving a total of 4 months × 2 paychecks per month = 8 total paychecks with an ‘extra’ $248, or a total of 8 × $248 = $1,984.
In light of the changes made by the Appropriations Act, Otto must now repay the $1,984 ratably throughout 2021. Thus, on top of any ‘normal’ reductions from his gross pay (e.g., payroll taxes, income tax withholding, retirement plan contributions, etc.), Otto will have an additional $1,984 ÷ 24 = $82.67 deducted from each of his 24 bi-monthly paychecks in 2021 (whereas prior to the Appropriations Act, $1,984 ÷ 8 = $248 would have been withheld from each of Otto’s eight paychecks from January 1, 2020 through April 30, 2020).
Due to the substantial operational and challenges associated with implementing President Trump’s payroll tax deferral, the short timeline businesses had to make those changes, and frankly, the fairly nominal benefit offered workers, many employers opted not to adopt this option for employees. And even when employers offered such a benefit, not all employees chose to take advantage of it.
Notably, though, while many private employers did not adopt the payroll deferral changes from earlier in 2020, the Federal government did adopt such relief, and eligible employees were forced to use it. As a result, when seeking to answer the question come “Who does this affect?” a good place to start is with any Federal employees.
‘Permanent’ Reduction In The AGI Hurdle For Medical Expense Deductions
Section 101 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 provides a welcome change that tax planners have been clamoring over for the better part of a decade; it ‘permanently’ restores the AGI ‘hurdle rate’ for medical expense deductions to 7.5% of AGI.
In recent years, the hurdle rate had oscillated between 7.5% of AGI and 10% of AGI, and for a while, even depended upon a taxpayer’s age! Now, the 7.5% rate is restored for all taxpayers, for all future years (or at least until Congress changes its mind again passes another law!?).
Lifetime Learning Credit With Higher Income Phaseout To Replace Tuition And Related Expenses Deduction
Section 104 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 also makes 2020 the last year that the Tuition and Related Expenses above-the-line deduction can be claimed. After 2020, the deduction will literally be wiped from the Internal Revenue Code.
But all is not lost… Far from it, in fact.
Because replacing the Tuition And Related Expenses deduction will be a Lifetime Learning Credit with a higher phaseout range. More specifically, the current Lifetime Learning Credit phaseout range is from $59,000-$69,000 for single filers, and from $118,000-$138,000 for joint filers.
Beginning in 2021, however, the Lifetime Learning Credit phaseout range will be aligned with the American Opportunity Tax Credit phaseout range. Accordingly, both credits will phase out from $80,000-$90,000 for single filers, and from $160,000-$180,000 for joint filers.
In the end, this is a solid win for taxpayers. The elimination of the Tuition and Related Expenses deduction reduces the number of education-related tax benefits taxpayers have to contend with. And the primary reason that an individual would use the Tuition and Related Expenses deduction instead of the American Opportunity Tax Credit or Lifetime Learning Credit was because they were unable to claim the American Opportunity Tax Credit (often because they had already claimed it for the maximum four allowable years), and their income was too high to allow you to claim the Lifetime Learning Credit. In some other, more limited situations, taxpayers in the 22% bracket and subject to state income taxes may have faired modestly better using the Tuition and Related Expenses deduction.
We now have a simpler Internal Revenue Code, and taxpayers who in the past would have used the Student and Related Expenses deduction can now use the Lifetime Learning Credit, a generally superior option (given the size of the credit itself under Lifetime Learning relative to the benefit of the deduction under the Tuition and Related Expenses deduction, and the fact that higher income limits will allow those previously claiming the deduction to claim the better credit instead).
CARES Act Charitable Contribution Benefits Modified And Extended
When the CARES Act was introduced in March 2020, it included new tax benefits for individuals making charitable contributions. The first of those benefits was the creation of an above-the-line deduction for cash contributions made to charitable organizations (subject to limited restrictions) for individuals who do not itemize deductions on their Federal income tax returns. Initially, this deduction was only scheduled to exist for 2020 and was capped at a maximum of $300 for both single and joint filers.
Section 212 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 extends this benefit to 2021 as well. In addition, for 2021 only, it removes the marriage penalty associated with the 2020 version, by allowing joint filers to claim a deduction of up to $600.
Section 213 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 addresses the other CARES Act-created tax benefit for charitable contributions, the ability to deduct up to 100% of an individual’s AGI as a qualified contribution when making an all-cash contribution to a charity (including public and private charities, but not a donor-advised fund or a 509(a)(3) supporting organization). This benefit, too, was initially slated to be a ‘one and done,’ but is now been extended through the end of 2021.
Notably, though, this provision does not increase the AGI limit for cash contributions in general. Rather, it allows an individual to elect to bypass the ‘regular’ deduction limits for such cash contributions by making an election. Thus, it is an option, not a requirement.
While the ability to deduct up to 100% of an individual’s AGI as a charitable contribution may sound good in theory – after all, it would produce a zero dollar income tax bill – the reality is that from a tax planning perspective, it’s actually poor strategy… particularly for high-income individuals. Notably, a deduction for 100% of an individual’s AGI means offsetting income (with the deduction) not only at the individual’s highest income tax brackets but also at their lowest income tax bracket (i.e., all the way down to $0 by offsetting 100% of their income). Accordingly, from a tax planning perspective, individuals may actually be better off splitting their total deduction over several years and not claiming a cash charitable contribution for 100% of income (even if it is now possible to elect to do so!).
Certain Meal Expenses Are 100% Deductible For 2021 And 2022
Section 210 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 will come as welcome news to sole proprietors and other business owners. In an effort to encourage business spending at restaurants, the Act allows for a full (100%) deduction for such expenses in 2021 and 2022 (but not retroactively for 2020).
Notably, the 100% deduction is allowed only to the extent that the expenses incurred “for food or beverages provided by a restaurant.” [Emphasis added] From the language of the statute, it would certainly appear that expenses related to both in-restaurant dining, as well as takeout dining, would qualify for such treatment, as in either case the food or beverages are “provided” by the restaurant. However, subsequent guidance will surely be needed from the IRS to clarify the definition of a “restaurant” (e.g., regarding everything from externally catered food at private events to various hosted private venues).
Certainly, many situations will be obvious, but how about expenses incurred at a bar that does not provide any (or substantial) food? A restaurant within a hotel really qualifies, but would room service? For now, there is no clear answer. Stay tuned for more guidance from the IRS in early 2021.
2019 Earned Income Can Be Used To Determine Eligibility For 2020 Earned Income Tax Credit And Additional Child Tax Credit
With the Internal Revenue Code as complicated as ours is, there are bound to be unintended consequences whenever things don’t go as initially foreseen. Such is the case this year with the Earned Income Tax Credit and the Additional Child Tax Credit (the refundable portion of the Trial Tax Credit).
More specifically, both credits require that an individual have (enough) earned income in order to qualify for the (full) credit. Unfortunately, many individuals who would otherwise be working, through no fault of their own, have been out of work for part – and in some cases most – of 2020. As such, they may not have enough earned income to be able to qualify for one or both credits (to the same extent as normal).
In order to mitigate the impact of an individual’s lost earned income on the amount of the Earned Income Tax Credit and/or the Additional Child Tax Credit that they would normally receive, Section 211 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 allows individuals to use their 2019 earned income to calculate the amount they will receive for either credit for 2020.
Notably, there is no requirement of an intention to work, so even those who intentionally retired in, or voluntarily took off large chunks of 2020 – or even those who left the workforce partially through 2019, but had some earned income for the year before they did so – may be able to receive one or both credits for 2020.
As a result of the COVID-19 pandemic, many individuals, some for the first time ever, received unemployment compensation in 2020. The combination of the extended unemployment benefits provided for by the CARES Act, as well as the additional $600 per week included in such checks (also authorized by the CARES Act) for a portion of the year, means that some individuals may end 2020 with as much unemployment compensation as they normally would from working (and in some cases, possibly even more).
Like earned income, unemployment compensation is taxable at ordinary income tax rates. So, absent this provision, individuals with similar income to previous years, but whose ‘swapped’ earned income for unemployment compensation, could have ended up with substantially higher (and likely unexpected) tax bills.
Exclusion For Employer Payments Of Student Loans Extended Through 2025
First authorized by the CARES Act earlier this year for 2020 only, the ability for an employer to provide up to $5,250 of annual tax-free education assistance used to pay the principal or interest on an employee’s qualified student debt is extended through 2025. Such payments may be made directly to a lender, or they can also be made to the employee, who can then use the payments to pay down their own student debt.
Providing such assistance in lieu of a raise can be a win-win for both employees and employers.… At least through 2025. Notably, neither the employee nor the employer is liable for employment taxes on the amount. Additionally, the payment is received income tax-free to the employee!
Often times, when business owners learn about this provision, their first question is, “Hey! Can I do this for myself or my family?” The answer, unfortunately, is, “No.” The program can’t be discriminatory towards highly compensated employees or their dependents. More specifically, no more than 5% of total amounts paid or incurred by an employer for education assistance during a year can be attributable to individuals who own more than 5% of the stock, or of the capital or profits, of the employer.
Exclusion For Discharge Of Qualified Principal Residence Debt Extended Through 2025 (But Scaled-Back)
The Act extends the period of time for which forgiven debt attributable to a primary residence may be excluded from income through 2025, for those who go through a short sale and end out resolving their outstanding mortgage balance with a foreclosure/sale of the home for less than the remaining balance.
However, beginning in 2021, the maximum amount of debt that can be discharged is reduced from $2 million dollars under prior law to $750,000 for joint filers, and from $1 million under prior law to $375,000 for single filers.
The reduced amounts align with the TCJA-reduced maximum amounts of acquisition indebtedness for which a mortgage interest deduction may be claimed.
Carryforward Relief For Flexible Spending Account Funds That Remain Unused At End Of Year
Dependent Care Flexible Spending accounts and Health Flexible Spending Accounts (FSAs) are valuable tax-saving tools offered by many employers. In general, employees are required to make an irrevocable election as to how much they would like to contribute to such accounts throughout the following year.
Furthermore, any amounts remaining unused in an individual's Dependent Care FSA at the end of the year are generally forfeited. Amounts remaining in a Health FSA at the end of the year are also subject to forfeiture.
However, employers can provide some relief for these funds, allowing employees to either roll over up to $550 of their remaining Health FSA balance to the following year or to use prior year funds during the first 2 ½ months of the following year.
Given the unusual circumstances of 2020, many individuals miscalculated the amount of money that they would spend that would be eligible to be reimbursed from their Dependent Care FSA and/or their Health FSA. For instance, parents may have been laid off from work or chose to work from home, limiting the need for childcare expenses.
In an effort to avoid substantial employee forfeitures, Congress has authorized significant relief for unused FSA (both Dependent Care and Healthcare) funds. More specifically, Section 214 of the Taxpayer Certainty and Disaster Relief Act of 2020 permits employers to let employees roll forward (carryover) any unused 2020 balances to 2021. It further allows any remaining balances at the end of 2021 to be rolled forward into 2022.
Notably, the language of the Act does not appear to require employers to adopt such a policy. Rather, the language essentially says that a plan will not fail to qualify and receive its intended tax benefits because it “permits” plan participants to roll forward such funds. Accordingly, employees should be encouraged to reach out to their HR departments, or other responsible persons, to see whether the plan will/has adopted such relief because it will still be up to the employer to choose to do so (or not).
Section 214 also allows employers to adopt up to a 12-month grace period for 2020 and/or 2021 unused balances. Once again, such relief appears to be up to employers, so impacted employees should inquire accordingly.
Finally, Section 214 also authorizes FSA plans to allow participants to modify future contributions to the FSA (or is normally, once selected, contribution amounts for the year are irrevocable). This provision is only effective for 2021.
Other Notable Changes And Extensions
Beyond the wide range of Personal Income Tax and other areas, a 5,000+ page piece of tax legislation not surprisingly includes a wide range of “miscellania” peppered throughout the law. Accordingly, some other notable changes and extensions include:
Educator Expenses include COVID-19-related supplies – Section 275 of the COVID-19 tax relief portion of the Appropriations Act requires the IRS to produce guidance by February 28, 2021, related to the inclusion of certain COVID-19 prevention-related expenses in the definition of Educator Expenses. More specifically, the Act states that the IRS should “clarify that personal protective equipment, disinfectant, and other supplies used for the prevention of the spread of COVID–19 are” eligible to be treated as Educator Expenses, provided they were incurred on, or after, March 13, 2020. In other words, educators buying their own PPE or other COVID-19 supplies for their classrooms will be able to claim a deduction for those expenses as part of their overall Educator Expenses deduction.
Notably, though, the maximum amount of total Educator Expenses (including COVID-19-related expenses) that are deductible as an above-the-line deduction continues to be $250 per educator.
Qualified Disaster Distributions and Enhance Plan Loans for non-COVID-19-related Federal Disaster Areas – Section 302 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 provides for Qualified Disaster Distributions from retirement accounts and for enhanced plan loans for individuals who qualify based on areas deemed a Federal disaster area between January 1, 2020, and 60 days after the enactment of this legislation… with one very important caveat. The reason for the declaration (of a Federal disaster area) must be for something other than COVID-19.
Qualified Disaster Distribution benefits mirror those of Coronavirus-Related Distributions (e.g., they are exempt from the 10% early distribution penalty, the income from the distribution may be split over three years, the distribution may be repaid for up to three years, a distribution from an employer-sponsored retirement plan is not subject to mandatory withholdings, etc.). Enhanced plan loan provisions also mirror those advisors have become familiar with thanks to the CARES Act (e.g. $100,000 maximum loan limit, ability to take a loan of up to 100% invested balance (subject to the $100,000 maximum cap), ability to temporarily delay loan payments).
Qualifications for both benefits include the requirement that an individual has a principal place of residence in the Federally declared disaster area and sustain an economic loss as a result of that disaster.
Mortgage insurance premiums remain deductible through 2021 (subject to phaseout limits).
Energy-Efficient Homes Credit and Qualified Fuel Cell Motor Vehicle Credits are extended through 2021.
A Simplified FAFSA And The Student Aid Index – The Free Application For Federal Student Aid, better known as the FAFSA form, will be getting a makeover. Effective July 1, 2023, big changes will be coming to the FAFSA, including the elimination of the Expected Family Contribution (EFC)!
Well, sort of.
The concept of the EFC isn’t going anywhere, but the name is. The phrase Expected Family Contribution will be eliminated and replaced with the Student Aid Index (SAI).
There will, however, be more meaningful changes to the college aid application process. For instance, the number of “questions” on the FAFSA form, currently 108, will be substantially reduced.
Students who receive full Pell Grants will automatically receive an SAI of $0 unless their actual SAI is negative. Individuals who are not required to file an income tax return as a result of having only modest, or no income, will be given an SAI of -$1,500 as a default.
In general, other students will calculate their SAI by adding together the sum of their parents’ adjusted available income, plus the sum of their own available income, plus their available assets, in what should hopefully be a simplified formula.
What’s Not Included In The Consolidated Appropriations Act Of 2021?
While the majority of the focus will, and should, be on what is actually in the Appropriations Act of 2021, questions will inevitably arise about what’s not in the bill. But searching through a 5000+ page document trying to ‘find’ what’s not in it is difficult, time-consuming, and frankly, not all that much fun.
Accordingly, having a working-level of knowledge regarding some of the key things that aren’t in the bill can be helpful.
To that end, the following issues/items are not addressed in the Appropriations Act:
- No Waiver Of Future Required Minimum Distributions (RMDs) – There is no extension of the temporary waiver of RMDs for defined contribution accounts that applied to 2020. Accordingly, individuals should be prepared to resume RMDs, as normal, in 2021.
- No Additional relief for unwanted 2020 ‘RMDs’ – Earlier this year, in Notice 2020-51, the IRS authorized individuals who took what would have been 2020 RMDs (if not for the CARES Act’s suspension of such distributions for 2020) to roll them back into a retirement account even if the 60-day rollover window had already lapsed. In an unprecedented move, the IRS even allowed individuals to ignore the once-per-year rollover rule and or to roll back what would have been RMDs from inherited IRAs. That relief, however, expired on August 31, 2020. The Appropriations Act of 2021 does nothing to provide further relief.
- No Further Student Loan Relief – With respect to Federally backed student loans, the CARES Act suspended collection efforts on defaulted loans, suspended loan payments, and set the interest rate to 0% through September 30, 2020. And on August 8, 2020, President Trump issued an Executive Order that extended this relief through the end of 2020, which Secretary Devos then further extended that relief through January 31, 2021. The Appropriations Act of 2021 does not further extend this relief, though.