Once again, Congress has passed significant legislation at year-end. The Consolidated Appropriations Act, 2021, includes a surprising number of tax provisions, many of which had not been widely publicized until the final bill was up for a vote. The legislation passed with bipartisan support, and President Trump, after initially demanding changes to the bill, signed it on Dec. 27, 2020.
As so often happens with year-end tax legislation, the Internal Revenue Service had already come out with many of its forms and instructions, at least in draft form, and the legislation included a number of provisions that impact 2020 tax returns. The IRS announced on Jan. 12, 2021, that it had updated all of its forms and instructions for the new legislation; however, as of this writing, the IRS had not yet announced the date for the start of tax filing season. There are apparently some problems with the second round of stimulus checks going to bank accounts of tax return preparers rather than to the bank accounts of taxpayers, which is holding up the process of getting the payments to taxpayers before starting the tax filing season. The IRS was to try to get out the payments by Jan. 15, but it appears that date may have to be pushed back, which in turn could delay the start of tax filing season.
Following are tax provisions in CAA that may have an impact on 2020 tax returns.
- Economic stimulus payments.The second round of stimulus payments, even though received in 2021, will be treated as payments associated with the 2020 tax return. The advance payments are being sent in the form of direct deposits, debit cards or checks. The recovery rebate credit for both the first and second round is to be claimed on Line 30 of Form 1040 to the extent that they have not already been received in the form of advance payments. The IRS has sent out Notice 1444 with respect to the first round of advance payments and plans to send Notice 1444-B with respect to the second round of payments. Taxpayers should provide both forms to their return preparer to assist in determining whether the taxpayer is entitled to any additional recovery rebate credit on their 2020 tax return.
- Employee Retention Credit.The CAA has made a number of changes to the Employee Retention Credit. In a change from the CARES Act, the ERC can now be claimed retroactively even if the business has received forgiveness of a Paycheck Protection Program loan. It can be claimed, however, only for wages not covered under a forgiven PPP loan. IRS guidance will be needed to determine how to handle a number of issues.
The CAA appears to give priority to claiming the ERC; however, it is not clear how to revise a PPP request for forgiveness to remove wages now claimed for the ERC. The ERC can be claimed on an amended Form 941 for the second and third quarter of 2020, or as a catch-up credit for the fourth quarter of 2020. The CAA also changes the treatment of health insurance costs, allowing them to count as wages even during periods when no other wages were being paid to the employee. The definition of qualified wages under the ERC and payroll under the PPP are also different, so the calculations for someone seeking to claim both could be somewhat difficult.
The CAA also changed a number of the criteria for ERC eligibility, generally applying only going forward through June 2021. The percent of qualifying wages is increased from 50 percent to 70 percent, with a new maximum of $10,000 per employee per quarter. A 20 percent decline in gross receipts now qualifies for eligibility, rather than a 50 percent decline, and it may be tested in the prior quarter. The full-time-employee threshold for determining whether an employee needs to be providing services is increased from 100 to 500 full-time-equivalent employees.
The Treasury is authorized to make advance payments of the ERC. Certain government employers and new employers are made eligible for the ERC. Businesses seeking to take advantage of these ERC changes would probably be well advised to wait for further IRS guidance before trying to tackle these issues.
As Congress has done with prior federal disasters, an ERC with its own separate requirements is also made available to victims of natural disasters that occurred during 2020 and through Feb. 25, 2021.
- Deduction of expenses paid with a forgiven PPP loan. Businesses and members of Congress had criticized the IRS position taken after enactment of the CARES Act that expenses paid for with forgiven PPP loans were not deductible. This is consistent with long-term tax policy that expenses associated with untaxed income are not deductible. However, many in Congress said this was inconsistent with congressional intent to help businesses during the COVID pandemic, and the CAA makes those expenses deductible. While generally good news for taxpayers, there could still be issues if the PPP is not forgiven until 2021 and that basis adjustment is needed to support any additional losses claimed on the 2020 tax return.
- Paid sick and family leave credits. The CAA extends the paid sick and family leave credits enacted as part of the Families First Coronavirus Response Act from Dec. 31, 2020, through March 31, 2021. The extension is optional for the employer. An election is provided for self-employed persons to claim the credit using net earnings from the prior year. Some technical changes were also made to the definition of qualified wages and the exclusion of leave from employer taxes. The changes are effective as if included in the FFCRA.
- EITC and ACTC.The CAA provides an election for taxpayers claiming the Earned Income Tax Credit or the Additional Child Tax Credit to utilize 2019 income rather than 2020 income in calculating the credits on the 2020 tax return.
- Educator expenses and PPE.The CAA permits the $250 educator expense deduction to be utilized for personal protection equipment and other COVID-related expenses retroactive to March 12, 2020.
- Emergency financial aid grants. Under the CAA, emergency financial aid grants made under the CARES Act are not included in gross income and do not reduce education tax credits. This change is retroactive to the effective date of the CARES Act, March 28, 2020.
- Disaster relief. In addition to the ERC for federal disasters other than the COVID pandemic, the CAA provides additional disaster relief for federal disasters other than the COVID pandemic occurring during 2020. The relief includes penalty-free distribution of retirement funds, additional tax breaks for disaster-related contributions, and expansion of the casualty loss deduction.
- Depreciation of rental real property.A CAA provision changing the depreciation period for rental real property from 40 years to 30 years is retroactive to 2018.
- Other provisions with potential 2020 impact. Other CAA provisions with potential impact on 2020 and even earlier tax returns include a waiver of certain information reporting requirements, permitting COVID-related withdrawals from money purchase pension plans, permitting farming loss carryback elections, and permitting a temporary hold on transfers from pension plans for retiree health coverage obligations.
While the IRS has stated that it has updated its 2020 forms and instructions for these CAA changes, there will still be some need for additional IRS guidance.
