IS 2021 THE YEAR TO SELL YOUR CAPITAL ASSETS?

I do not typically like to comment on legislation until I’m relatively sure it will become law. The reason for this is that up until tax law is passed both republicans and democrats propose changes. I am taking the time to address a couple of possible provisions being proposed and what can be done by taxpayers.

What are the proposals that are being discussed?

There a few tax provisions that the current administration is discussing. The provisions garnering the most traction are the following:

• Raising the corporate income tax rate from 21% to 35%
• Raising the top income tax rate from 37% to 39.6%
• Elimination of long term capital gains tax rate for taxpayers that earn $1 million or more.
• Elimination of step-up in basis for Estates in excess of $1 million

Raising the corporate tax rate from 21% to 35%

For smaller companies this may mean a shift to S corporation status. Each corporation will need to examine a variety of circumstances. C corporation status, which are the corporations that this tax pertains to, was mainly used by larger corporations not eligible to be S corporations before the Tax Cut and Jobs Act was passed at the end of 2017. When the law passed in 2017 dropping the corporate rate to 21% some smaller businesses did convert to C corporations because the 21% tax rate was lower than the individual income tax rate of the shareholders in many circumstances.

S corporations have been extremely popular because they eliminate the “double taxation” of corporations. If you’ve heard this term before what it refers to is a corporation realizing a profit, paying a tax and the taxpayers also paying a tax when they take money from the corporation. This can best be explained by an example.

Let’s say a corporation finishes the year with a $100,000 profit and pays income tax at the rate of 21%. Also assume that at the end of the year, before the tax payment was made, the corporation had $100,000 in cash. The corporation would pay a tax of $21,000 reducing it’s cash to $79,000. If the corporate shareholder takes this money out of the corporation it will come out in one of two ways. Either the shareholder receives a dividend and pays tax at long term capital gains rates and the corporation receives no deduction or the corporation will pay the shareholder wages and the shareholder must pay income tax, at ordinary income tax rates, Social security tax and Medicare tax as well. The corporation would receive a deduction if wages and payroll taxes were paid.

If the corporation were an S corporation, then the $100,000 would not be taxed at the corporate level but would instead flow to the individual shareholders, thereby eliminating the double taxation. If the shareholders were in the 24% bracket, for example, it would cost $24,000. At first glance it is clear the $24,000 exceeds the $21,000 of the corporation, however once you add the long term capital gains rates (15% to 23.8% depending on income tax bracket) to the $79,000 cash left for the shareholder, the resulting tax is somewhere between $11,850 and $18,802 on top of the $21,000. If the $79,000 were paid as wages the corporation would get a deduction, but the tax would probably still be higher because wages would be subject to Social Security and Medicare taxes and the individual may also be in a higher tax bracket.

There are certain criteria that must be met in order to be an S corporation. One of limiting factors is that an S corporation can have no more than 100 shareholders.

Raising the top individual income tax rate from 37% to 39.6%

This does make taxes exceedingly high, especially if you live in a high tax state like New York, California, or New Jersey. With state tax and the additional 3.8% tax already levied by the Federal government on investment income over $200,000 for those filing as single or head of household, $500,000 for those married filing jointly and $125,000 for those married filing separately, the overall tax rate can exceed 50%.

Elimination of long term capital gains rate for taxpayers earning $1 million or more.

The capital gains rate for these individuals is currently 20% and, as mentioned earlier, there is also a 3.8% investment tax on these individuals. The end result is a nearly doubling of the tax rate on affected individuals. Instead of paying 23.8% they would now be paying 43.4% (39.6% individual rate and 3.8% investment tax rate). This could have a significant impact on investment and the stock market.

Elimination of the step up in basis for Estates over $1 million

From what I’ve read, the first $1,000,000 of an Estate would be exempt from this provision. I’m not sure how that would work, whether taxpayers would have to identify the $1 million of assets that get the step up or whether there will be a methodology baked into the law.

Step up in basis upon death has been a provision that not only helps taxpayers reduce total tax it also cures some basis issues. Let’s say we have a taxpayer that passes away with stock with a Fair market value (FMV) of $2,000,000 and a basis of $1,200,000. Without the step up in basis the heirs of the Estate would recognize an $800,000 gain upon the sale of these securities. With the step up in basis, the heirs are able to “step up” the basis of these securities to the FMV of $2 million. When the securities are sold (assuming a sales price of $2 million), no gain or loss is recognized.

Step up is also helpful if a taxpayer passes and their basis in the assets is unknown. Instead of having to figure out when the securities were purchased and what the purchase price was, all that is needed is the FMV at the date of death, in most cases.

Keep in mind that when the elimination of the step up in basis is combined with the elimination of the long term capital gains rates for taxpayers earning over $1 million, this could become a very painful outcome.

Is there anything we can do about it?

There are a couple of possible of things that may mitigate these provisions.

First of all, the Senate is 50/50 with the VP being the deciding vote and there is also a slim majority for the democrats in the House. This may make both sides negotiate a bit and the resulting compromise may reduce the tax burden being proposed.

Second, taxpayers should examine their portfolio and decide if there is anything they would like to sell in 2021. I can’t tell you if tax legislation will pass, or how painful the legislation may be, but I can tell you that your tax rate will not be going down. This may be the year to sell certain assets while you are still eligible for the capital gains tax rate.

Additionally, if you are in your own business, or have any control over your income, you may want to realize more income in 2021, instead of pushing it off to 2022. This typically goes against the strategies most taxpayers utilize, however, if you believe your income tax rate may be going up it makes sense.

Conclusion

A reminder that any discussion of proposed tax law changes is exactly that, discussion for now. I advise keeping on eye on what’s going on, have some strategies ready to go if you need them and then waiting until the legislation passes or at least until we have more concrete evidence of a legislative change.

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Jeff Skolnick, CPA, M.S. Taxation

IRS PROVIDES SAFE HARBOR FOR PPP RECIPIENTS CLAIMING DEDUCTIONS

The IRS issued Revenue Procedure 2021-20 on Thursday April 22nd. This revenue procedure provides a safe harbor to PPP borrowers that received loans, either had them forgiven or expected them to be forgiven and did not deduct expenses because of IRS guidance issued during 2020.

The IRS had issued guidance during 2020 which stated that any expenses paid with forgiven PPP funds were not allowed to be deducted based on the fact that the forgiven funds were not taxable income. The Consolidated Appropriations Act, 2021 was signed into law on December 27, 2020 and overruled the IRS. The law specifically states that expenses paid with forgiven PPP funds are fully deductible.

Rev Proc 2021-20 states a covered taxpayer is able to deduct these expenses on the income tax return immediately subsequent to the one filed on or before December 27, 2020 instead of having to file an amended return for 2020.

By definition, a covered taxpayer is a taxpayer that satisfies all of the following:

1. The taxpayer received an original PPP covered loan;
2. The taxpayer paid or incurred original eligible expenses during the taxpayer’s 2020 taxable year;
3. On or before December 27, 2020, the taxpayer timely filed, including extensions, a Federal income tax return or information return, as applicable, for the taxpayer’s 2020 taxable year; and
4. On the taxpayer’s Federal income tax return or information return, as applicable, the taxpayer did not deduct the original expenses because—

• (a) The expenses resulted in forgiveness of the original PPP covered loan; or
• (b) The taxpayer reasonably expected at the end of the 2020 taxable year that the expenses would result in such forgiveness.

The procedure applies to first draw loans taken before December 27, 2020 therefore no loans, whether first or second draw, received after December 27, 2020 are eligible.

The procedure does not permit any of the expanded costs (covered operations expenditures, covered property damage costs, covered supplier costs or covered worker protection expenditures) allowed for first or second draw loans taken after December 27, 2020 to be considered for this safe harbor.

What is unclear to me is when the procedure discusses timely filed 2020 returns, filed on or before December 27, 2020. Most 2020 returns would not have been filed until 2021 which makes the procedure not very useful. I’m not sure whether it only applies to 2020 returns or prior returns with 2020 expenses. Federal income tax returns use the year that contains December 31st as the year of the income tax return. A tax return with a year that ends September 30, 2020 would be a 2019 return since December 31st of that return year was 2019. Although this return is considered 2019, there are expenses incurred in calendar year 2020. This would generally only apply to C corporations. Individuals, partnerships, and S corporations almost all file on a calendar year basis.

Keep in mind, if you do not meet the criteria to use this safe harbor, you can always amend your 2020 return if you did not take the proper income tax deductions.

Other PPP Items

Schedule C Filers

On March 3, 2021 guidance was issued which allowed Schedule C filers to use their gross income rather than their net profit to determine their maximum PPP loan. This allows these borrowers to obtain larger loan amounts. The issue is the law only applies to loans not approved by March 3rd. This means any borrower that received a loan before March 3rd is not eligible which penalizes those borrowers that were the most efficient.

The AICPA has been pushing to allow Schedule C filers that received loans prior to March 3rd to amend their loans and obtain additional funds. At a recent AICPA town hall webinar, I attended it was indicated that while this change to the law is still possible, it is not probable.

PPP Funds Expected to Run Out

After months of fighting to extend the PPP filing deadline from March 31st to May 31st I have been consistently hearing for the past three weeks that PPP funds are expected to run out at the very end of April or beginning of May. It is unclear whether there would be any additional funds allocated to the program if it does run out. I have been pushing any clients that have not filed for either first or second draw loans to do so immediately just in case the funds run out and are not replenished.

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Jeff Skolnick, CPA, M.S. Taxation

HOW TO DEAL WITH THE UPCOMING MAY 17TH DEADLINE

As all of you know, the income tax deadline for filing individual income tax returns and any payments due on these returns has been extended to May 17th. My advice is that if you have not submitted your return, that you get on it quickly. One month will fly by more quickly than you think.  Keep in mind, even those returns on extension must have payments submitted by May 17th. An extension of time only grants you an extension of time to file income tax returns, not to pay them.

TIME FOR A TAX CHECK-UP

This is a good time for everyone to examine their personal tax situation.  The last 14 months have made for some very strange looking tax returns. As we hopefully head for more stable economic times it is important that everyone assess their personal income tax situation in order to avoid surprises next April.

Self-Employment Tax

If you are an individual that is self-employed (sole proprietor or single member LLC), and you are subject to self-employment tax it is important to realize that the rate is approximately 14.1%.  In addition, individuals that own interests in partnerships or LLCs may also be subject to self-employment tax.  If an individual is subject to self-employment tax and does not account for this amount in their estimated tax payments it can be painful in April. I am therefore stressing to all those individuals that are subject to self-employment tax that they make quarterly estimated income tax payments to avoid pain and misery in April.

Additionally, self-employed individuals always have a more difficult time estimating their current tax situation then do W-2 employees. Income can vary greatly year to year, and you must monitor your individual situation in order to avoid surprises.

Changes in your personal situation

There may be changes in your personal situation that can affect your tax liability.  An example of this might be the child tax credit. Child tax credits which are available for children under the age of 17 in the amount of $2,000 have been expanded only for 2021.

The new credit allowed is $3,000 per child under age 18 and $3,600 per child under age 6. Again, these amounts are only for 2021.

One more change to this credit is the credit is fully refundable. The $2,000 credit is 70% refundable. If a family had a child eligible for the $2,000 credit but had no income tax liability, they would only receive $1,400 (70% of the $2,000 credit). If the family had an income tax liability of $500, they would be allowed a $1,900 credit ($500 vs. income tax and $1,400 refundable). If the tax liability were $600 or more, then this family would receive the full $2,000 credit. Under the expanded law, the family would receive the full $3,000 (or $3,600) regardless of whether or not they had an income tax liability.

One big thing to keep in mind are the AGI limits.

The expanded law uses threshold amounts of $150,000 for joint filers, $112,500 for head of household filers and $75,000 for everyone else. Credits phase out at the rate of 5% for each dollar of AGI in excess of these limits.

If you exceed the income limits just discussed there is still a $2,000 tax credit for children under the age of 17.   If you have a child that will reach age of 17 during the year, and your income exceeds the limits of the 2021 expanded credit, then the credit will not be available for you next April.  It is highly likely that you will still have a $500 credit, but you will not have a $2,000 credit. I also want to mention the income limitation on this ($2,000 or $500) credit although it is not nearly as important as it once was.  The credit starts to phaseout for married couples filing jointly at $400,000 and $200,000 for all others.

Medical expenses are not deductible unless they exceed 7.5% of your income.

Most married couples filing jointly did not itemize and used the $24,800 standard deduction in 2020.  This should be kept in mind as such things as charitable contributions, mortgage interest and real estate taxes may not impact your tax return as much as they did in the past.

In many instances individuals that have children in college are entitled to education credits either through the American Opportunity Credit or the Lifetime Learning credit.  Both of these credits, however, have income limitations and therefore a credit you are counting on now may not be available to you.  In some instances, it may make sense for a parent to not claim the child as a deduction and allow the child to claim the credit.  While this may raise the tax liability on the parents, the overall taxes on the family may be lower.  Additionally, the American Opportunity Credit is only available for the first 4 years of college and has a significantly higher income phaseout then the Lifetime learning Credit. Taxpayers should be alert as to how many years they have taken the American Opportunity credit and should plan for a potential reduced or completely phased out credit if they have already used the credit for 4 years.

Taxpayers should of course be reviewing their investment activity as well.  If a taxpayer has any capital gains, they may want to start to look at stocks that are not doing as well that could be sold at a loss to offset the gains. This strategy is typically performed closer to yearend, but taxpayers should monitor their capital gains and losses during the year to allow enough time to plan to offset some of these gains.

If you were subject to the Alternative Minimum Tax (AMT) this past year, it is a good idea to take a look at your estimated income and deductions to see if this tax will apply, although far fewer individuals are subject to this tax since the law was changed at the end of 2017.

Lastly, it is always important to remember that if you have any significant income not subject to withholding (income from a sole proprietorship or single member LLC, income from a partnership, multiple Member LLC, S corporation, trust, or investment income such as interest, dividends, or capital gains), then you will either have to increase the withholding on income that is subject to withholding or make quarterly estimated income tax payments.

Conclusion

If you found this year that your withholding was not sufficient to cover your liability you may have to increase your deductions or make quarterly estimated income tax payments in order to avoid being underpaid on your tax liability at yearend. You have over 8 months before yearend and almost a year before April 15th to remedy the situation which is much better than finding out a few weeks before your return is due.  Once again if you’re not sure, then check with a tax professional to help determine your tax position.

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Jeff Skolnick, CPA, M.S. Taxation

ESTIMATED INCOME TAXES DUE BY APRIL 15TH

IMPORTANT FILING DEADLINES

As most, if not all, of you know the Federal income tax deadline is extended from April 15th to May 17th, 2021. This extension is for individual income tax returns and any payments due on these returns. Any balances normally due on April 15th are extended to May 17th with no additional penalties or interest due regardless of the amount owed.

What the law does not extend are C corporation income tax returns, Trust and Estate income tax returns, gift tax returns and Estimated income tax payments. Each of these are still due on April 15th.

If you are a taxpayer that makes estimated tax payments, make sure to pay your first quarter by April 15th. If you have been unable to complete enough of your 2020 income tax return to accurately calculate your first quarter estimate, then do your best to approximate the amount. It’s better to make an estimate, even if it’s not totally accurate, then to not make any payment. If you pay in either too much or too little in the first quarter, you can adjust that in subsequent quarters.

Another alternative is to file your Federal extension, complete with payment, by April 15th. The reason for this is if you have an overpayment on your return and payment was made on or before April 15th, then it can be applied to your 2021 first quarter estimate and it should be considered timely.

If you file C corporation returns, trust returns, income tax returns of Estates or gift tax returns make sure to file by April 15th, or file for extension.

Additionally, individuals must check to see if their state individual income tax deadlines are moved.

Lastly, S corporations and partnerships which had a Federal due date of March 15th must be looked at because many of these entities have state filing deadlines on April 15th.

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Jeff Skolnick, CPA, M.S. Taxation

UPDATES TO TAX CALENDAR, UNEMPLOYMENT, PPP, AND RECOVERY REBATES APRIL 4, 2021

IMPORTANT FILING DEADLINES

As most, if not all, of you know the Federal income tax deadline is extended from April 15th to May 17th, 2021. This extension is for individual income tax returns and any payments due on these returns. Any balances normally due on April 15th are extended to May 17th with no additional penalties or interest due regardless of the amount owed.

What the law does not extend are C corporation income tax returns, Trust and Estate income tax returns and Estimated income tax payments. Each of these are still due on April 15th.

If you are a taxpayer that makes estimated tax payments, make sure to pay your first quarter by April 15th. If you have been unable to complete enough of your 2020 income tax return to calculate your first quarter estimate, then do your best to approximate the amount. It’s better to make an estimate, even if it’s not totally accurate, then to not make any payment. If you pay in either too much or too little in the first quarter, you can adjust that in subsequent quarters.

If you file C corporation returns, trust returns or income tax returns of Estates make sure to file by April 15th, or file for extension.

Additionally, individuals must check to see if their state income tax deadlines are moved.

IRS TO ISSUE REFUNDS TO TAXPAYERS THAT REPORTED UNEMPLOYMENT INCOME NOW EXEMPTED BEGINNING IN MAY

The Rescue Plan allows the first $10,200 of unemployment received by a taxpayer (or, in the case of a joint return, received by each spouse), to be excluded from income if the Adjusted Gross Income (AGI) of the taxpayer is less than $150,000. This rule only applies to 2020. The new law does not currently extend this same income tax treatment to unemployment received in 2021, therefore taxpayers should be aware of the tax ramifications.

The IRS stated last week that it will begin sending refunds to those taxpayers that filed their income tax returns before the Rescue Plan became law and paid income tax on unemployment benefits that are now not taxable. The IRS has stated that since the law was passed taxpayers that filed returns and paid income tax on these unemployment funds do not have to file amended returns. The IRS will automatically issue refunds.

The IRS changed the way the $150,000 of AGI is calculated. Originally, taxpayers were required to include unemployment compensation when calculating AGI for purposes of the $150,000 limitation. The calculation was changed and taxpayers do not have to include unemployment received. This increases the number of taxpayers that are eligible to exclude unemployment benefits from taxable income.

You must keep in mind that not every state has decided to exempt the first $10,200 of unemployment compensation received from taxable income. Currently, New Jersey my home state, never includes unemployment compensation as taxable income, same with Pennsylvania. New York, however, does not exempt the first $10,200. All unemployment compensation is currently taxable in New York.

PPP

Last week (Tuesday March 30th) Joe Biden signed the law extending the Paycheck Protection Program (PPP) from March 31, 2021 to May 31, 2021.

With the changes made to the program both recently (an example would be Schedule C filers being allowed to use Gross income instead of net profit) and since the Consolidated Appropriations Act passed on December 27th, it makes sense to extend the deadline.

The changes made since passing the Act in December are, among other items, error codes put in place by the SBA to reduce fraud. While that is a very good idea, these codes have caused significant delays on applications that are legitimate. The extended time gives borrowers, the SBA, and professionals, like me, that are assisting borrowers much needed time to properly file necessary paperwork.

This also potentially allows taxpayers that received a first draw loan in 2021 to receive a second draw loan if their covered period for the first draw loan has expired and all funds have been expended.

RECOVERY REBATES

The IRS and Treasury announced last week that they would begin to send Recovery Rebates to Social Security recipients and other federal beneficiaries who do not normally file a tax return this weekend.

Per the IRS website, “Many federal beneficiaries who filed 2019 or 2020 returns or used the Non-Filers tool last year were issued Economic Impact Payments, if eligible, during the last three weeks. The update applies to Social Security retirement, survivor or disability (SSDI), Supplemental Security Income (SSI), and Railroad Retirement Board (RRB) beneficiaries who did not file a 2019 or 2020 tax return or did not use the Non-Filers tool.”

The IRS announced that as of March 18, 2021 the Recovery Rebate Credit will no longer be applied to past due federal income tax debts. While the IRS has the authority to offset these payments against prior tax obligations, they will not do so. This announcement does not apply to debts owed to other federal government or state agencies. This means money recovery rebates may be applied to debts owed to federal agencies (other than for income tax debt) as well as state agencies.

Below is a brief description of the current Recovery Rebate program:

The IRS has started sending recovery rebate checks, also known as Economic Impact Payments ($1,400 per person) to individuals ever since the President signed the American Rescue Plan Act into law on March 11th.

Many individuals have or will receive payment without having to do anything. Payments are based on either taxpayer 2020 income tax returns or 2019 if 2020 has not been filed. Individuals that have provided the IRS with banking information on their income tax returns or through the non-filer tool last year will most likely receive a direct deposit. Some taxpayers will receive paper checks.

As with the rebates issued in 2020 if taxpayers have not received their payments, then they may go to the “Get My Payment” site (https://www.irs.gov/coronavirus/get-my-payment)to to check the status. If the taxpayer is unable to use this tool (sometimes it doesn’t work), then ultimately the payment will be reconciled on the 2021 income tax return. This is the same way the rebates issued last year have worked. If taxpayers did not receive the payments in 2020, they may take credit on their 2020 income tax return. The downside with reconciling this on the 2021 return is taxpayers will be waiting over a year to receive this money. The other issue is if taxpayers receive payments based on their 2019 or 2020 income tax return that they would not have been entitled to because their 2021 income exceeds the limits for eligibility, they will not have to repay it, if these same taxpayers do not receive the money and reconcile on their 2021 returns they will not receive it if their income exceeds eligibility limits.

Below are the AGI limitations for the Recovery Rebate

Single taxpayers with AGIs of no more than $75,000 are fully eligible for the credit. The credit phases out for those with AGI in excess of $75,000 until they reach $80,000. There is no credit allowed for those with AGI of $80,000 or more.

Married taxpayers filing jointly must substitute the figures $150,000 for $75,000 and $160,000 for $80,000. 

Taxpayers classified as Head of Household must substitute the figures $112,500 for $75,000 and $120,000 for $80,000. 

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Hang in there and stay safe,

Jeff Skolnick, CPA, M.S. Taxation

HOUSE PASSES PPP DEADLINE EXTENSION

Last night (Tuesday March 16th) the House of Representatives voted 415 -3 to extend the Paycheck Protection Program (PPP) from March 31, 2021 to May 31, 2021.

Although this bill must pass in the Senate and be signed into law by the President, with almost unanimous support I feel it is likely to become a reality.

With the changes made to the program both recently (an example would be Schedule C filers being allowed to use Gross income instead of net profit) and since the Consolidated Appropriations Act passed on December 27th, it makes sense to extend the deadline.

The changes made since passing the Act in December are, among other items, error codes put in place by the SBA to reduce fraud. While that is a very good idea, these codes have caused significant delays on applications that are legitimate. The extended time gives borrowers, the SBA, and professionals, like me, that are assisting borrowers much needed time to properly file necessary paperwork.

I will update everyone when and if this bill becomes law.

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Jeff Skolnick, CPA, M.S. Taxation

AMERICAN RESCUE PLAN ACT OF 2021

On Thursday afternoon March 11th Joe Biden signed the $1.9 trillion dollar stimulus bill into law. The new law is cited as the American Rescue Plan Act of 2021. There were a number of provisions that affect taxpayers, and I am going to cover some of them here.

Extension of Unemployment Assistance

The original CARES Act that was signed into law last March 27th contained a provision where those individuals receiving state unemployment assistance also received $600 per week of unemployment funds from the Federal government called Pandemic Unemployment Assistance (PUA). This figure was eventually dropped to $300 and was set to run out on March 14, 2021. The new law extends the $300 per week through September 6, 2021.

Taxation of Unemployment Benefits

The Rescue Plan allows the first $10,200 of unemployment received by a taxpayer (or, in the case of a joint return, received by each spouse), to be excluded from income if the Adjusted Gross Income (AGI) of the taxpayer is less than $150,000. This rule only applies to 2020. The new law does not currently extend this same income tax treatment to unemployment received in 2021, therefore taxpayers should be aware of the tax ramifications.

Limitation on Excess Business Losses

Noncorporate taxpayers are limited to the amount of losses they are allowed to take on their income tax returns from businesses. The limitation is $500,000 for joint filers and $250,000 for everyone else. Business losses would include losses on Form Schedule C (for sole proprietors or single member LLCs) as well as pass-thru income such as from an S corporation or partnership (also multi member LLCs treated as partnerships). This provision was slated to sunset after December 31, 2025. The new law extends this provision to December 31, 2026.

Changes to COBRA Subsidies

COBRA coverage allows workers that are laid off to stay on their company’s health plan as long as they pay the full premium. The new law will subsidize these COBRA payments allowing laid off workers to stay on their company health plans for free through September 30, 2021.

Recovery Rebates to Individuals

The new law provides $1,400 per taxpayer ($2,800 for joint filers) plus $1,400 multiplied by the number of dependents of the taxpayers, regardless of the age of the dependent. This includes college students as well as parents.

Eligible individuals must not be a dependent of another taxpayer.

There is also an eligibility limitation based on AGI.

Single taxpayers with AGIs of no more than $75,000 are fully eligible for the credit. The credit phases out for those with AGI in excess of $75,000 until they reach $80,000. There is no credit allowed for those with AGI of $80,000 or more.

Married taxpayers filing jointly must substitute the figures $150,000 for $75,000 and $160,000 for $80,000. 

Taxpayers classified as Head of Household must substitute the figures $112,500 for $75,000 and $120,000 for $80,000. 

An example of how this works will help. Let’s say we have a married couple with 2 children as dependents. The law allows a $5,600 credit ($1,400 multiplied by both spouses and both children). If the taxpayers AGI was $150,000 or less, all $5,600 may be claimed. If the taxpayers had an AGI of $155,000 (halfway between $150,000 and the full phaseout of $160,000), then 50% of the credit or $2,800 would be allowed. If the taxpayers had $160,000 or more of AGI none of the credit would be allowed. In other words, the credit is phased out ratably between $150,000 and $160,000.

Payments will be based on either 2020 income tax returns or 2019 income tax returns for those have not yet filed 2020.

Child Tax Credits

Child tax credits which were previously available for children under the age of 17 in the amount of $2,000 have been expanded. The new credit allowed is $3,000 per child under age 18 and $3,600 per child under age 6. These amounts are only for 2021.

One more change to this credit is the credit is fully refundable. Under prior law the credit was 70% refundable. If a family had a child eligible for the $2,000 credit but had no income tax liability, they would only receive $1,400 (70% of the $2,000 credit). If the family had an income tax liability of $500, they would be allowed a $1,900 credit ($500 vs. income tax and $1,400 refundable). If the tax liability were $600 or more, then this family would receive the full $2,000 credit. Under the new law, the family would receive the full $3,000 (or $3,600) regardless of whether or not they had an income tax liability.

One big thing to keep in mind are the AGI limits. Under the Tax Cuts and Jobs Act (passed in December of 2017), the credits discussed did not phase out until AGI exceeded $400,000 for joint filers and $200,000 for everyone else. This was to be the law for years 2018 through 2025.

The new law uses threshold amounts of $150,000 for joint filers, $112,500 for head of household filers and $75,000 for everyone else. Credits phase out at the rate of 5% for each dollar of AGI in excess of these limits.

While there are increased amounts for 2021 the reduction in AGI limits may disallow this credit for many taxpayers that have been eligible in years 2018, 2019 and 2020.

Advance Payments

The law provides that advance payments will be made to parents of either $300 or $250 per child per month (depending on whether they were under 6 or under 18). You must beware. These are advance payments on the 2021 income tax returns. Unlike stimulus payments, if taxpayers receive too much in the way of advance payments based on their income, they will have to pay it back.

 Earned Income Tax Credit

For 2021 the minimum age for taxpayers without children to claim the credit had been 25. The new law changes this for 2021 to 19, except for students (age 24) and qualified former foster or homeless youth (age 18).

The credit is allowed for separated spouses.

Normally the credit is disallowed for taxpayers with investment income exceeding $2,200. This limit has been raised to $10,000.

Lastly, taxpayers are allowed to use 2019 income to calculate this credit if it is more beneficial than using 2021 income.

Child and dependent care

Prior law allowed a dependent care credit for dependents under age 13 and dependents or spouses over age 12 that are physically or mentally unable to care for themselves.

This credit was available to taxpayers that incurred dependent care expenses that allowed them to work.

The credit ranged from 35% down to 20% based on a taxpayer’s AGI.

The maximum credit allowed was $3,000 for 1 qualifying dependent and $6,000 for 2 or more qualified dependents.

This credit was not refundable and was allowed only against any income tax liability.

The new law, which only pertains to 2021, makes the credit fully refundable. This means eligible taxpayers will receive the full credit whether or not they have an income tax liability.

It increases the credit to $4,000 for 1 qualified dependent and $8,000 for 2 or more qualified dependents.

The credit allowed is increased from 35% to 50% and does not begin to phase out (down to 20%) until AGI exceeds $125,000. Under prior law this amount began phasing out when AGI exceeded $15,000.

The credit phases out by 1% for each $2,000 (or fraction thereof) by which a taxpayer’s AGI exceeds $400,000.

For 2021 the amount of dependent care assistance allowed to be provided by employers tax free to employees is increased from $5,000 to $10,500.

Family and sick leave credits

The law allows a credit for sick and family leave which is applied against Federal payroll taxes. The credits apply through September 30, 2021 and are available to employers and self-employed individuals.

The maximum allowed for paid family leave is increased from $10,000 to $12,000.

Employee Retention Credit

The Employee Retention Credit (ERC) has been extended through December 31, 2021.

Below is a recent article I had written which explains the ERC for both 2020 and 2021. Again, keep in mind, the 2021 ERC has been extended for all 4 quarters of 2021.

The Employee Retention Credit (ERC) was originally part of the CARES Act which was signed into law on March 27, 2020. The ERC allows eligible taxpayers a credit against Form 941 taxes (Federal withholding, Employer and Employee Social Security and Medicare taxes). The Consolidated Appropriations Act 2021 was signed into law on December 27, 2020 and made significant changes to the ERC. I will now outline the latest provisions of both the 2020 ERC and the 2021 ERC.

2020 ERC

Who is eligible for an ERC?

The ERC is available to employers of any size that paid wages and meet one of the two following tests:

The first test is for any business that has its operations fully or partially suspended during the calendar quarter due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings due to COVID-19. As an example, I have a number of hair salons as clients in the New Jersey / New York area. All of these salons were shut down for approximately 3 months from between approximately March 20th through their reopening on June 22nd of 2020. These salons would be eligible for the credit for any wages paid during the shutdown period.

This same first test still applies to 2021.

The second test is one in which the business had a reduction of its gross receipts of more than 50% when compared to the same quarter of 2019. To use my salons as an example. Each salon was open for 10 days in the 2nd quarter. Gross receipts were down by 80 – 90% in most cases. These salons would be eligible under this second test as gross receipts are clearly less than 50% of the corresponding 2019 quarter. This test allows the taxpayer to count as wages all wages from the first day of the quarter gross receipts fell below 50% up through and including the quarter where gross receipts are at least 80% of the corresponding quarter in 2019.

I will explain this second test by giving an example. Let’s say gross receipts in 2019 were $100,000 in each of the four quarters for an annual total of $400,000. Sales for 2020 were $90,000 in the 1st quarter, $10,000 in the 2nd quarter, $70,000 in the 3rd quarter and $95,000 in the 4th quarter. We now test each quarter. In the 1st quarter sales were down 10%, therefore the taxpayer is not eligible. The 2nd quarter gross receipts are down 90% from the 2019 amount ($100k in 2019 compared to $10k in 2020). The taxpayer is now eligible for the 2nd quarter and the 3rd quarter. The 3rd quarter sales are only 70% of the 2019 figure and therefore since the salon has not reached 80%, it is automatically eligible in the 4th quarter. The 4th quarter is only down 10% compared to the 2019 figure, however, the law states you are eligible up to and including the quarter where gross receipts are restored to at least 80% of the 2019 corresponding quarter. If the 3rd and 4th quarter figures of 2020 were reversed ($95,000 in the 3rd quarter and $70,000 in the 4th quarter), then the salon would not be eligible for a credit in the 4th quarter. The salon reached the 80% threshold in the 3rd quarter which means although it is eligible in 3rd quarter, it is not in the 4th quarter.

The second rule above pertains only to the 2020 ERC credit. The rules change in 2021 and I will get to them shortly.

Please keep in mind the two tests are completely separate. If your business is eligible because you were shut down, and not because your receipts dropped by at least 50%, then you are eligible only during the shutdown period. It is generally more advantageous if a business can qualify under the second test.

Aggregation Rules

I want to point out that related employers (generally companies that share greater than 50% common ownership) must be looked at in total to determine the gross receipts test. Additionally, if just one entity has its operations partially or fully suspended, then all related entities are considered to be partially or fully suspended. Aggregation rules can be complicated and are beyond the scope of this writing. I just want to say if you have companies that may be related discuss it with a professional to ensure that you apply the law correctly.

What wages specifically can be included in the computation?

Qualified wages for eligible employers with greater than 100 full-time employees are wages paid to employees not providing services during the period of eligibility. Full time employees are employees working at least 30 hours per week. If you employ more than 100 full time employees than only wages for employees being paid that are not working are counted. There is a limitation on these employees based on the amount such employees would have been paid for working an equivalent duration during the 30 days immediately preceding the coronavirus crisis. All this last sentence means is that employers were not allowed to boost someone’s pay rate during a period of eligibility in order to increase the credit.

Qualified wages for eligible employers with no more than 100 full-time employees are all wages paid whether or not the employee is working or not during the period of eligibility.

While the 100-employee test focuses on full time employees, the actual computation counts full and part time employees. If a company employs more than 100 full time employees than the wages of all full and part time employees that are being paid but not providing services are counted.

If a company has 100 or less full-time employees than all the wages of the full and part time employees are counted.

Group health benefits of employees are considered qualified wages.

Are there any other limits on eligible wages?

Wages of more than 50% owners and related parties to a more than 50% owner are not eligible wages. In addition, there is a limit of $10,000 per individual in 2020.

There are also exclusions for pre-existing paid time off, severance pay and wages where other credits have been taken such as paid family and medical leave credit.

Only wages incurred after March 12, 2020 are eligible.

What is the amount of the credit?

The credit is a 50% credit of qualified wages, or up to $5,000 per individual in 2020. Let’s say an employer has two employees, Employee 1 that earns $2,000 each quarter and Employee 2 that earns $15,000 each quarter. This includes the employee’s wages and health benefits. Lastly, I will assume the entity was eligible for the ERC in the 2nd, 3rd, and 4th quarters of 2020. Employee 1 will earn $6,000 while Employee 2 will have compensation of $45,000 in 2019. The ERC would be 50% of $6,000, or $3,000 and 50% of $10,000 (remember there is a $10,000 limit per employee), or $5,000. The business has an $8,000 credit. In actuality the 2nd quarter would show a $6,000 credit ($1,000 credit on Employee1 and a $5,000 credit on the Employee 2). The 3rd and 4th quarters would each have a $1,000 credit (all on Employee 1 and none on Employee 2 because the limit had been reached).

If this is such a great credit, why haven’t I heard of it before?

The original law had a provision which stated any employer that received a PPP loan was not eligible. PPP was a better deal and that’s why PPP was in the news every day and there was little mention of the ERC.

The new law passed December 27th, 2020 changes the rules and allows employers that received a PPP loan to also receive an ERC. You must be careful.  Wages considered for PPP loan forgiveness may not be used for ERC purposes.

Further, the law states that we are to assume this was always the law. Eligible taxpayers are able to file amended payroll tax Forms to claim the 2020 ERC. If you are filing an amended Form 941-X solely for the change in the law pertaining to the allowance of PPP borrowers to also obtain an ERC, then you can file one amended 4th quarter 2020 Form 941-X to correct all quarters of 2020.

Reduction in income tax deductions by the amount of ERC

The law requires taxpayers that obtain an ERC to reduce their tax deductions by the amount of the ERC. In my example of the employer that obtained an $8,000 credit, that same employer would be required to reduce the deductions on their 2020 income tax return by $8,000.

2021 ERC

While the shutdown test remains in place in 2021, the second test has changed. Employers are eligible on a quarter-by-quarter test. If the gross receipts for the any quarter of 2021 are less than 80% of the gross receipts of the corresponding 2019 quarter the employer is eligible. The new law changed this from 1st and 2nd quarters of 2021 to all four quarters of 2021. Additionally, employers have the option of using the prior quarter for the test. Let’s say the 1st quarter of 2021 was only down 15% compared to the 1st quarter of 2019, but the 4th quarter of 2020 was 25% lower than the 4th quarter of 2019. The taxpayer may choose to use the 4th quarter of 2020 for the computation instead of the 1st quarter of 2021. The same would hold true for an employer calculating the 2nd through 4th quarters of 2021. The employer could choose to use the prior quarter for the computation. This is only for purposes of qualifying under the gross receipts test. If an employer is eligible the actual computation of the quarterly ERC would be based on wages on the appropriate quarter (not the prior quarter used for the gross receipts test).

What other changes were made for 2021?

In 2020 there was a limitation of $10,000 of wages per employee for the year. In 2021 this figure has changed to $10,000 per quarter. The new law changed this from the first 2 quarters of 2021 to all four quarters of 2021.

The credit has been increased in 2021 from 50% in 2020 to 70% in 2021. This means that while the limit was a $5,000 credit per employee in 2020 ($10,000 multiplied by 50%), it is now up to $28,000 per employee in 2021 ($10,000 per quarter multiplied by 70%).

Let’s look at another example. An employer has two employees, Employee1 and Employee 2. Employee 1 makes $6,000 in the 1st quarter, $12,000 in the 2nd quarter and $8,000 each in the 3rd and 4th quarters. Employee 2 makes $15,000 in each of the four quarters. The credit in the 1st quarter would be $6,000 X 70% ($4,200) + $10,000 X 70% ($7,000) or $11,200.

The 2nd quarter would be $10,000 X 70% for both employees or a total of $14,000. The employer is limited to $10,000 of wages on Employee 1 even though that employee did not use the full $10,000 amount in the 1st quarter. In other words, the employer cannot carry over any amount under the $10,000 threshold.

The 3rd and 4th quarters would be $8,000 X 70% + $10,000 X 70% or $12,600 for each quarter.

The test of full-time employees was changed from 100 to 500 full time employees; therefore, it is a much easier eligibility test for employers to reach. The advantage of meeting this test is that all wages, not just wages of those being paid and not working, are eligible for the credit.

Reduction in income tax deductions by the amount of ERC

The law requiring taxpayers that obtain an ERC to reduce their tax deductions by the amount of the ERC remains in place for an ERC taken in 2021.

How this might affect PPP loan forgiveness

We know from the law passed in December of 2020 that employers that obtained a PPP loan can now also obtain an ERC but cannot use the same wages for both. We also know that borrowers of PPP loans must utilize 60% of the loan proceeds for payroll in order to obtain forgiveness.

Without the passage of this law, we might just use 100% of wages for PPP forgiveness and be finished. Now it may be beneficial to utilize some of the other allowed expenses (in 2020 it was rent, mortgage interest and utilities) in order to maximize the ERC. Let’s take an example where an employer obtained a $100,000 PPP loan. Let’s also assume the employer had $40,000 of rent during the covered period of the PPP loan. If the employer applies for forgiveness using $60,000 of payroll and $40,000 of rent, then they now have $40,000 of payroll that may be eligible for the ERC. I say may be eligible because there are additional rules ($10,000 cap per individual and/or wages of individuals owning more than 50% of the entity).

These computations may become complex. Take an example of a borrower that obtained a PPP loan before the PPP Flexibility Act passed on June 5th of 2020. This borrower has the option of using an 8-week covered period or a 24-week covered period. There could be a situation where during the 8-week covered period the employer meets the full-time equivalent requirement of their forgiveness because they maintained all employees during the 8 weeks but subsequently reduced their work force based on economic conditions. Using a 24-week covered period might reduce forgiveness, however being able to use 6 months of rent and freeing payroll for the ERC may result in a bigger benefit from the ERC than the reduction in forgiveness. My point is you must coordinate your PPP loan forgiveness with the ERC in order to maximize your benefit.

Premium Tax Credit

For 2021 and 2022 there is an expanded credit which is accomplished by changing the percentage of premium the taxpayer is required to pay.

The law also eliminates the requirement, for 2020 only, that a taxpayer that received advanced credits in excess of what would be allowed based on their 2020 income figures shown on their tax return, has to repay the amount they were overpaid.

For example, let’s say a taxpayer, based on estimated income and family size amounts provided to an insurance carrier received a credit on their health insurance of $300 per month, or $3,600. When the 2020 income tax return is prepared it shows that the taxpayer should have only received a credit of $3,000. In all other years, the taxpayer would be required to pay back the $600 difference. Again, in 2020 only, this money does not have to be repaid.

Miscellaneous Provisions

EIDL advance grants and restaurant revitalization grants are not included in gross income.

Student loans discharged in 2021 through 2025 are not included in income.

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Hang in there and stay safe,

Jeff Skolnick, CPA, M.S. Taxation