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