Be Ready for Big Changes: 2021 Tax Planning
The year 2020 was one like no other, and thus far into 2021, the 2020 mantra “expect the unexpected” has continued...
The election cycle of 2020 officially ended on January 5, 2021 with the Georgia runoff elections with Democrats miraculously wining both Senate seats.
As a result, President Biden will have slight Democratic majorities in both the House and the Senate (with the Vice President’s tie breaking vote). It was not the tsunami “Blue Wave” Democrats had been hoping for, but Democratic control nonetheless, opening the door to potentially significant tax and regulatory policy changes in 2021.
Executive Summary
On January 14, we received our first indication of what 2021 legislation will look like, when President Joe Biden outlined his "American Rescue Plan". The $1.9 trillion economic relief plan includes additional $1,400 direct stimulus checks for qualifying Americans, raises the federal minimum wage to $15 per hour, and includes $350 billion in emergency funding for state and local governments. Biden said the proposal is the first step in a two-part plan that is needed immediately and will be followed by an economic recovery plan -- the "Build Back Better Recovery Plan" -- that he will outline in February. The American Rescue Plan will bring the total amount of Covid-19 relief to exceed $5 trillion.
From a tax policy perspective, 2021 could be a year of significant legislative tax change as well. Under the Biden plan, the top income tax rate on taxpayers with income greater than $400,000 will most likely revert back to 39.6 percent, the top rate prior to the Tax Cuts and Jobs Act (TCJA) passed in 2017. Many of the other TCJA tax cuts could be rolled back as well, including the 21 percent corporate tax rate. A new corporate alternative minimum tax could also be introduced. Other tax increases are expected as well, including increased social security taxes and capital gains rates on income above $400,000 and $1 million, respectively.
The most significant proposed tax policy changes, could be in the area of estate and gift, where Biden’s proposals have included eliminating the step-up in basis at death for inherited assets, and reducing the estate tax exemption from the current $11.7 million amount to pre-TCJA levels of $5 million (indexed for inflation), or possibly even lower, to $3.5 million.
Some fear that these tax increases will be retroactive to January 1, 2021, which is certainly possible. The last time a significant tax increase was enacted retroactively was in August 1993, when the Omnibus Budget Reconciliation Act included an increase in the top estate tax rate from 50 percent to 55 percent, retroactive to January 1, 1993.
Many feel, however, that retroactive tax increases are unlikely in 2021, because unemployment is still high, and given the slow economic recovery from COVID-19, it’s not an ideal time for significant tax increases. It seems more likely that the expected tax increases would be effective later in 2021 or on January 1, 2022, giving investors more time to plan.
THE CONSOLIDATED APPROPRIATIONS ACT, 2021
The bipartisan Consolidated Appropriations Act, 2021 (CAA) was signed into law on December 27, 2020, providing $2.3 trillion of federal funding and COVID-19 relief. The law includes refundable tax credits, new Paycheck Protection Program (PPP) and Economic Injury Disaster Loans (EIDL) programs, and numerous extenders from the 2020 Coronavirus Aid, Relief, and Economic Security (CARES) Act. The 5,593 page CAA also adds numerous new tax, payroll and retirement provisions.
Recovery Rebates and Unemployment Benefits
The CAA provides a refundable tax credit in the amount of $600 per taxpayer ($1,200 for married taxpayers filing jointly), in addition to $600 per qualifying child. The credit phases out starting at $75,000 of modified adjusted gross income ($112,500 for heads of household and $150,000 for married taxpayers filing jointly). The rebates are based on 2019 tax returns, and therefore a taxpayer could receive a payment that is less than they are entitled to. These taxpayers would be able to claim an additional credit for the shortfall on their 2020 tax return. Conversely, if a taxpayer receives too high a payment, they won’t have to repay the difference.
For the 14 million Americans collecting unemployment, the Act provides an addition $300 per week from December 26, 2020 through March 14, 2021. The law also provides an extra benefit of $100 per week for certain workers who have both wage and self-employment income but whose base unemployment benefit calculation doesn’t take their self-employment into account.
Deductibility of PPP-Funded Expenses
The CAA relief package provides $284 billion to reinstate the CARES Act PPP loan program through March 31, 2021; $15 billion for live venues, independent movie theaters, and cultural institutions; and $20 billion for EIDL grants to businesses in low-income communities. The Act makes numerous modifications to the CARES Act PPP and EIDL programs, generally making them simpler and more favorable for borrowers.
In a welcome provision, the Act clarifies that gross income does not include any amount that would otherwise arise from the forgiveness of a PPP loan. This addresses a controversial issue where the IRS had taken the position that no deduction would be allowed for an expense if the payment of the expense results in forgiveness of a PPP loan. The IRS position had effectively negated Congressional intent that the PPP forgiveness be tax-free. The Act corrects that.
The deductibility provision is retroactive back to the date of enactment of the CARES Act. The Act provides similar treatment for Second Draw PPP loans, effective for tax years ending after the date of enactment of the provision. The Act also clarifies that gross income does not include forgiveness of certain loans, emergency EIDL grants, and certain loan repayment assistance, also provided by the CARES Act.
CAA CARES Act Pandemic Provisions
Employee retention tax credit: The Act extends the CARES Act Employee Retention Tax Credit (ERTC) through June 30, 2021, expanding the ERTC and making necessary technical corrections. The expansions of the credit include:
An increase in the credit rate from 50 percent to 70 percent of qualified wages;
An increase in the limit on per employee creditable wages from $10,000 for the year to $10,000 each quarter;
A reduction in the required year-over-year gross receipts decline from 50 percent to 20 percent;
A safe harbor allowing employers to use prior-quarter gross receipts to determine eligibility;
A provision to allow certain governmental employers to claim the credit;
An increase from 100 to 500 in the number of employees counted when determining the relevant qualified wage base; and
Rules allowing new employers who were not in existence for all or part of 2019 to be able to claim the credit.
The Act also makes the following changes retroactive to the effective date of the CARES Act:
Provides that employers who receive PPP loans may still qualify for the ERTC with respect to wages that are not paid with forgiven PPP proceeds;
Clarifies the determination of gross receipts for certain tax-exempt organizations; and
Clarifies that group health plan expenses can be considered qualified wages even when no other wages are paid to the employee, consistent with IRS guidance.
Payroll tax credits: The CAA extends the refundable payroll tax credits for paid sick and family leave enacted in the Families First Coronavirus Response Act through the end of March 2021. It also modifies the payroll tax credits so that they apply as if the corresponding employer mandates were extended through March 31, 2021. The CAA also allows individuals to elect to use their average daily self-employment income from 2019 rather than 2020 to compute the credit.
Deferral of employees’ portion of payroll tax: In August, President Trump issued a memorandum allowing employers to defer the withholding, deposit, and payment of the employee portion of the Old-Age, Survivors, and Disability Insurance (OASDI) tax for any employee whose pretax wages or compensation during any biweekly pay period generally is less than $4,000.
Trump’s deferral applies to payroll taxes on wages paid from Sept. 1 through Dec. 31, 2020. Under the memorandum, employers are required to increase withholding and pay the deferred amounts ratably from wages and compensation paid between Jan. 1, 2021, and April 30, 2021. The CAA extends the repayment period through Dec. 31, 2021.
Educator expenses for protective equipment: The CAA requires Treasury to issue regulations or other guidance providing that the cost of personal protective equipment and other supplies used for the prevention of the spread of COVID-19 is treated as an eligible expense for the educator expense deduction. The regulations or guidance will apply retroactively to March 12, 2020.
Retirement Plan Relief: The CARES Act temporarily allows individuals to make penalty-free withdrawals from certain retirement plans for coronavirus-related expenses, permits taxpayers to pay the associated tax over three years, allows taxpayers to recontribute withdrawn funds, and increases the allowed limits on retirement plan loans. The CAA adds money purchase pension plans to the retirement plans qualifying for these temporary rules. The provision applies retroactively to the effective date of the CARES Act.
Be aware that the CAA doesn’t extend the CARES Act’s temporary waiver of required minimum distributions. Affected taxpayers should plan on resuming those distributions for 2021.
CAA Tax Provisions
Temporary allowance of full deduction for business meals: The Act temporarily allows a 100 percent business expense deduction for meals (rather than the current 50 percent) as long as the expense is for food or beverages provided by a restaurant. This provision is effective for expenses incurred after Dec. 31, 2020, and expires at the end of 2022.
Certain charitable contributions deductible by nonitemizers: Under the CARES Act, taxpayers who don’t itemize their deductions on their tax returns can nonetheless claim a $300 “above-the-line” deduction for cash contributions to qualified charitable organizations in 2020. The CAA extends that deduction through 2021 and doubles the deduction for married filers to $600. Contributions to donor-advised funds and supporting organizations don’t qualify for the deduction. The penalty is increased from 20 percent to 50 percent of the underpayment for taxpayers who overstate this deduction.
Modification of limitations on charitable contribution: The CARES Act increased the limitations on charitable deductions for cash contributions made in 2020, boosting it from 50 percent to 100 percent of Adjusted Gross Income (AGI). The CAA carries that over for 2021 more tax planning flexibility. Any excess cash contributions are carried forward to later years.
Education expenses: The Act repeals the deduction for qualified tuition and related expenses and in its place increases the phase out limits on the lifetime learning credit (so they match the phase-out limits for the American opportunity credit), effective for tax years beginning after Dec. 31, 2020.
Earned Income Tax Credits: The CAA includes a temporary change that could result in larger Earned Income Tax Credits (EITCs) and Child Tax Credits (CTCs). It allows lower-income individuals to use their earned income from the 2019 tax year to determine their EITC and the refundable portion of their CTC for the 2020 tax year. This could produce larger credits for eligible taxpayers who earned lower wages in 2020 due to the pandemic.
Temporary special rules for health and dependent care flexible spending arrangements: The CAA allows taxpayers to roll over unused amounts in their health and dependent care flexible spending arrangements from 2020 to 2021 and from 2021 to 2022. This provision also permits employers to allow employees to make a 2021 midyear prospective change in contribution amounts.
Depreciation of certain residential rental property over 30-year period: The CAA provides that the recovery period for residential rental property placed in service before January 1, 2018, and held by an electing real property trade or business, is 30 years.
Waste energy recovery property eligible for energy credit: The CAA makes waste energy recovery property eligible for the energy investment tax credit, effective for 2021 through 2023. Waste energy recovery property generates electricity from the heat from buildings or equipment.
Minimum age for distributions during working retirement: The CAA will allow certain qualified pensions to make distributions to workers who are 59½ or older and who are still working. For certain construction and building trades workers, the age is lowered to 55.
Temporary rule preventing partial plan termination: The CAA provides that qualified plans will not be treated as having a partial termination during any plan year that includes the period March 13, 2020, through March 31, 2021, as long as the number of active participants covered by the plan on March 31, 2021, is at least 80 percent of the number covered on March 13, 2020.
CAA Disaster Tax Relief
The CAA provides disaster tax relief for individuals and businesses in presidentially declared disaster areas for major disasters (other than COVID-19) declared after Dec. 31, 2019, through 60 days after the date of enactment.
Use of retirement funds for disaster mitigation: The CAA allows residents of qualified disaster areas (as defined in the Act) to take a qualified distribution of up to $100,000 from a retirement plan or individual retirement account (IRA) without penalty. Amounts withdrawn are included in income over three years or may be recontributed to the plan.
Employee retention credit for disaster zones: The CAA allows a tax credit of 40 percent of wages (up to $6,000 per employee) to employers who conducted an active trade or business in a qualified disaster zone (as defined in the Act). The credit applies to wages paid without regard to whether the employee performed any services associated with those wages.
Qualified disaster relief contributions: The CAA modifies the CARES Act’s modification of the charitable contribution limits for 2020 to allow corporations to make qualified disaster relief contributions of up to 100 percent of their taxable income.
Qualified disaster-related personal casualty losses: The CAA permits individuals who have a net disaster loss (as modified by the Act) to increase their standard deduction amount by the amount of the net disaster loss.
CAA Tax Extenders
Medical Expense Deductions: For tax years beginning before January 1, 2021, an itemized deduction is allowed for unreimbursed medical expenses that exceeded 7.5 percent of adjusted gross income (AGI). The threshold was scheduled to jump to 10 percent of AGI for 2021. The CAA permanently sets the threshold at 7.5 percent of AGI for tax years beginning after December 31, 2020.
Five-Year Tax Extenders: The CAA includes five-year extensions to the following provisions:
New markets tax credit.
Employer credit for paid family and medical leave, which is in addition to the payroll tax credits for paid sick and family leave.
Work opportunity credit.
Gross income exclusion for discharge of indebtedness on a principal residence, although the amount of exclusion is lowered to $750,000 from $2 million.
Tax-free exclusion for certain $5,250 employer payments of student loans through 2025. The payment can be made to the employee or the lender.
Empowerment zone designation.
Two-Year Tax Extenders: The Act provides two-year extensions to the following provisions:
Residential energy-efficient property credit. The bill also makes qualified biomass fuel property expenditures eligible for the credit.
Carbon oxide sequestration credit (through 2025).
Energy investment tax credit for solar and residential energy-efficient property.
One-Year Tax Extenders: The Act provides one-year extensions to the following provisions:
10 percent credit for qualified non-business energy property.
Credit for qualified fuel cell motor vehicles.
30 percent credit for the cost of alternative fuel vehicle refueling property.
10 percent credit for plug-in electric motorcycles and two-wheeled vehicles.
Health coverage tax credit.
Credit for electricity produced from certain renewable resources.
Energy-efficient homes credit.
Treatment of qualified mortgage insurance premiums as qualified residence interest.
Three-year recovery period for racehorses two years old or younger.
Excise tax credits for alternative fuels.
The American Samoa economic development credit
Looking Ahead... The "Blue Wave" Legislative Agenda
Biden’s "American Rescue Plan"
President Biden’s "American Rescue Plan" builds on previous relief to individuals, households and small businesses. It would include funding for vaccine distribution and aid to state and local governments.
Stimulus Checks: The Biden plan was said to boost direct payments to individuals to $2,000 for most Americans, on top of the $600 that the CAA provided in December. The plan would also allow residents who are married to undocumented residents, who were barred in prior rounds, to receive stimulus payments.
Biden's press secretary recently confirmed that they were now focusing on delivering $1,400 checks which would "Be equal $2,000 when combined with the check from the previous round" a change from their promise of $2,000 "immediately" if they won both senate seats. --- It remains to be seen what congress will approve.