President Biden signed the American Rescue Plan Act of 2021 (the “ARPA”) on Thursday, March 11. The legislation is one of the largest economic stimulus plans in U.S. history. Providing for approximately $1.9 trillion in federal spending, the ARPA contains an array of economic assistance programs, including continued direct payments to Americans, extended jobless benefits, funding for coronavirus testing and vaccine distribution and an infusion of cash to state and local governments. The ARPA also contains significant anti-poverty measures and various benefits for low-income Americans. As with previous coronavirus-related stimulus packages, many of these benefits are provided via temporary and permanent changes to the U.S. tax system. This Tax Report summarizes the significant tax provisions of the Act.
Child Tax Credit
The ARPA made significant changes to the Child Tax Credit (“CTC”) which may be worth as much as $3,600 per child for tax year 2021. Under the CTC in effect for tax year 2020, (i) the CTC was $2,000 per dependent child under the age of 17, (ii) the CTC did not begin to phase out until a taxpayer’s adjusted gross income reached $200,000 (and $400,000 for a joint return) and (iii) only up to $1,400 of the CTC was refundable and could only be obtained if the taxpayer earned income of at least $2,500. These final two limitations on the CTC have been historically criticized as being disproportionately burdensome for lower-income individuals who presumably need the benefit of the CTC the most.
Under the ARPA, for tax year 2021 the CTC has been increased to $3,600 per child under the age of 6, and $3,000 per child ages 6 through 17 (the CTC previously applied only to children under 17). The credit is also fully refundable (the refundable amount was limited to $1,400 in 2020), and the $2,500 earned income requirement has been eliminated. Further, those eligible for the CTC will enjoy some of the cash benefit of the CTC this year as opposed to realizing receiving cash only when filing their tax return in the spring of following year, as had been the case prior to the ARPA. More specifically, the IRS will make monthly payments from July 2021 through December 2021 amounting to ½ of the CTC, and the remaining half will be realized when claimed in the spring of 2022 when the taxpayer files the 2021 tax return.
Finally, the CTC will effectively have 2 sets of phase-outs. The expanded CTC benefits added by the ARPA begin to phase out for taxpayers with an adjusted gross income of $75,000 ($150,000 for a joint return). However, those who do not qualify for the expanded benefits are still eligible for the CTC under the same rules applicable to 2020, meaning they can receive up to $2,000 per child with the higher phase-outs covered above ($200,000 for single, and $400,000 for joint returns). For now, the expanded benefits of the CTC are only available for 2021. Unless extended, the rules for 2022 will revert back to those in place for 2020.
Child and Dependent Care Credit
The ARPA made several modifications to the Section 21 of the Internal Revenue Code of 1986, as amended (the “Code”) which governs the child and dependent care tax credit. Like the changes to the CTC, changes to the child and dependent care credit are effective for tax year 2021 only. The ARPA raises the dollar limit on employment-related child and dependent care expenses from $3,000 to $8,000 for one qualifying individual and from $6,000 to $16,000 for two or more qualifying individuals. In addition, the maximum reimbursement percentage is increased from 35% to 50%. Consequently, the maximum allowable credit amount has been increased to $4,000 for one qualifying individual and $8,000 for two or more qualifying individuals. This 50% maximum credit amount is reduced, to a floor of 20%, by one percentage point for every $2,000 that a taxpayer’s adjusted gross income exceeds $125,000. For taxpayers with adjusted gross income in excess of $400,000, the 20% maximum credit amount is further reduced for every $2,000 of adjusted gross income in excess of $400,000 until the credit is fully phased out.
Student Loan Debt
Relief for taxpayers with student loan debt has been a common target of previous COVID related stimulus packages. Federal student loans have been in a forbearance period since March of 2020 (scheduled to continue until October of 2021). The Biden Administration is also expected to move to cancel some portion of existing federal student loan debt, though it is unclear what amount will be cancelled or when such a move will be made. Continuing along this path, the ARPA provides further relief for those with student loans by temporarily changing the income tax treatment of student loan debt cancellation. Under prior law, any amount of private or federal student loan debt that is cancelled or forgiven is treated as gross income for the debtor. The ARPA amends Code Section 108(f) to exclude any amount of private or federal student loan debt forgiven after December 31, 2020. Notably, however, the ARPA did not make this change permanent and the revision to Code Section 108(f) is scheduled to sunset as of January 1, 2026.
The ARPA authorizes a third round of stimulus payments up to $1,400. Like previous stimulus payments, the $1,400 payments are excluded from taxable income. This round expands the eligibility for certain dependents of eligible taxpayers from children under the age of 17 to all dependents in the household. The stimulus payments are subject to certain limitations with respect to a household’s adjusted gross income. Households with adjusted gross income of more than $80,000 for single filers, $120,000 for head of household filers, and $160,000 for married filing jointly will not receive any payment. For taxpayers with adjusted gross incomes below those respective limitations the stimulus is subject to a phaseout beginning at $75,00 for single filers, $112,500 for head of household, and $150,000 for married filing jointly.
Earned Income Credit
For the tax year 2021 only, the ARPA will increase the availability of the earned income tax credit (“EIC”) for childless households, effectively making more taxpayers eligible to claim the EIC. Pursuant to the ARPA, individual taxpayers (with no qualifying children) will see changes to the computation of their EIC, including increases in (i) the phase-out percentage, (ii) the earned income amount, and (iii) the phase-out amount. Also, the maximum EIC amount for childless households, will increase from $540 to $1,500. Moreover, the age range for the EIC recipients has been broadened. For childless households, individual taxpayers will be able to claim the EIC beginning at age 19 (instead of age 25), with the exclusion of certain students ages 19 to 24. Further, the upper age limit of 65 years will be eliminated and the EIC will not be subject to an upper age limit. For purposes of calculating the 2021 EIC, individual taxpayers may choose to use their 2019 income if it was higher than their 2021 income.
For all future tax years, including tax year 2021, married individual taxpayers who are separated may be treated as not married for the purpose of the EIC if, and only if, such married individual taxpayers do not file a joint tax return. This change applies only if the individual taxpayer (who is claiming the EIC) lived with a qualifying child for more than one-half of the applicable tax year and also did not have the same principal residence as the spouse for at least six (6) months of the applicable tax year. In addition, individual taxpayers who otherwise would be eligible to claim the EIC, but whose children do not have social security numbers (SSNs), will now be permitted to claim the EIC available to childless households.
Unemployment Compensation Benefits
Although unemployment compensation benefits are normally includable as taxable income, retroactive for the 2020 tax year only, the ARPA has made the first $10,200 of income from unemployment compensation benefits tax-free for individual taxpayers with incomes of less than $150,000 for the 2020 tax year. How this tax benefit will be claimed and applied is subject to further instructions or guidance to be issued by the Internal Revenue Service.
Employee Retention Credit
The Employee Retention Credit (the “ERC”) under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), which was originally scheduled to expire on December 31, 2020 and was extended by the Consolidated Appropriations Act, 2021 (the “CAA”) until June 30, 2021 (see our prior Alert). The ERC is extended under the ARPA to cover qualified wages paid through December 31, 2021. In addition, the ARPA provides the following changes to the ERC rules:
- Expansion of ERC eligibility to “recovery startup businesses” which is defined as employers that (i) commenced operations after February 15, 2020, (ii) have gross annual receipts of less than $1 million, and (iii) otherwise don’t satisfy the ERC eligibility requirements. The ERC is capped at $50,000 per quarter for “recovery startup businesses.”
- Expansion of ERC eligibility to “severely financially distressed” employers (even those with more than 500 employees) which is defined as employers that are experiencing a gross receipts reduction of more than 90% as compared to the same calendar quarter in 2019.
- As a reminder, the CAA increased the amount of the ERC from 50% of qualified wages to 70% of qualified wages paid per calendar quarter (this was not increased by the ARPA). Thus, eligible employers may now claim up to $28,000 per employee in 2021.
- The ERC may now be claimed against the employer’s share of Medicare tax (1.45%).
Revenue Raising Changes
The ARPA also includes certain Code changes designed to raise federal revenue to offset some of the cost of the forgoing stimulus measures.
Code Section 162(m) limits the deduction that a publicly held corporation can take with respect to compensation paid to its “covered employees” to $1 million per year. Generally speaking, a “covered employee” means the corporation’s principal executive officer (“CEO”), principal financial officer (“CFO”), and its three other highest compensated officers for the taxable year. Beginning with tax years commencing on or after January 1, 2027, the ARPA expands the number of “covered employees” to include the CEO, the CFO, and the next eight highest compensation employees of the publicly-held corporation (i.e., an increase in five covered employees). The Joint Committee on Taxation (the “Joint Committee”) estimates that the expansion of the Code Section 162(m) limits will raise $7.8 billion over 10 years.
The ARPA also permanently repeals the worldwide interest allocation rules of Code Section 864. These rules were initially adopted in 2004 as part of the American Jobs Creation Act and were intended to limit the extent to which interest expenses of a U.S. parent company are overallocated to foreign subsidiaries, which can cause an unintended reduction in foreign tax credits available to US parent companies. Since the enactment of these rules, Congress has consistently delayed their effective date and used such delay as an offset to other tax cuts. The ARPA effectively makes those prior delays a permanent repeal. The Joint Committee estimates that the repeal of the worldwide interest allocation rules will raise $22.3 billion over 10 years.
In addition, the ARPA extends the Code Section 461(l) excess business loss rule that limits certain current losses attributable to trades or businesses of noncorporate taxpayers to $250,000 for individual filers and $500,000 for joint filers. The limitation was enacted under the Tax Cuts and Jobs Act of 2017 (the “TCJA”) but was suspended by the CARES Act for tax years 2018, 2019 and 2020. As originally enacted under the TCJA, the limitation was set to expire at the end of tax year 2025. The ARPA extends the limitation through tax year 2026. The Joint Committee estimates that the extension of the excess business loss rule will raise $31 billion over 10 years.
The ARPA contains several material tax law changes that will impact most businesses and individuals. If you have any questions or would like assistance in understanding how the ARPA affects you or your business, please contact Matt Zischke, Chip Gray, Nate Dutt, Bobby Streisel, Drew Hermiller or Wells Hall, who contributed to the drafting of this Tax Report, or any member of the Nelson Mullins Tax Practice.