After months of protracted negotiations, the Senate and the House passed the omnibus spending and Coronavirus relief bill known as the Consolidated Appropriations Act, 2021, H.R. 133 (the “Act”) on December 21, 2020. On December 27, 2020, the President signed the Act into law. The Act provides approximately $900 billion in financial assistance and various tax benefits intended to provide relief against the continued economic fallout of the coronavirus. This includes the extension of many benefits initially included in the Coronavirus, Aid, Relief, and Economic Security Act that was enacted on March 27, 2020 (the “CARES Act”) (for a summary of the tax provisions of the CARES ACT see our previous Tax Report at this link. The Act also includes extensions for various temporary tax breaks as well as a much-anticipated Congressional approval of tax deductions arising from business expenses funded with Paycheck Protection Program (“PPP”) loans eligible for forgiveness.

Direct Payments to Taxpayers

The Act provides a second round of direct payments to eligible taxpayers (the “Direct Payments”). A point of much contention, the amount of the Direct Payments this time around is notably smaller with the maximum payment amount ending up at $600 per single filers and $1,200 per married couples filing jointly. An additional $600 is available for each qualifying child of an eligible taxpayer with a social security number or adoption taxpayer identification number. Similar to the first round of Direct Payments, the new Direct Payments phase out for higher-income taxpayers. The phase out begins at $75,000 of adjusted gross income for individual filers, $112,500 for heads of households, and $150,000 for married couples filing jointly. The Direct Payments phase out completely at $87,000 for individual filers, $124,500 for heads of households, and $174,000 for married couples filing jointly. The Direct Payment amount and phase-out calculations will be based on information provided in taxpayers’ 2019 returns (otherwise, the processing of the Direct Payments would have to wait on the filing of 2020 returns).

To be eligible for the Direct Payments, a taxpayer must have a valid social security number. However, married couples filing jointly are eligible for a $600 Direct Payment if only one spouse has a social security number. This is an expansion of the rules from the first round of Direct Payments which required both spouses to have a valid social security number unless they were a member of the military and should result in more taxpayers qualifying for Direct Payments. Nonresidents and individuals who can be claimed as a dependent on another taxpayer’s return, estates and trusts are all ineligible. Much like the first round of Direct Payments, the Direct Payments are structured as advanced rebates of a 2020 tax credit. The Act stipulates that no repayment will be required for Direct Payments received that exceed the actual credit amount as eventually determined on a recipient’s 2020 return. Eligible individuals who do not receive a Direct Payment – either the first or the second payment – will be able to claim it when they file their 2020 taxes in 2021. Many people, including recent college graduates, may be eligible to claim it on their 2020 income tax returns. The Direct Payments will be referred to as the Recovery Rebate Credit (“RRC”) on Form 1040 or Form 1040-SR since the Direct Payments are an advance payment of the RRC.

PPP Loan Expense Deductibility

The Act clarified that business expenses paid for with PPP loans that are ultimately forgiven will be fully deductible. The clarification was in response to a contrary position taken by the IRS shortly after the enactment of the CARES Act.

In May, the IRS issued Notice 2020-32 (the “Notice”) which stipulated that, pursuant to Section 265 of the Internal Revenue Code of 1986, as amended (the “Code”), and existing case law, the IRS would be taking the position that no deduction is allowed for otherwise deductible expenses if the payment of such expense results in forgiveness of a PPP loan because the cancellation of debt income that would result from such forgiveness is explicitly excluded from gross income pursuant to the CARES Act. The vast majority of PPP borrowers used loan proceeds to pay expenses that are typically deductible, such as wages, payroll expenses, utilities and rent. While the Notice was based on well-established income tax principles, the inability to deduct these expenses was viewed by many practitioners as unnecessarily burdensome to struggling PPP borrowers. In addition, the Notice was critiqued by multiple members of Congress as being plainly against the legislative intent of the PPP loan program.

By providing that expenses funded with a forgiven PPP loan will be fully deductible and that the tax basis and other attributes of PPP borrowers’ assets will not be reduced as a result of PPP loan forgiveness, the Act makes the legislative intent of the tax treatment of PPP loans explicitly clear and effectively overrides the Notice. The Act provides that deductibility will apply to expenses funded by prior PPP loans and expenses funded by new PPP loans issued from the additional $284 billion of PPP funds provided under the Act. The Act also stipulates that owners of pass-through business entities (partnerships and S corporation) will receive an increase in their adjusted basis when the PPP loan is forgiven despite the fact that such forgiveness will not result in a taxable income.

While the deductibility of PPP related expenses will likely be viewed as a taxpayer friendly reversal of the IRS position set forth in the Notice, certain timing issues arising from the timing of the PPP loan forgiveness should be considered. In particular, the deduction for PPP related expenses for owners of pass-through entities may be limited due to inadequate tax basis or amounts at risk if the PPP loan is not forgiven or deemed to be forgiven in the same year in which the expenses were incurred. This is because the increase in tax basis resulting from PPP loan forgiveness does not occur until the year in which the PPP loan is actually forgiven. The suspension of the deduction as a result of the basis or at-risk limitation may only be temporary, and the deduction would be available for the year the taxpayer is at risk or income tax basis is available.

Earned Income Credit & Child Tax Credit Look Back

Under the Act, the computation of the Earned Income Tax Credit and the Child Tax Credit will be determined using taxpayers’ 2019 income. The amount of Earned Income Credits and Child Tax Credits available to taxpayers is based upon the income of a taxpayer in the year in which the credits are received. The amount of the Earned Income Credit available to a taxpayer equals a percentage of the taxpayer’s earnings from the first dollar up to a maximum amount after which the amount of the credit is phased out. The Child Tax Credit is only available to taxpayers who have earned at least $2,500. The Child Tax Credit is then subject to a phase out at higher levels of income.

Due to the economic disruption caused by the pandemic, it has been expected that many lower income taxpayers that typically rely on these credits will have significantly lower income in 2020 and, therefore, will be eligible for reduced credits relative to prior years. This “double whammy” effect of (i) reduced income and (ii) reduced credits, was addressed via the “look back” rules provided for under the Act. Under these rules, taxpayers are permitted to use their 2019 income for purposes of calculating their 2020 Earned Income Credits and Child Tax Credits.

Modified Limitations on Charitable Contribution Deductions

The Act extends into 2021 the modified limitations on charitable contributions provided by the CARES Act which were set to expire at the end of 2020.

By way of background, the CARES Act significantly benefited individuals and corporations making cash contributions to qualified charitable organizations during 2020. Absent the temporary changes provided by the CARES Act, individuals are not allowed to deduct cash contributions to charitable organizations in an amount that exceeds 60% of their contribution base which is based on adjusted gross income (AGI). The CARES Act suspended the 60% limit for 2020 and permits deduction of amounts up to 100% of the taxpayer's contribution base. Similarly, the 10% of taxable income limit for charitable contributions by corporations was increased to 25% for 2020 by the CARES Act. Pursuant to the Act these relaxed deduction rules will now remain in place for 2021.

Allowing individual taxpayers to deduct up to 100% of AGI has in effect provided taxpayers 59½ years of age and older a vehicle for making unlimited cash contributions to qualifying charities using IRA assets without adverse federal tax consequences. Notwithstanding the modified limitations discussed above, individuals over the age of 70½ years of age can make a Qualified Charitable Distribution (“QCD”) directly to a qualified charity from an IRA without including the distribution in taxable income. However, in addition to the age requirement, the QCD rules limit these types of distributions to $100,000.00. The CARES Act, and now extended into 2021 by the Act, allows individuals over 59½ to take a cash distribution from an IRA in any amount (which will be included in income), contribute the cash to a qualifying charity, and then offset in full the income by taking a charitable deduction up to 100% of AGI. The QCD rules remain in place and will generally be the preferred option for individuals over the age of 70½ making charitable contributions up to $100,000.00, but the CARES Act and now the Act provide significant benefits to individuals ages 59½ through 70½ wanting to make charitable contributions using IRA assets, and it accommodates individuals wanting to make contributions in excess of the $100,000.00 limitation in the QCD rules.

“Above-the-Line” Charitable Contribution Deductions

The Act also extends into 2021 the ability for taxpayers who do not itemize their deductions to deduct up to $300 for cash contributions made to certain qualifying charities. In addition, taxpayers filing a joint return can deduct up to $600 for cash contributions made in 2021, whereas the deduction is limited to $300 total for 2020 even for taxpayers filing jointly.

This charitable deduction is applied “above-the-line” and therefore allows taxpayers who use the standard deduction (as opposed to itemizing their deductions) to take advantage of the deduction. Taxpayers who itemize their deductions (rather than using the standard deduction) will continue to deduct charitable contributions “below-the-line” as they normally would be, subject to the increased limitations discussed above. The Act also increases the penalty for taxpayers overstating the above the line deduction from 20% to 50%.

Full Deduction for Business Meals

One of the more controversial provisions in the Act, referred to by many as the “Three-martini lunch” deduction, allows business meals to be deducted in full for 2021 and 2022. Previously, business meals could be deducted at only 50% of their cost. The full deduction is intended to help restaurants, but it is viewed by others as a tax break for wealthy business owners and executives. For now, the full deduction is set to expire at the end of 2022.

Medical Expense Deductions

The Act makes permanent the 7.5% AGI floor that applies to the deduction for unreimbursed medical expenses which was set to increase to 10% in 2021. Taxpayers who itemize their deductions in 2021 and thereafter will thus continue to deduct unreimbursed medical expenses that exceed 7.5% of AGI.

Educator Expense Deduction for PPE and Other Covid-19 Prevention Supplies

The Act provides clarification aimed towards allowing eligible educators to deduct unreimbursed expenses incurred after March 12, 2020, for the purpose of reducing the spread of COVID-19 in the classroom. Currently, teachers and other eligible educators can deduct up to $250 for certain unreimbursed trade or business expenses related to their teaching. The Act requires the Secretary of the Treasury, by February 28, 2021, to provide guidance clarifying that the deduction is available for expenses incurred after March 12, 2020, for personal protective equipment (“PPE”), disinfectant, and other supplies used for the prevention of the spread of COVID–19.

Employee Retention Credit

The Act extends the availability of the Employee Retention Credit (“ERC”) (which was originally scheduled to expire under the CARES ACT on December 31, 2020) through June 30, 2021. Under the CARES Act, the ERC is a fully refundable employee retention payroll credit equal to 50% of qualified wages (including qualified health expenses) that eligible employers pay their employees between March 13, 2020 and December 31, 2020 up to a maximum of $5,000 per employee. Among other changes, the Act increases the payroll credit to an amount equal to 70% of qualified wages per quarter. During Q1 and Q2 of 2021, a maximum of $10,000 in qualified wages paid in each quarter may be counted for purposes of determining the 70% credit. Therefore, the maximum credit for each employee for 2021 is $14,000.

The Act also removes the CARES Act restrictions that prevented employers who obtained a PPP loan from claiming the ERC. Under the modifications provided by the Act, employers are permitted to claim the ERC on any eligible wages not used to support PPP loan forgiveness. In addition, any wages that are eligible for both PPP loan forgiveness and the ERC are now permitted to be applied to either, but not both, per an employer election.

The Act reduces from 50% to 20% the reduction in gross receipts (compared to the same calendar quarter in 2019) that potentially triggers the availability of the credit for certain employers. For example, under the CARES Act, an employer qualified for the ERC for the period beginning with the first calendar quarter for which gross receipts for the employer were less than 50% of gross receipts for the same calendar quarter of 2019. Under the Act, an employer qualifies for the ERC for the period beginning in a calendar quarter in which the employer’s gross receipts are less than 80% (instead of 50%) of gross receipts for the same calendar quarter of 2019. Employers may also elect to apply the gross receipts test based on gross receipts from the prior calendar quarter to determine their eligibility for the credit. The Act also makes the ERC available in 2021 to employers that were not in existence in 2019 by permitting them to apply the gross receipts test based on 2020 gross receipts. The Act also increases the 100-employee delineation to 500 or fewer employees allowing businesses with PPP loans to qualify.

Deferred Employee Payroll Tax

On August 28, 2020, the IRS issued guidance (IRS Notice 2020-65) implementing the President’s August 8, 2020 Executive Order directing that employers be allowed to defer the withholding, deposit and payment of the employee portion of certain payroll taxes paid from September 1, 2020 through December 31, 2020. This deferral applies to the 6.2% Social Security portion (not the 1.45% Medicare tax portion) of payroll taxes otherwise due during the September 1, 2020 through December 31, 2020 time period. The due date for the withholding and payment of the deferred amount was postponed until the period beginning January 1, 2021 and ending April 30, 2021. The Act extends the due date for that deferral to be repaid to December 31, 2021.

Flexible Savings Account Changes

The Act, permits, but does not require, employers to amend their flexible spending account (“FSA”) plans to allow employees to carryover unused FSA balances from the 2020 plan year into the 2021 plan year and to carryover any unused balances from the 2021 plan year into the 2022 plan year. Employers may also extend the 2020 and 2021 FSA grace periods (to spend unused amounts in the following plan year) until 12 months after the 2020 or 2021 plan years end.

Payroll Tax Credits for Paid Leave

The Families First Coronavirus Response Act (the “FFCRA”) required eligible employers to provide COVID-19 related emergency paid sick leave and paid family leave. The FFCRA provided employers with a refundable payroll tax credit to cover wages paid in connection with such leave taken between April 1, 2020 and December 31, 2020. Under the Act, employers may voluntarily provide COVID-19 related leave and the associated payroll tax credit is extended to leave taken between January 1, 2021 and March 31, 2021.

Technical Correction for Depreciation of Residential Rental Property

Pursuant to changes included in the the Tax Cuts and Jobs Act of 2017 (“TCJA”), a “real property trade or business” (“RPTB”) is eligible to elect out of Section 163(j) of the Code, which limits the deductibility of business interest for taxpayers under certain circumstances. If a RPTB, makes this election it must depreciate its property under the alternative depreciation system (“ADS”) resulting in a longer cost recovery period. When TCJA was enacted, the ADS cost recovery period was reduced from 40 years to 30 years for residential rental property, but this reduction only applied to buildings placed in service after December 31, 2017, leaving out taxpayers that made the section 163(j) election for tax year 2017. The Act corrects this retroactively by allowing all residential rental properties to use the 30-year cost recovery period including those properties placed in service prior to 2018.

Section 954(c) Look Through Rules

Section 954(c)(6) of the Code currently provides that dividends, interest, rents, and royalties received or accrued by a controlled foreign corporation (“CFC”) from a related CFC is not treated as foreign personal holding company income, which is includible as subpart F income, of a U.S. shareholder, provided that the payment is not itself subpart F income or income that is effectively connected with a U.S. trade or business. A CFC is a foreign corporation that is more than 50% owned by U.S. shareholders. A U.S. shareholder is a person that owns 10% or more of the total combined value or voting power of the CFC. This rule was set to expire on December 31, 2020. The Act extends this rule to taxable years beginning before January 1, 2026 and to taxable years of U.S. shareholders with or within which such taxable years of CFCs end.

Work Opportunity Credit

The Act extends the Work Opportunity Tax Credit through tax year 2025. This credit is meant to incentivize employers to hire employees from certain targeted groups listed in Section 51(d) of the Code, such as veterans, ex-felons, and participants in specified government assistance programs. The credit amount is equal to between 25% to 40% of qualified first-year wages for the applicable taxable year, depending on the amount of work hours that the employee performs.

Low-Income Housing Tax Credit (LIHTC)

Low-Income Housing Tax Credit (LIHTC) is modified under the Act by creating a permanent, 4% floor for LIHTC. As a result, the applicable percentage rate can no longer fall below 4% as a result of cuts to the federal borrowing rate. The LIHTC is generally used for the rehabilitation and renovation of affordable housing. Under the program, there are two credits available: (i) the 9% credit used for new construction and (ii) the 4% credit typically used for rehabilitation of older rental housing and the preservation of subsidized rental developments as well as tax-exempt bond financed projects. For tax-exempt bond-financed projects, the fixed 4% rate is effective for projects placed in service after December 31, 2020, a portion of which is financed by tax-exempt bonds issued after December 31, 2020. For projects that are not bond-financed, the fixed 4% rate is effective for existing buildings that are placed in service after December 31, 2020, and which receive a LIHTC allocation in or after 2021.

New Markets Tax Credit

The Act includes a five-year, $25 billion extension of the New Markets Tax Credit under Section 45D of the Code, which was set to expire on December 31, ,2020. Specifically, the Act provides $5 billion annually for each of calendar years 2020 through 2025. Additionally, the Acts extends the use of the carryover of any unused new markets tax credits from 2025 to 2030, giving taxpayers the ability to carryover unused new markets tax credits for five additional years.

Carbon Capture Credits

The Act modifies the definition of “Qualified Facility” under Section 45Q(d) of the Code which provides for the carbon oxide sequestration credit. Prior to the enactment of the Act, the construction of a “Qualified Facility” had to begin prior to January 1, 2024. The Act amended that date to January 1, 2026, which gives taxpayers seeking to obtain the carbon oxide sequestration credit an extra two years to begin construction of a “Qualified Facility”.

Craft Beverage Credits

The Act adopted language from the Craft Beverage Modernization and Tax Reform Act, making existing federal excise tax rates for small and independent breweries permanent. The Act also makes permanent the reduced beer excise tax rate under Section 5051 of the Code.

Section 179D Deductions for Efficiency Improvements

The Act makes permanent the Energy Efficient Commercial Buildings Deduction under Section 179D of the Code. This provision of the Code was previously set to expire for property placed into service after December 31, 2020. The Act also provides for an inflation adjustment for the Energy Efficient Commercial Buildings Deduction. Further, the Act extends the $2,000 energy efficient homes credit under Section 45L from December 31, 2020 to December 31, 2021.

Additional Tax Extender Provisions

The following additional extender provisions were also included in the Act:

  • Section 108(a)(1)(E) is amended to extend the exclusion from income for mortgage debt forgiveness for five years (through January 1, 2026), however, the maximum amount is reduced from $2 million to $750,000.
  • Section 163(h) which treats mortgage insurance premiums as deductible qualified residence interest under certain circumstances is amended and the deduction is extended for one year through December 31, 2021.
  • Section 48 was amended to extend the investment tax credit for solar and the residential energy-efficient property tax credit is extended for two years (through January 1, 2024).