The Consolidated Appropriations Act, 2021 (H.R. 133) (CAA) took effect on December 27, 2020. This insight provides highlights of the COVID-19-related tax relief contained within Division N, Subchapter B of the CAA, as well as other tax provisions contained within the CAA.
Despite Conventional Thinking, Double Dipping OK
The CAA confirms that approved Paycheck Protection Program (PPP) loan forgiveness be treated as a form of tax-exempt income and provides that any approved business expenses paid with PPP loan proceeds are fully tax deductible for federal income tax purposes.
The CAA effectively reverses the Internal Revenue Service’s (IRS) position set forth in Notice 2020-32 regarding the tax deductibility of business expenses paid with PPP loan proceeds. Although the Notice provided that the PPP loans wouldn’t be considered taxable proceeds (e.g., the proceeds are tax-exempt), it also stated that all expenses paid with the PPP proceeds wouldn’t be deductible for tax purposes.
In addition, Economic Injury Disaster Loan (EIDL) advances (which were up to $10,000 to each business that applied for an EIDL loan) wouldn’t generate any taxable income and all the associated expenses paid with the EIDL advances are fully tax deductible.
The CAA provides that loan forgiveness shouldn’t result in a decrease in tax basis and other attributes of the borrower’s assets. Loan forgiveness will generally generate tax basis for investors in partnerships, S Corporations, and sole proprietorships. The increase to tax basis is meant to be a mechanism to allow investors to deduct additional pass-through expenses. Special consideration should be given to the nuances for S Corporation investor’s accumulated adjustments accounts (AAA) and special allocations to entities filing a Form 1065, US Return of Partnership Income.
These provisions are effective as of the date of the enactment of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. Per the CAA, similar treatment should be provided for “Second Draw PPP” loans, effective for tax years ending after the date of the CAA.
Additional consideration should be given to address a taxpayer’s state and local tax liability. To the extent states don’t adopt a rolling conformity, adoption of the federal “double dipping” measures remain unclear. See below for further insight regarding considerations for Massachusetts taxpayers.
Employee Retention Tax Credit
The CARES Act provided an eligible employer with a refundable payroll tax credit equal to 50% of certain qualified wages paid to its employees beginning March 13, 2020 through December 31, 2020. The credit can be used to offset all the federal payroll taxes, including federal withholding tax, and the employer’s and employee’s share of social security and Medicare tax. The Act extends the availability of the Employee Retention Tax Credit through June 30, 2021, expands the eligibility of the credit, and provides technical improvements to the CARES Act employee retention credit.
The credit available for 2021 is increased significantly. Previously, the qualified wages were capped at $5,000 annually. The CAA increases this to $7,000 per quarter, effectively increasing the maximum amount of credit available from $5,000 to $28,000 per employee in 2021. Specifically, the CAA changed the Employee Retention Tax Credit eligibility requirements for the 2021 tax year as follows:
- Year-over-year gross receipts threshold reduced from 50% to 20%
- The Large Employer full time employee limit has been raised from 100 to 500 employees
- Employee Retention Tax Credit percentage of wage base increased from 50% to 70%
- Increased wage limit from $10,000 per employee per year to $10,000 per employee per quarter
The CAA permits an employer that receives a PPP loan to receive the employee retention tax credit subject to limitations. The limitation effectively results in reducing the amount of loan forgiveness or reducing the employee retention credit.
Massachusetts Tax Considerations
Businesses organized as subchapter C corporations generally follow rolling conformity with the Internal Revenue Code (IRC). Therefore, we would expect measures enacted for federal income tax purposes to be adopted for Massachusetts income tax purposes. Note, Massachusetts does have certain adoption exceptions. For example, Massachusetts doesn’t adopt IRC section 172 regarding the use of net operating losses and entities are unable to use losses incurred in 2018 through 2020 to be carried back and deducted to prior years as provided by the CARES Act.
Passthroughs and Individuals
Unlike subchapter C corporations, entities taxed as partnerships, subchapter S corporations, or as sole proprietorships adopt the IRC in effect on January 1, 2005. Therefore, the federal income exclusion for loan forgiveness isn’t available and businesses are effectively taxed on the refundable portion of the loans provided. However, even though passthroughs and individuals wouldn’t be eligible for the “double dip,” to the extent refundable loan proceeds are treated as gross income for Massachusetts income tax purposes, we would expect expenses paid with such funds to be tax deductible.
All Massachusetts Taxpayers
Massachusetts will follow the CARES Act provision which temporarily modified the interest expense limitation rules of IRC section 163(j). As such, taxpayers subject to these rules are permitted to increase allowable deductible expenses from 30% to 50% of the taxpayer’s adjusted taxable income for the 2019 and 2020 tax years.
We will continue to monitor any additional guidance from the Massachusetts Department of Revenue regarding these issues.
CARES Act Extensions and Other Key Tax Considerations
Business Meals Fully Deductible
Business meals are fully tax deductible (previously 50% deductible) for expenses incurred on January 1, 2021 through December 31, 2022. Meals must be provided by a restaurant.
Employee’s Portion of Payroll Tax Deferral
Per the presidential memorandum issued on August 8, 2020 and subsequent IRS Notice 2020-65, employers are able to defer withholding the employee’s portion of social security taxes from September 1, 2020 through December 31, 2020, but are required to increase withholding and pay the deferred amounts ratably from wages and compensation paid from January 1, 2021 through April 30, 2021. The repayment period is extended through December 31, 2021. Any lack of repayment on the unpaid tax liability will trigger penalties and interest which would start accruing on January 1, 2022.
Extension of Paid Sick and Family Leave Tax Credits
The CAA extends the paid and sick family tax credits provided by the Families First Coronavirus Response Act (FFCRA) through March 31, 2021. Employers aren’t required to provide leave, however, are eligible for tax credits for wages paid relating to the leave.