On December 27, 2020, President Donald Trump signed the Consolidated Appropriations Act, 2021 (the “Act”) into law. The President noted his disagreement with a few provisions in the Act, including the $600 stimulus payments (which he viewed as too low) and the two year expiration date for fully deductible business meals. He also stated that he would submit a request for Congress to remove certain spending approved under the Act.
On December 28, the House of Representatives passed a bill with a 275-134 vote to increase the $600 stimulus payments under the Act to $2,000 for certain taxpayers. The bill has been sent to the Senate, where its future is unclear.
The Act includes a number of tax provisions that aim to provide relief to individuals and businesses impacted by the COVID-19 pandemic. The Act expands and enhances several significant provisions included in the Coronavirus Aid, Relief, and Economic Security Act (P.L. 116-136) (the “CARES Act”) and provides for direct payments to eligible individuals. This Client Alert discusses the key tax aspects of the Act for businesses, employers and individuals and outlines various tax extenders under the Act.
Businesses: The key business tax aspects of the Act are summarized below.
- Expands and Extends Tax Provisions Related to the Paycheck Protection Program (“PPP”): The Act makes a few changes to the PPP tax provisions included in the CARES Act. First, the Act states that forgiven PPP loans are not included in a taxpayer’s gross income. A borrower’s tax basis and other tax attributes will not be reduced as a result of loan forgiveness. For partnerships and S corporations with tax-exempt income from PPP loan forgiveness, such tax-exempt income is also treated as tax-exempt income for purposes of Code Sections 705 and 1366 (in order to, among other things, prevent gain on the ultimate sale of the partnership or S corporation interest from undoing the PPP changes in the Act).
The Act also provides that deductions are allowed for otherwise deductible expenses that are paid with funds from a forgiven PPP loan, overturning guidance from the Treasury Department and the IRS that disallowed a deduction for expenses paid with a forgiven PPP loan (including Notice 2020-32, discussed here, and Rev. Rul. 2020-27 (which held that a taxpayer could not deduct eligible expenses in its 2020 tax year if the taxpayer had a reasonable expectation of loan forgiveness)).
These provisions are effective as of the date of enactment of the CARES Act.
- Expands and Extends Tax Provisions Related to Other CARES Act Loans and Grants: Similarly, the Act provides that other forgiven loans, including Emergency Economic Insurance Disaster Loan grants and advances, are not included in a taxpayer’s gross income. The Act allows a deduction for otherwise deductible expenses paid with forgiven amounts.
- Temporarily Allows Full Deduction for Business Meals: The Act provides that business expenses for food and beverages are fully deductible (rather than 50% deductible under current law) if such expenses are paid or incurred in 2021 or 2022. The full deduction applies to food and beverage expenses that are provided by a restaurant (including takeout and delivery), but expressly excludes business “entertainment” expenses. When the President signed the Act, he noted that a full deduction for such expenses should be allowed for a longer period of time.
- Extends Increased Limit on Deductible Charitable Contributions: The Act extends the increased limit for corporations under the CARES Act on deductible charitable contributions for 2021.
Employers: The key tax aspects of the Act for employers are summarized below.
- Extends and Modifies Payroll Tax Credits: The Act extends refundable payroll tax credits for paid sick and family leave, enacted in the Families First Coronavirus Response Act (P.L. 116-127) (“Families First Act”), to wages paid through March 31, 2021. Self-employed individuals are permitted to use their 2019 average daily self-employment income (rather than 2020 income) to calculate the tax credit. This provision is effective as of the date of enactment of the Families First Act.
- Expands and Extends Employee Retention Tax Credit (“ERTC”): The Act extends the ERTC through June 30, 2021 and modifies it in a number of ways to make the credit available to additional employers and more advantageous for eligible employers. The ERTC is beyond the scope of this Client Alert. For greater detail about the changes to the ERTC under the Act, see our Client Alert on this topic.
- Extends Repayment Period for Certain Deferred Payroll Taxes:On August 8, 2020, President Trump issued a memorandum allowing employers to defer the withholding and payment of an employee’s share of social security taxes and the railroad retirement tax equivalent from September 1, 2020 through December 31, 2020 if the employee’s pre-tax compensation for a biweekly pay period generally is less than $4,000. The memorandum required employers to increase withholding and pay the deferred amounts ratably from wages and compensation paid between January 21 and April 31, 2021. The memorandum provided that penalties and interest would accrue on deferred unpaid tax liability starting May 1, 2021.
The Act extends the repayment period for employers through December 31, 2021 (rather than April 31, 2021 as provided in the memorandum). Penalties and interest on deferred unpaid tax liability will begin to accrue on January 1, 2022 (rather than on May 1, 2021).
- Health and Dependent Care FSA provisions: The Act introduced several provisions to promote flexibility for flexible spending accounts (“FSAs”). The Act permits, but does not require, employers to amend FSAs to allow for the following:
- A carryover of any unused FSA benefits or contributions from the 2020 plan year into the 2021 plan year (typically $500 maximum carryover is permissible, which was increased by the CARES Act to $550 for 2020 FSA funds);
- A carryover of 2021 unused FSA benefits or contributions into the 2022 plan;
- A 12-month “grace period” for unused 2020 or 2021 plan year benefits or contributions;
- A mid-year modification of FSA election amount for 2021 plans; and
- An opportunity for reimbursement of unused health FSA benefits or contributions for employees who cease participation in a health FSA during 2020 or 2021.
Individuals: The key individual tax aspects of the Act are summarized below.
- Direct Stimulus Payments: The Act authorizes a refundable tax credit of $600 per eligible taxpayer ($1,200 for married filing jointly taxpayers and $600 per qualifying child). The credit is phased out beginning with a modified adjusted gross income of $75,000 ($112,500 for those filing as head of household and $150,000 for those married filing jointly). Treasury will issue the advance payments based on 2019 tax return information; however, taxpayers receiving an advance payment that exceeds their eligible amount will not be required to repay the payment while those eligible for additional credit based on 2020 tax return information will receive the additional amount as a refundable tax credit.
After signing the Act, the President called on Congress to increase direct stimulus payments from $600 to $2,000.
- Tax Credit Lookback: The Act provides a temporary provision allowing eligible taxpayers to use 2019 earned income (e., to normalize the calculation with income earned in a non-pandemic year) to determine the Earned Income Tax Credit as well as the refundable Additional Child Tax Credit for 2020.
- Extends and Modifies Charitable Deductions for 2021: The Act modifies and extends the charitable deduction for taxpayers who do not itemize deductions in 2021. Single filers who do not itemize deductions can deduct up to $300 of 2021 charitable contributions – this rule was included in the CARES Act, but only for 2020 charitable contributions. For taxpayers who are married, file jointly, and do not itemize deductions, the Act increases the amount of deductible charitable contributions from $300 to $600 for 2021. However, the Act also increases the penalty for taxpayers who overstate the deduction – increasing the penalty from 20% to 50% of the underpayment.
For taxpayers who itemize deductions, the Act extends the increased limit under the CARES Act on deductible charitable contributions for 2021.
Tax Extenders: The Act extends a number of temporary “tax extender” provisions, as summarized below.
- Permanent Rules: The Act makes a few provisions permanent, including the following:
- Reduced medical expense deduction floor, allowing individuals to deduct out-of-pocket medical expenses that exceed 7.5% of adjusted gross income (rather than 10%)
- Lower excise tax rates for small brewers, wine makers, and distillers – the lower excise tax rate was set to expire on December 31, which would have threatened the survival of businesses in these industries
- Deduction for energy-efficient commercial buildings (which will be inflation adjusted after 2020)
- Five-Year Extensions: The Act provides that a few provisions are extended for five years, with the result that such provisions now generally expire December 31, 2025. Many of the provisions under the 2017 Tax Cuts & Jobs Act (“TCJA”) are also scheduled to expire after 2025 (including the qualified business income deduction). The provisions extended for five years include the following:
- New markets tax credit
- Work opportunity tax credit
- Empowerment zone designation
- Employer credit for paid family and medical leave
- Expanded exclusion for employer student loan payments
- Gross income exclusion for discharge of indebtedness on a principal residence (with the maximum exclusion limited to $750,000 (rather than $2 million))
- Look-through treatment for payments of dividends, interest, rents, and royalties between related controlled foreign corporations
- Two-Year and One-Year Extensions: The Act provides that a few provisions are extended for two years, including the residential energy-efficient property tax credit, the energy investment tax credit for solar and residential energy-efficient property and the tax credit for carbon capture and sequestration. The Act also extends for an additional year certain provisions that were schedule to expire at the end of 2020 (primarily provisions related to renewable and efficient energy).
Please reach out to us with any questions about the Act and its tax implications for businesses and individuals.
 Both the individual and business tax aspects of the Act may be relevant for entities that are treated as flow-through entities for tax purposes (including partnerships and S corporations).
 The Act provides for similar tax treatment with respect to “second draw” PPP loans.
 Employee Retention Tax Credit: New Features Require a Fresh Look for All Employers, January 4, 2021.