On March 10, 2021, the U.S. House of Representatives passed the final version of the American Rescue Plan Act (ARPA) of 2021, clearing the way for its enactment into law pending the President’s signing. Included within the provisions of this Act are several notable tax related items, which are addressed below.
2021 Recovery Rebates to Individuals
The ARPA provides recovery rebates for the 2021 tax year to qualifying individuals. The amount of the rebate is the sum of $1,400 ($2,800 in the case of a joint return) plus $1,400 for each dependent of the taxpayer. The amount of the credit will phase out for those with modified adjusted gross income between $75,000 and $80,000 ($150,000 and $160,000 for married filing joint and $112,500 and $120,000 for head of household). The advanced payment of the rebate will be based on a taxpayer’s 2019 tax return unless the taxpayer has already filed its 2020 tax return before the date the Internal Revenue Service (IRS) computes the payout. If the actual credit based on the taxpayer’s 2021 tax return results in a greater payout, the taxpayer will be entitled to the additional amount. If the actual credit in 2021 is less than the advanced credit computed under tax year 2019 or 2020, the difference will not be returned.
Child Care Credit
Special rules are provided with respect to the 2021 tax year. The ARPA raises the child tax credit to $3,000 for each qualifying child under the age of 18. In the case of children under the age of six as of the close of the calendar year, the credit amount is $3,600. The credit remains subject to phase out rules for taxpayers with adjusted gross income in excess of the stipulated threshold amounts. The credit is refundable, and under certain conditions, part of the credit can be paid in advance.
Dependent Care Tax Credit
The ARPA made several changes to the dependent care tax credit for the 2021 tax year. ARPA expanded the amount of the dependent care tax credit by increasing the maximum amount of qualifying employment-related expenses from $3,000 to $8,000 for one qualifying individual and from $6,000 to $16,000 if there are two or more qualifying individuals. The credit which may be claimed is based upon the qualifying expense amount times the “applicable percentage.” Under ARPA, the “applicable percentage” also increased from 35 percent to 50 percent. The “applicable percentage” rate is reduced in the case of taxpayers with adjusted gross income exceeding the phase-out threshold. Additionally under ARPA, the phase out threshold for 2021 starts at $125,000 of adjusted gross income rather than the normally applicable $15,000 of adjusted gross income. While the normally applicable credit rules provide that the “applicable percentage” cannot drop below 20 percent regardless of adjusted gross income levels, the ARPA includes a rule which does reduce the “applicable percentage” below the 20 percent for taxpayers with adjusted gross income in excess of $400,000. Under this rule, the “applicable percentage” is further reduced by one percent for each $2,000, or fraction thereof, by which adjusted gross income exceeds $400,000.
Earned Income Tax Credit
The ARPA enhanced the earned income credit – special rules applicable to the 2021 tax year were included for individuals with no qualifying children. These rules lowered the minimum age and removed the ceiling age, which was 65. In addition, a special rule applicable to all taxpayers provides that if the earned income for tax year 2021 is less than the earned income for tax year 2019, the taxpayer may elect to substitute the earned income for 2019 for such earned income for 2021 when computing the 2021 credit amount.
Other changes made by the ARPA, which will be effective beginning with the 2021 tax year, include increases in the earned income and phase out amounts as well as an increase in the amount of investment income a taxpayer may have without being disqualified for the credit.
Taxability of Unemployment Compensation
The tax treatment of unemployment benefits a taxpayer receives depends on the type of program paying the benefits. Generally, if a taxpayer receives unemployment compensation, it should be included in gross income. In the case of any taxable year beginning in 2020, if the taxpayer’s adjusted gross income, with some specified modifications, for such taxable year is less than $150,000, the gross income of the taxpayer shall not include so much of the unemployment compensation received by the taxpayer (or, in the case of a joint return, received by each spouse) as does not exceed $10,200.
Student Debt Forgiveness
If student debt is forgiven after Dec. 31, 2020, and before Jan. 1, 2026, it could be federal tax free. Qualified student debt that would be excluded from gross income includes any loan provided expressly for post-secondary educational expenses whether provided through the educational institution or directly to the borrower. Generally, the loans must also be either made, insured or guaranteed by the U.S., state or certain educational institutions.
Employee Retention Credit (ERC)
The Employee Retention Credit (ERC), introduced in March 2020 by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, was initially set to expire at the end of 2020. The ERC was expanded in December 2020 by the Consolidated Appropriations Act (CAA) and extended through the second quarter of 2021. The ARPA has further expanded and extended the ERC through the end of 2021.
Under previous versions of the ERC, in order to be eligible for the credit, an employer had to either demonstrate a significant decline in gross receipts (as compared to 2019) or that a government mandate caused suspension of business operations. The ARPA introduces a third type of eligible employer, a Recovery Startup Business (RSB). An RSB is a business which began carrying on any trade or business after Feb. 15, 2020, and whose average annual gross receipts for the three preceding taxable years are not more than $1,000,000. The ARPA’s definition of qualifying wages does not incorporate by reference this new class of eligible employer, making it somewhat unclear how these newly eligible employers will determine the credit. Eligible employers in this category are also subject to an aggregate $50,000 limit on the ERC claimed for each quarter.
The ARPA expands the credit for certain large employers. Organizations with greater than 500 employees are generally only able to claim the credit on wages paid to employees for a time during which they were not providing services to the organization. The ARPA also introduces a Severely Financially Distressed Employer, which is an employer who has seen a 90 percent drop in revenue when compared to the same quarter in 2019. This type of employer is eligible to claim all wages paid as qualified wages, up to $10,000 per quarter per employee, regardless of the size of the employer.
All of the ERC changes made by the ARPA would be effective beginning in the third quarter of 2021.
Extension of Families First Coronavirus Response Act (FFCRA) Credits
The ARPA extends credits made available under the Families First Coronavirus Response Act (FFCRA). These credits allow employers to take a payroll tax credit for wages paid when providing paid leave to individuals affected by COVID-19. Originally introduced with the CARES Act and extended through the CAA, these credits are now available through Sept. 30, 2021, under the ARPA.
Qualified leave has been expanded to include testing and diagnosis, including time spent waiting for COVID-19 test results if the employee has either been exposed to COVID-19 or the employer has requested such a test. Qualified leave may also include obtaining COVID-19 immunization or recovering from a sickness or condition relating to such immunization.
Healthcare Continuation Credit
The ARPA provides premium assistance for COBRA continuation coverage of eligible individuals and their families. The premium assistance is funded by means of a tax credit equal to the amount of continuation payments not paid by assistance eligible individuals. Depending upon the type of group health plan, the person entitled to the credit may be the plan itself, the employer or the insurer. No credit is allowed under this section, however, with respect to any amount that is taken into account for determining the ERC or FFCRA credits. This credit applies to employer payroll taxes with any excess credit being refundable. Premiums for periods of coverage during the period beginning on April 1, 2021, and ending on Sept. 30, 2021, are subject to the continuation assistance provisions. Persons claiming the credit are required to include the credit amount in their gross income for the tax year.
The ARPA provides up to $28.6 billion in support through Restaurant Revitalization Grants to eligible entities that experienced a pandemic related revenue loss. Eligible entities generally include businesses in which the public or patrons assemble for the primary purpose of being served food or drink. Restaurants, food trucks, stands or carts as well as the premises of licensed alcohol beverage producers where the public may taste, sample or purchase products are included in the specific list of eligible entities. Entities that are operated by a state or local government, or who own or operate (together with any affiliated businesses) more than 20 locations or are publicly traded companies are excluded from qualifying for these grants.
Generally, the amount of the grant is based upon the comparative revenue loss during 2020 when compared to 2019. However, rules are also provided to allow participation by eligible entities who were not in operation during all of 2019, who opened for the first time in 2020 or even if not yet opened for business the first time incurred certain described expenses during 2020. Revenue losses must be reduced by any proceeds received from Paycheck Protection Program (PPP) first-draw or second-draw loans. Entities applying for these grants will need to certify that the current economic uncertainty makes the grant necessary and that they have not applied for or received a grant from the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act. The grant will be limited in total to $10,000,000 per eligible entity and no more than $5,000,000 per physical location of an eligible entity.
The grant funds must be used to cover specific types of costs incurred between Feb. 15, 2020, and Dec. 31, 2021. These costs include, among others, payroll, mortgage and rent payments, utilities, maintenance, supplies and normal operational type food and beverage expenses. Excess funds must be returned if not fully utilized during the covered period.
The tax treatment of any grant received pursuant to the Restaurant Revitalization Grant program is set to mirror the tax treatment of PPP loan forgiveness proceeds. The grant will not be included in gross income – as a result, no deduction will be lost, a reduction to a tax attribute will not occur and the basis increase will still occur as a result of the grant being treated as tax-exempt income.
Economic Injury Disaster Loan (EIDL) Advance
The ARPA provides up to $15 billion in additional targeted EIDL advances to covered entities that have experienced an economic loss greater than 50 percent and employ no more than 10 employees. Both covered entities and economic loss have the same meaning as was given to the term in the Economic Aid to Hard-Hit Small Business, Nonprofits, and Venues Act. The additional targeted EIDL advance for a covered entity under this program will be $5,000.
The tax treatment of any EIDL advance received is also set to mirror the tax treatment of PPP loan forgiveness proceeds. The EIDL advance will not be included in gross income – as a result, no deduction will be lost, a reduction to a tax attribute will not occur and the basis increase will still occur as a result of the EIDL advance being treated as tax-exempt income.
Compensation Limits Under Section 162(m)
Public corporations are limited as to the amount of compensation they may deduct with respect to covered employees. The ARPA expands this deduction limitation for tax years beginning after Dec. 31, 2026. Beginning with the 2027 tax year, companies will have to subject the compensation of additional employees to this limitation. The limitation will apply to compensation paid to the CFO, the CEO, the three highest paid officers other than the CFO and CEO and the five highest compensated employees not already covered within one of the preceding groups.
Excess Business Loss Limitation
Originally introduced under the Tax Cuts and Jobs Act (TCJA), Section 461(l) imposes a limitation on the excess business losses of noncorporate taxpayers. Taxpayers who file single returns may not utilize more than $250,000 of business losses to offset other income on a return. Twice this amount is allowed for those who are married filing jointly. Any amount in excess of this limitation is treated as a net operating loss, which is carried forward.
As originally written in the TCJA, these rules were set to apply to the 2018-2025 tax years. The ARPA has now extended the excess business loss limitation rules by an extra year so that the limitation is now applicable to 2026 tax years.
The CARES Act, enacted in March 2020, temporarily suspended this loss limitation for the 2018-2020 tax years.
Repeal of Section 864(f) - Worldwide Interest Election
The ARPA includes a provision to repeal Section 864(f). Previously, Section 864(f) allowed taxpayers an opportunity to make a one-time election to allocate and apportion interest expense on a worldwide basis. This provision was to be effective for tax years beginning after Dec. 31, 2020. Making the election could have been beneficial for multinational taxpayers by reducing the allocation of U.S. interest expense to foreign source income (including the global intangible low-taxed income (GILTI) inclusion amount), resulting in a larger foreign tax credit. The Joint Committee on Taxation estimates that repealing the Section 864(f) election will raise in excess of $22 billion over 10 years.