2021 Consolidated Appropriations Act

2021 Consolidated Appropriations Act Which Includes $900 Billion in Covid-19 Relief

On December 27, 2020, President Trump signed into law a $900 billion Covid-19 relief package for individuals and businesses. Highlights of the relief package, include $600 payments to individual taxpayers with adjusted gross income (AGI) of $75,000 or less (or $112,500 AGI for heads of households), payments of $1,200 to joint filers with AGI of $150,000 or less, and an additional $600 payment for each qualifying child. For businesses, additional time is provided for paying previously deferred payroll taxes, another round of Paycheck Protection Program (PPP) loans is available, and borrowers with PPP loans may take deductions for expenses paid with PPP loan proceeds. The legislation also extends numerous expiring tax provisions for both individuals and businesses. President Trump sharply criticized the package and demanded changes before ultimately signing it into law, as passed. Consolidated Appropriations Act, 2021 (12/27/2020).

2021 Consolidated Appropriations Act Which Includes $900 Billion in Covid-19 Relief

Executive Summary

Highlights of the year-end Covid-19 related legislation include:

  • Additional unemployment assistance which provides 11 weeks of $300 per-week emergency unemployment benefits, an extension of expiring pandemic-related unemployment assistance, and protection for individuals who received pandemic-related unemployment benefit overpayments through no fault of their own and are now unable to repay the funds;
  • A second round of direct cash assistance payments of $600 for each family member, subject to certain family adjusted gross income limitations, with mixed-status families now eligible where only one spouse has a social security number;
  • The creation of a Paycheck Protection Program (PPP) Second Draw loan program with a maximum loan amount of $2 million made available for businesses that employ 300 or less employees and have used, or will use, the full amount of their first PPP loan;
  • A new rule establishing that business expenses paid with the proceeds of a forgiven PPP loan are deductible (effectively overriding prior law and IRS guidance issued earlier this year);
  • Eligibility to use 2019 income to determine the earned income tax credit and the additional child tax credit;
  • A permanent reduction in the adjusted gross income threshold for medical expense deductions from 10 percent to 7.5 percent;
  • An expansion of the carryover and grace period policies relating to employees with unused amounts in their health and dependent care flexible spending accounts;
  • A three month extension of credits reimbursing employers for paid sick and family leave paid to employees due to Covid-19;
  • An increase in the income threshold at which the Lifetime Learning Credit phases out;
  • Additional time for employees and employers to pay back deferred employee payroll tax amounts from the President’s August memorandum;
  • An extension and expansion of the employee retention tax credit;
  • Permanent and temporary extensions of expiring tax provisions (“tax extenders”); and
  • A 100-percent deduction for business meal and beverage expenses, including any carry-out or delivery meals, provided by a restaurant that are paid or incurred in 2021 and 2022.

Legislative Components

The relief package’s tax provisions and the PPP extension appear in three separate bills that were part of the 2,124-page Consolidated Appropriations Act, 2021 as follows:

  • The Covid-Related Tax Relief Act of 2020 (Covid-Related Tax Relief Act), which extends and modifies earlier Covid relief provisions from the Families First Coronavirus Response Act (Families First Act) and the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).
  • The Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (Economic Aid Act), which extends and modifies the Paycheck Protection Program.
  • The Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Disaster Tax Relief Act), which extends numerous expiring tax breaks and adds several new ones.

The provisions of greatest interest to tax practitioners fall in the following categories spanning the three bills: (i) Covid-related tax relief, (ii) Paycheck Protection Program extension and enhancement, (iii) tax extenders, (iv) miscellaneous tax provisions, and (v) disaster tax relief.

I. COVID-19 RELATED TAX RELIEF

Additional 2020 Recovery Rebates for Individuals and Amendments to CARES Act Recovery Rebates

Sections 272 and 273 of the Covid-Related Tax Relief Act provide a refundable tax credit in the amount of $600 per eligible family member. The credit is $600 per taxpayer ($1,200 for married filing jointly), in addition to $600 per qualifying child. The credit phases out starting at $75,000 of modified adjusted gross income ($112,500 for heads of household and $150,000 for married filing jointly) at a rate of $5 per $100 of additional income.

The provision also provides for the Department of Treasury to issue advance payments based on the information on 2019 tax returns. Eligible taxpayers treated as providing returns through the nonfiler portal in the first round of Economic Impact Payments, provided under the CARES Act, will also receive payments. The Treasury Department may issue advance payments for Social Security Old-Age, Survivors, and Disability Insurance beneficiaries, Supplemental Security Income recipients, Railroad Retirement Board beneficiaries, and Veterans Administration beneficiaries who did not file 2019 returns based on information provided by the Social Security Administration, the Railroad Retirement Board, and the Veterans Administration.

Taxpayers receiving an advance payment that exceeds the amount of their eligible credit will not be required to repay any amount of the payment. If the amount of the credit determined on the taxpayer’s 2020 tax return exceeds the amount of the advance payment, taxpayers will receive the difference as a refundable tax credit.

In general, taxpayers without an eligible social security number are not eligible for the payment. However, married taxpayers filing jointly where one spouse has a social security number (SSN) and one spouse does not are eligible for a payment of $600, in addition to $600 per child with an SSN. The provision aligns the eligibility criteria for the new round of Economic Impact Payments and the credit for the Economic Impact Payments provided by the CARES Act.

Advance payments are generally not subject to administrative offset for past due federal or state debts. In addition, the payments are protected from bank garnishment or levy by private creditors or debt collectors. Additionally, the provision instructs the Treasury Department to make payments to the United States territories that relate to each territory’s cost of providing the credits.

Tax Treatment of PPP Loans

Section 276 of the Covid-Related Tax Relief Act provides that gross income does not include any amount that would otherwise arise from the forgiveness of a PPP loan. This provision also (1) overrides current law (and IRS guidance) preventing the deduction of expenses paid with tax-exempt income by allowing businesses to deduct business expenses paid with the proceeds of a PPP loan that is forgiven, and (2) provides that the tax basis and other attributes of the borrower’s assets will not be reduced as a result of the loan forgiveness. The provision is effective as of the date of enactment of the CARES Act (3/27/2020).

Employee Retention Tax Credit Modifications

Sections 206 and 207 of the Disaster Tax Relief Act extend and expand the CARES Act employee retention tax credit (ERTC) and makes technical corrections. Beginning on January 1, 2021 and through June 30, 2021, the provision:

  • Increases the credit rate from 50 percent to 70 percent of qualified wages;
  • Expands eligibility for the credit by reducing the required year-over-year gross receipts decline from 50 percent to 20 percent and provides a safe harbor allowing employers to use prior quarter gross receipts to determine eligibility;
  • Increases the limit on per-employee creditable wages from $10,000 for the year to $10,000 for each quarter;
  • Increases the 100-employee delineation for determining the relevant qualified wage base to employers with 500 or fewer employees;
  • Allows certain public instrumentalities to claim the credit;
  • Removes the 30-day wage limitation, allowing employers to, for example, claim the credit for bonus pay to essential workers;
  • Allows businesses with 500 or fewer employees to advance the credit at any point during the quarter based on wages paid in the same quarter in a previous year;
  • Provides rules to allow new employers who were not in existence for all or part of 2019 to be able to claim the credit; and
  • Retroactive to March 13, 2020, the provision: (1) clarifies the determination of gross receipts for certain tax-exempt organizations; (2) clarifies that group health plan expenses can be considered qualified wages even when no other wages are paid to the employee, consistent with IRS guidance; and (3) provides that employers who receive PPP loans may still qualify for the ERTC with respect to wages that are not paid for with forgiven PPP proceeds.

Extension of Credits for Paid Sick and Family Leave

Section 286 of the Covid-Related Tax Relief Act extends the refundable payroll tax credits for paid sick and family leave, enacted in the Families First Coronavirus Response Act (Families First Act), through the end of March 2021. It also modifies the tax credits so that they apply as if the corresponding employer mandates were extended through the end of March 2021. This provision is effective as if included in Families First Act.

Election to Use Prior Year Net Earnings from Self-Employment in Determining Average Daily Self-Employment Income for Purposes of Credits for Paid Sick and Family Leave

Section 287 of the Covid-Related Tax Relief Act provides an election for an individual who elects the credit for paid sick or family leave to use prior year net earnings from self-employment income, rather than current year earnings, in calculating the income tax credit available.

Extension of Certain Deferred Payroll Taxes

On August 8, 2020, the President Trump issued a Presidential Payroll Tax Memorandum allowing employers to defer withholding employees’ share of social security taxes or the railroad retirement tax equivalent from September 1, 2020, through December 31, 2020, and requiring employers to increase withholding and pay the deferred amounts ratably from wages and compensation paid between January 1, 2021, and April 31, 2021.

Under the Payroll Tax Memorandum, the deferral is only available with respect to any employee with wages or compensation, as applicable, payable during any bi-weekly pay period of less than $4,000, calculated on a pre-tax basis, or the equivalent amount with respect to other pay periods. This equates to wages of $104,000 per year. The Payroll Tax Memorandum provides that the amounts deferred are not subject to any penalties, interest, additional amounts, or additions to the tax. The Payroll Tax Memorandum also authorizes the Treasury Secretary to issue guidance to implement these orders and directs the Treasury Secretary to explore avenues, including legislation, to eliminate the obligation to repay the deferred taxes. Under the Payroll Tax Memorandum, penalties and interest on deferred unpaid tax liability would begin to accrue on May 1, 2021.

Section 274 of the Covid-Related Tax Relief Act extends the repayment period through December 31, 2021. Additionally, penalties and interest on deferred unpaid tax liability will not begin to accrue until January 1, 2022.

Clarification of Educator Expense Deduction for PPE

Section 275 of the Covid-Related Tax Relief Act requires the IRS to issue guidance or regulations providing that personal protective equipment (PPE) and other supplies used for the prevention of the spread of Covid-19 are treated as eligible expenses for purposes of the educator expense deduction. Such regulations or guidance will be retroactive to March 12, 2020.

Emergency Financial Aid Grants

Section 277 of the Covid-Related Tax Relief Act provides that certain emergency financial aid grants under the CARES Act are excluded from the gross income of college and university students. The provision also holds students harmless for purposes of determining eligibility for the American Opportunity and Lifetime Learning tax credits. The provision is effective as of March 27, 2020, the date of enactment of the CARES Act.

Clarification of Tax Treatment of Certain Loan Forgiveness and Other Business Financial Assistance Under the Coronavirus Relief Legislation

Section 278 of the Covid-Related Tax Relief Act clarifies that gross income does not include forgiveness of certain loans, emergency EIDL grants, and certain loan repayment assistance, each as provided by the CARES Act. The provision also clarifies that deductions are allowed for otherwise deductible expenses paid with the amounts not included in income by this section, and that tax basis and other attributes will not be reduced as a result of those amounts being excluded from gross income. The provision is effective for tax years ending after March 27, 2020..

Authority to Waive Certain Information Reporting Requirements

Section 279 of the Covid-Related Tax Relief Act gives the Treasury Department authority to waive information filing requirements for any amount excluded from income by reason of the exclusion of covered loan amount forgiveness from taxable income, the exclusion of emergency financial aid grants from taxable income or the exclusion of certain loan forgiveness and other business financial assistance under the CARES Act from income.

Application of Special Rules to Money Purchase Pension Plans

The CARES Act temporarily allows individuals to make penalty-free withdrawals from certain retirement plans for coronavirus-related expenses, permits taxpayers to pay the associated tax over three years, allows taxpayers to recontribute withdrawn funds, and increases the allowed limits on retirement plan loans. Section 280 of the Covid-Related Tax Relief Act clarifies that money purchase pension plans are included in the retirement plans qualifying for these temporary rules. The provision applies retroactively as if included in Section 2202 of the CARES Act.

Election to Waive Application of Certain Modifications to Farming Losses

Section 281 of the Covid-Related Tax Relief Act allows farmers who elected a two-year net operating loss carryback prior to the CARES Act to elect to retain that two-year carryback rather than claim the five-year carryback provided in the CARES Act. This provision also allows farmers who previously waived an election to carry back a net operating loss to revoke the waiver. These clarifications are aimed at eliminating unnecessary compliance burdens for farmers. The provision applies retroactively as if included in the CARES Act.

II. PAYCHECK PROTECTION PROGRAM EXTENSION AND ENHANCEMENT

Section 311 of the Economic Aid Act creates a second loan from the Paycheck Protection Program (PPP), called a “PPP Second Draw” loan for smaller and harder-hit businesses, with a maximum loan amount of $2 million. In order to receive a PPP Second Draw loan, eligible entities must: employ not more than 300 employees, have used or will use the full amount of their first PPP; and must demonstrate at least a 25 percent reduction in gross receipts in the first, second, or third quarter of 2020 relative to the same 2019 quarter (although applicable timelines for businesses that were not in operation in Q1, Q2, and Q3, and Q4 of 2019 are provided). Applications submitted on or after January 1, 2021, are eligible to utilize the gross receipts from the fourth quarter of 2020.

In addition to the creation of the PPP Second Draw, Section 304 of the Economic Aid Act expands the list of eligible expenses for which a PPP loan may be used. Additional eligible expenses include (1) covered operations expenditures; (2) covered property damage costs; (3) covered supplier costs; and (4) covered worker protection expenditures.

Eligible and Noneligible Entities

Entities eligible for the PPP Second Draw include businesses, certain non-profit organizations, housing cooperatives, veterans’ organizations, tribal businesses, self-employed individuals, sole proprietors, independent contractors, and small agricultural co-operatives. Entities ineligible include entities listed in 13 C.F.R. 120.110 and subsequent regulations (except for entities from that regulation which have otherwise been made eligible by statute or guidance, and except for nonprofits and religious organizations); entities involved in political and lobbying activities including engaging in advocacy in areas such as public policy or political strategy or an entity that otherwise describes itself as a think tank in any public document, entities affiliated with entities in the People’s Republic of China; and registrants under the Foreign Agents Registration Act.

Loan Terms

In general, borrowers may receive a loan amount of up to 2.5 times the average monthly payroll costs in the one year prior to the loan or the calendar year. Seasonal employers may calculate their maximum loan amount based on a 12-week period beginning February 15, 2019 through February 15, 2020. New entities may receive loans of up to 2.5 times the sum of average monthly payroll costs. Entities in industries assigned to NAICS Code 72 (Accommodation and Food Services) may receive loans of up to 3.5 times average monthly payroll costs. Businesses with multiple locations that are eligible entities under the initial PPP requirements may employ not more than 300 employees per physical location. Waiver of affiliation rules that applied during initial PPP loans apply to a second loan. An eligible entity may only receive one PPP second draw loan. Fees are waived for both borrowers and lenders to encourage participation. For loans of not more than $150,000, the entity may submit a certification attesting that the entity meets the revenue loss requirements on or before the date the entity submits its loan forgiveness application and non-profit and veterans organizations may utilize gross receipts to calculate their revenue loss standard.

Loan Forgiveness

Borrowers of a PPP Second Draw loan are eligible for loan forgiveness equal to the sum of their payroll costs, as well as covered mortgage, rent, and utility payments, covered operations expenditures, covered property damage costs, covered supplier costs, and covered worker protection expenditures incurred during the covered period. The 60/40 cost allocation between payroll and non-payroll costs in order to receive full forgiveness will continue to apply.

Churches and Religious Organizations

Churches and religious organizations are eligible for PPP Second Draw loans.

Safe Harbor on Restoring Full-time Employees and Salaries and Wages Applies

The rule of reducing loan forgiveness for a borrower reducing the number of employees retained and reducing employees’ salaries in excess of 25 percent applies.

Maximum Loan Amount for Farmers and Ranchers

A specific loan calculation for the first round of PPP loans for farmers and ranchers who operate as a sole proprietor, independent contractor, self-employed individual, who report income and expenses on a Schedule F, and were in business as of February 15, 2020, is established. These entities may utilize their gross income in 2019 as reported on a Schedule F. Lenders may recalculate loans that have been previously approved to these entities if they would result in a larger loan. This provision applies to PPP loans before, on, or after the date of enactment (i.e., December 27, 2020), except for loans that have already been forgiven.

Seasonal Employer

A seasonal employer is defined as an eligible recipient which: (1) operates for no more than seven months in a year, or (2) earned no more than 1/3 of its receipts in any six months in the prior calendar year.

Eligibility of News Organizations for Loans

Eligible FCC license holders and newspapers with more than one physical location are eligible for a PPP Second Draw loan, as long as the business has no more than 500 employees per physical location or the applicable Small Business Administration size standard; and includes eligible Code Sec. 511 public colleges and universities that have a public broadcasting station if the organization certifies that the loan will support locally focused or emergency information.

Prohibition on Use of Loan Proceeds for Lobbying Activities

An eligible entity is prohibited from using proceeds of the covered loan for lobbying activities, lobbying expenditures related to state or local campaigns, and expenditures to influence the enactment of legislation, appropriations, or regulations.

III. TAX EXTENDERS

The Disaster Tax Relief Act permanently extends the following tax provisions:

  • Reduction in medical expense deduction floor from 10 percent of adjusted gross income (AGI) to 7.5 percent of AGI;
  • Energy efficient commercial buildings deduction;
  • Exclusion from income of certain tax benefits for volunteer firefighters and emergency medical responders;
  • Repeal of deduction for qualified tuition and related expenses, replaced with increased income limitation on lifetime learning credit;
  • Railroad track maintenance credit;
  • Modification of the uniform capitalization rules and reduction of excise tax rate for beer, wine, and distilled spirits;
  • Refunds in lieu of reduced rates for certain craft beverages produced outside the United States;
  • Disallowance of reduced excise tax rates for smuggled or illegally produced beer, wine, and spirits;
  • Minimum processing requirements for reduced distilled spirits rates; and
  • Modification of single taxpayer rules with respect to beer, wine, and distilled spirits.

The Disaster Tax Relief Act extends the following tax provisions through December 31, 2025:

  • Look-thru rule for related controlled foreign corporations;
  • New markets tax credit;
  • Work opportunity credit;
  • Exclusion from gross income of discharge of qualified principal residence indebtedness;
  • Seven-year recovery period for motorsports entertainment complexes;
  • Expensing rules for certain qualified film and television and live theatrical productions;
  • Oil Spill Liability Trust Fund financing rate;
  • Empowerment zone tax incentives;
  • Employer credit for paid family and medical leave;
  • Exclusion from income for certain employer payments of student loans; and
  • Carbon oxide sequestration credit.

The Disaster Tax Relief Act extends the following tax provisions through December 31, 2023:

  • Residential energy-efficient property credit; and
  • Energy credit under Code Sec 48.

The Disaster Tax Relief Act extends the following tax provisions through December 31, 2021:

  • Credit for electricity produced from certain renewable resources;
  • Treatment of mortgage insurance premiums as qualified residence interest;
  • Credit for health insurance costs of eligible individuals;
  • Indian employment credit;
  • Mine rescue team training credit;
  • Classification of certain race horses as three-year property;
  • Accelerated depreciation for business property on Indian reservations;
  • American Samoa economic development credit;
  • Second generation biofuel producer credit;
  • Nonbusiness energy property credit;
  • Qualified fuel cell motor vehicles credit;
  • Alternative fuel refueling property credit;
  • Two-wheeled plug-in electric vehicle credit;
  • Production credit for Indian coal facilities;
  • Energy efficient homes credit;
  • Extension of excise tax credits relating to alternative fuels; and
  • Black Lung Disability Trust Fund excise tax.

IV. MISCELLANEOUS TAX PROVISIONS

Temporary Rule Preventing Partial Plan Termination

Section 209 of the Disaster Tax Relief Act provides that a qualified retirement plan will not be treated as having a partial termination under Code Sec. 411(d)(3) during any plan year which includes the period beginning on March 13, 2020, and ending on March 31, 2021, if the number of active participants covered by the plan on March 31, 2021, is at least 80 percent of the number of active participants covered by the plan on March 13, 2020.

Temporary Allowance of Full Deduction for Business Meals

Effective for amounts paid or incurred after December 31, 2020, Section 210 of the Disaster Tax Relief Act amends Code Sec. 274(n)(2) to provide that the 50 percent limitation on the deduction for food or beverage expenses does not apply to expenses for food or beverages provided by a restaurant and paid or incurred before January 1, 2023.

Temporary Special Rule for Determination of Earned Income

Section 211 of the Disaster Tax Relief Act provides that, if the earned income of a taxpayer for the taxpayer’s first tax year beginning in 2020 is less than the taxpayer’s earned income for the preceding tax year, the credits allowed under Code Sec. 24(d) (i.e., child tax credit) and Code Sec. 32 (i.e., earned income tax credit) may, at the taxpayer’s election, be determined by substituting the taxpayer’s earned income for the preceding tax year for the earned income for the taxpayer’s first tax year beginning in 2020. For these purposes, in the case of a joint return, the earned income of the taxpayer for the preceding year means the sum of the earned income of each spouse for the preceding tax year.

Certain Charitable Contributions Deductible by Non-Itemizers

Section 212 of the Disaster Tax Relief Act provides that, in the case of any tax year beginning in 2021, if an individual does not elect to itemize deductions, the deduction under Code Sec. 170 for a charitable contribution equals the deduction, not in excess of $300 ($600 in the case of a joint return), which would be determined under Code Sec. 170 if the only charitable contributions taken into account in determining the deduction were contributions made in cash during the tax year to an organization described in Code Sec. 170(b)(1)(A) and not (1) to a Code Sec. 509(a)(3) supporting organization, or (2) for the establishment of a new, or maintenance of an existing, donor advised fund (as defined in Code Sec. 4966(d)(2)). In addition, the penalty under Code Sec. 6662(a) for an underpayment attributable to an overstatement of the deduction for charitable contributions by non-itemizers is increased from 20 percent to 50 percent of the underpayment.

Modification of Limitations on Charitable Contributions

The increase of the limitation for the deduction for donations of food inventory in a tax year from 15 percent to 25 percent under Section 2205 of the CARES Act is extended by Section 213 of the Disaster Tax Relief Act through 2021. Under the CARES Act, the increased deduction limitation for food inventory donations is available only to taxpayers other than C corporations.

Temporary Special Rules for Health and Dependent Care Flexible Spending Arrangements

Section 214 of the Disaster Tax Relief Act provides that, for plan years ending in 2020 or 2021, a plan that includes a health flexible spending arrangement or dependent care flexible spending arrangement will not fail to be treated as a cafeteria plan under the Code merely because the plan or arrangement permits participants to carry over any unused benefits or contributions remaining in any such flexible spending arrangement from the 2020 or 2021 plan year to the next plan year.

In addition, a plan that includes a health flexible spending arrangement or dependent care flexible spending arrangement will not fail to be treated as a cafeteria plan under the Code merely because the plan or arrangement extends the grace period for a plan year ending in 2020 or 2021 to 12 months after the end of such plan year, with respect to unused benefits or contributions remaining in a health flexible spending arrangement or a dependent care flexible spending arrangement.

A plan that includes a health flexible spending arrangement will not fail to be treated as a cafeteria plan under the Code merely because the plan or arrangement allows an employee who ceases participation in the plan during calendar year 2020 or 2021 to continue to receive reimbursements from unused benefits or contributions through the end of the plan year in which such participation ceased (including any grace period).

V. DISASTER TAX RELIEF

Disaster Tax Relief in General

Section 301 of the Disaster Tax Relief Act provides relief for individuals and businesses in Presidentially declared disaster areas for major disasters declared on or after January 1, 2020, through February 25, 2021. The relief generally applies to incident periods beginning on or after December 28, 2019. It does not apply to areas for which a major disaster has been so declared only by reason of Covid-19.

Special Disaster Related Rules for Use of Retirement Funds

Section 302 of the Disaster Tax Relief Act provides an exception to the 10 percent early retirement plan withdrawal penalty for qualified disaster relief distributions (not to exceed $100,000 in qualified disaster distributions cumulatively). Amounts withdrawn are included in income ratably over 3 years or may be recontributed to a retirement plan to avoid taxable income and restore savings. It also allows for the re-contribution of retirement plan withdrawals for home purchases cancelled due to eligible disasters, and provides flexibility for loans from retirement plans for qualified disaster relief.

Employee Retention Credit for Employers Affected by Qualified Disasters

Section 303 of the Disaster Tax Relief Act provides a tax credit for 40 percent of wages (up to $6,000 per employee) paid by a disaster-affected employer to a qualified employee. The credit applies to wages paid without regard to whether services associated with those wages were performed. Certain tax-exempt entities are provided the option to claim the credit against payroll taxes.

Other Disaster Related Tax Relief Provisions

Section 304 of the Disaster Tax Relief Act temporarily suspends limitations on the deduction for charitable contributions associated with qualified disaster relief. With respect to uncompensated losses arising in the disaster area, the provision eliminates the current law requirements that personal casualty losses must exceed 10 percent of adjusted gross income to qualify for deduction. The provision also eliminates the current law requirement that taxpayers must itemize deductions to access this tax relief.

Low-Income Housing Tax Credit

Section 305 of the Disaster Tax Relief Act increases the 2021 and 2022 state ceilings for 9-percent low-income housing tax credit allocations for allocations to qualified disaster zones. The maximum increase across 2021 and 2022 is equal to $3.50 multiplied by the number of state residents in disaster zones and is capped at 65 percent of the state’s 2020 low-income housing tax credit ceiling. The provision also allows an additional year for properties provided disaster allocations to place buildings in service.

Please call Gregory J. Spadea at 610-521-0604, if you have any questions.  The Law Offices of Spadea & Associates, LLC prepares tax returns year round.    

How To Deduct An Ordinary Loss of Up to $100,000 on Qualified Small Business Corporate Stock Under Section 1244 of the Internal Revenue Code

Unfortunately, not all startup companies succeed, however when they fail, all is not lost.  In what may otherwise be considered a complete loss, there are some potential tax benefits available to certain original individual shareholders of corporations in this position.   

After selecting the type of entity to form, if a corporation is the most favorable, I recommend making an S election and issuing Section 1244 stock for this newly incorporated entity.  As long as certain requirements are met, the original investors can claim an ordinary loss of up to $100,000 if the venture is unsuccessful and the stock is ultimately sold for a loss.  

Under normal circumstances, when you invest in corporate stock, any resulting loss on its sale is treated as a capital loss where the loss can offset capital gains and then up to $3,000 of ordinary income per year with the excess capital losses carried forward.  

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Under Section 1244 of the Internal Revenue Code, an ordinary loss deduction for a loss on stock from a “qualified small business corporation” can offset ordinary income and any capital gains. You can deduct up to $100,000 of losses from Section 1244 stock in any one year if  married and file a joint return, or $50,000 if you file as single.  

To qualify under Section 1244, these five requirements must be adhered to:  

1. The stock must be acquired in exchange for cash or property contributed to the corporation. Investors cannot receive shares as compensation for their services. However, cancellation of indebtedness may be sufficiently valid consideration.  

2. The corporation must issue the stock directly to the investors. They cannot acquire the stock from another shareholder, so gifts or inheritance of the shares will not qualify.  

3. The corporation must be an actual, operating company. During the past five years, it must have received less than 50% of its gross receipts from rents, royalties, dividends and other investment income. If the corporation is less than five years old, this test applies to the years it existed.  

4. The stock must be issued by a “small business corporation” defined as a corporation with invested capital of $1,000,000 or less. It can be an S corporation or a C corporation.  

5. The entity must be a domestic corporation.  

Under the current 2020 tax tables, a long-term capital gain that results from the sale of this Section 1244 stock will be taxed at the regular preferential rate of 15% for most individuals or 20% for high-income individuals with taxable income over $441,450. The 3.8% Net Investment Income Tax (NIIT) may also be due.  

Section 1244 of the Internal Revenue Code is the small business stock provision enacted to allow shareholders of domestic small business corporations to deduct a loss on the disposal of such stock as an ordinary loss rather than as a capital loss, which is limited to only $3,000 annually.   A loss on Section 1244 stock is reported on Form 4797 of your personal income tax return, not Schedule D.  

I recommend that when the corporation is set up, corporate records should document that the stock issued qualified as Section 1244 stock. The corporation and the individual shareholders should retain information about the qualifying stock purchased such as the number of shares received, date the stock was issued and price paid for the stock.  

If a partnership purchases Section 1244 stock of another corporate entity and later disposes of the stock at a loss, the partnership entity may pass the ordinary loss through to its partners. Note that for a partner to claim the loss as an ordinary loss instead of a capital loss, the partner must have been a partner when the stock was originally issued and remained so until the time of the loss. 

Alas, if an S corporation owns Section 1244 stock and passes a loss on the stock to its shareholders, they may not deduct the loss as an ordinary loss. Instead, they must deduct the loss as a capital loss.   Shareholders in S corporations who plan to invest in Section 1244 stock issued by other corporations should be certain to 1) acquire the stock directly from the issuing corporation themselves or 2) purchase the stock through a partnership in which they are partners. Assuming all other requirements are met, the stock will qualify as Section 1244 stock, and the taxpayers may deduct as ordinary losses any future losses realized on the stock up to $100,000 per year for joint filers.  

An additional tax planning strategy would be to have the S corporation issue Section 1244 stock to its shareholders. This way, the shareholders will be certain to realize the best of both worlds. They receive the benefit of having items of income and deduction passed through to them from the S corporation. In addition, should they subsequently sell the S corporation stock at a loss, the loss would be deductible as an ordinary loss up to $100,000 per year for joint filers, rather than as a capital loss. 

If you have any questions about Section 1244 stock, call Gregory J. Spadea at 610-521-0604. 

2020 Year End Tax Planning for Businesses

Tax legislation enacted at the end of 2019, as well as new tax laws enacted in 2020 in response to the coronavirus pandemic (COVID-19), will most assuredly affect your business’s 2020 income tax return. The plethora of legislation contains many new provisions which are likely to minimize your business’s 2020 tax liability. As a result, there are actions we may need to take before year end to ensure we take full advantage of all the opportunities introduced by these pieces of legislation.  In December of 2019, the Further Consolidated Appropriations Act, 2020, was signed into law. Included in that new law was the SECURE Act of 2019, which not only extended certain expiring tax credits, such as the employer credit for paid family and medical leave, it also made favorable changes to certain provisions relating to employer-provided retirement plans.

Tax Planning 2020

In 2020, the first piece of COVID-19 legislation signed into law was the Families First Coronavirus Response Act (Families First Act), which responded to the coronavirus outbreak by providing, among other things, payroll tax credits for leave required to be paid under the newly enacted Emergency Paid Sick Leave Act (EPSLA) and Emergency Family and Medical Leave Expansion Act (EFMLEA). The Families First Act was followed by the biggest piece of legislation for the year – the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). Included in the CARES Act was the Paycheck Protection Program (PPP), a program authorized by the Small Business Administration (SBA) to guarantee $349 billion in new loans to eligible businesses and nonprofits affected by coronavirus/COVID-19. Such loans may also qualify for tax-free loan forgiveness. We need to evaluate the changes made by the CARES Act, as well as subsequent coronavirus-related legislation, to determine their impact on your business’s tax liability. The following are some of the considerations we need to review when deciding what year-end actions may be appropriate to reap the most benefit to you and your business’s bottom line.

Depreciation Deductions

Among the many changes made by the CARES Act, the one which may have the most impact is the correction of a technical error made in the Tax Cuts and Jobs Act of 2017 (TCJA). That error resulted in the 15-year recovery period that applied to qualified leasehold improvements, qualified restaurant property, and qualified retail improvement property being eliminated for such property placed in service after 2017. After the TCJA, the depreciation period for such property, now referred to as “qualified improvement property,” was 39 years and, as a result, did not meet the requirements for additional first-year depreciation (i.e., bonus depreciation). Under the CARES Act, qualified improvement property is now depreciated over a 15-year life and meets the criteria for taking bonus depreciation. The change is effective as if it were included in the TCJA. Thus, if your business is affected by this change, we can file amended returns to claim refunds for the deductions that should have been available to you had the technical error not happened.

Relaxed Rules for Deducting Net Operating Losses

The CARES Act also temporarily removed the 80 percent limitation on taxable income for deducting net operating losses (NOLs) for 2020. In addition, the CARES Act amended the rules for NOLs to provide for a five-year carryback of any NOL arising in 2018, 2019, and 2020. As a result, if applicable, your business can take such NOLs into account in the earliest tax year in the carryback period and carry forward unused amounts to each succeeding tax year. Alternatively, you can waive this carryback period and instead carry forward any NOLs to offset income in future years. Depending on expected tax rates and cash flow in future years, this waiver option may make more sense than carrying back any NOLs.

Reduction in Business Interest Limitation

The CARES Act reduced the limitation on the deductibility of business interest. For tax years beginning in 2019 or 2020, 50 percent of a business’s adjusted taxable income, rather than 30 percent, is used to determine the business interest limitation. A special rule is provided for partnerships. Under this special rule, the increase in the limitation to 50 percent of adjusted taxable income in determining the business interest limitation does not apply to a partnership for 2019, subject to certain rules relating to allocations to the partners. There is also an election under which a business can substitute its adjusted taxable income for its last tax year beginning in 2019 for its adjusted taxable income for 2020 in calculating the business interest limitation for 2020. Keep in mind that the business interest deduction limitation only applies if the gross receipts of your business exceed $26 million in 2019 and 2020; Additionally, certain types of businesses are exempt from the limitation.

Modification of Excess Business Loss Limitation Rules

The CARES Act eliminated certain limitations on excess farm losses of a business other than a corporation. This change applies to any tax year beginning after December 31, 2017, and before January 1, 2026. Thus, if you had such losses that were limited in 2018 and/or 2019, we may be able to obtain tax refunds with respect to those years. Further, excess business losses, previously disallowed for tax years beginning after December 31, 2017, and before January 1, 2026, are now allowed for tax years beginning after 2017 and before January 1, 2021. This also presents an opportunity for amended tax returns if it applies to your business.

Minimum Tax Credit Refund

The CARES Act modified the rules for the minimum tax credit for alternative minimum tax (AMT) incurred by a corporation in a prior tax year. Under this provision, the limitation on the credit for prior year minimum tax liability does not apply to a corporation’s 2020 and 2021 tax years and the AMT refundable credit amount is 100 percent, rather than 50 percent, for tax years beginning in 2019. In addition, a corporation can elect to take the entire refundable credit amount in 2018. A corporation can apply for a tentative refund of any amount for which a refund is due by reason of this new election and, within 90 days, the IRS is required to review the application, determine the amount of the overpayment, and apply, credit, or refund the overpayment.

Retirement Plans and Other Employee Benefits

You can reap substantial tax benefits, as well as non-tax benefits, by offering a retirement plan and/or other fringe benefits to employees. Businesses that offer such benefits have a better chance of attracting and retaining talented workers. This, in turn, reduces the costs of searching for and training new employees. Contributions made to retirement plans on behalf of employees are deductible and you may be eligible for a tax credit for setting up a qualified plan. In addition, business owners can take advantage of the retirement plan themselves, as can their spouse. Where a spouse is not currently on the payroll of a business, consideration should be given to adding the spouse as an employee and paying a salary up to the maximum amount that can be deferred into a retirement plan. So, for example, if your spouse is 50 years old or over and receives a salary of $25,000, all of it could go into a 401(k), leaving him or her with a retirement account but no taxable income.

To help employees with medical expenses, your business might consider setting up a high deductible health plan paired with a health savings account (HSA). The benefits to a business include savings on health insurance premiums that would otherwise be paid to traditional health insurance companies and having employee wage contributions to the plan not being counted as wages and thus neither the employer nor the employee is subject to FICA taxes on the payroll contributions. As for employees, they can reap a tax deduction for funds contributed to the HSA, which they can invest the funds for future medical costs because there is no use-it-or-lose-it limit like there is for most flexible spending accounts; thus the funds can grow tax free and be used in retirement.

Your business might also consider establishing a flexible spending arrangement (FSA) which allows employees to be reimbursed for medical expenses and is usually funded through voluntary salary reduction agreements with the employer. The employer has the option of making or not making contributions to the FSA. Some of the benefits of an FSA include the fact that contributions made by the business can be excluded from the employee’s gross income, no employment or federal income taxes are deducted from the contributions, reimbursements to the employee are tax free if used for qualified medical expenses, and the FSA can be used to pay qualified medical expenses even if the employer or employee haven’t yet placed the funds in the account.

In addition, the SECURE Act made substantial changes to retirement plan-related provisions from which your business may benefit. For one, it increased the credit available for small employer pension plan startup costs. The credit is available for qualified startup costs of an eligible small employer that adopts a new qualified retirement plan, SIMPLE IRA plan, or SEP, provided that the plan covers at least one non-highly compensated employee. Qualified startup costs are expenses connected with the establishment or administration of the plan or retirement-related education for employees with respect to the plan. The credit, which applies for up to three years, was increased to the lesser of (1) a flat dollar amount of $500 per year, or (2) 50 percent of the qualified startup costs.

The SECURE Act also extended through 2020 an employer credit for paid family and medical leave. The credit allows eligible employers to claim a general business credit equal to an applicable percent of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave, provided that the rate of payment under the program is at least 50 percent of the wages normally paid to an employee.

The SECURE Act also extended the work opportunity credit through 2020. Under this provision, an employer can take a 40 percent credit for qualified first-year wages paid or incurred with respect to employees who are members of a targeted group of employees.

Qualified Business Income Deduction

If you participate in a business as sole proprietor, a partner in a partnership, a member in an LLC taxed as a partnership, or as a shareholder in an S corporation, you may be eligible for the qualified business income (QBI) deduction. The QBI deduction is generally 20 percent of qualifying business income from a qualified trade or business. A W-2 wage limitation amount may apply to limit the amount of the deduction. The W-2 wage limitation amount must be calculated for taxpayers with a taxable income that exceeds a statutorily-defined amount (i.e., the threshold amount). For any tax year beginning in 2020, the threshold amount is $326,600 for married filing joint returns, $163,300 for married filing separate returns, and $163,300 for all other returns.

The QBI deduction reduces taxable income, and is not used in computing adjusted gross income. Thus, it does not affect limitations based on adjusted gross income. The QBI deduction does not apply to a “specified service trade or business,” which is defined as any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities, and any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees. Engineering and architecture services are specifically excluded from the definition of a specified service trade or business. 

Some of the categories and fields listed as a specified service trade or business are fairly clear in their meaning. Others – such as “consulting” and “any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees” – are more vague. If your business could be considered a specified service trade or business, we will need to document why it should not be considered such a business and is thus eligible for the QBI deduction.

Employee Payroll Tax Deferrals

In a Payroll Tax Memorandum issued in August, President Trump directed Treasury Secretary Mnuchin to use his authority to defer the withholding, deposit, and payment of employee social security taxes, as well as taxes imposed under the Railroad Retirement Tax Act (RRTA) on railroad employees, for the period of September 1, 2020, through December 31, 2020. Because these taxes are not forgiven, and must be repaid at the end of the year, such a deferral could result in numerous practical challenges, such as what happens if an employee leaves before he or she repays the payroll taxes. Due to these practical challenges I recommended that my clients not defer any payroll taxes.  However, if you have deferred an employee’s payroll taxes under this Presidential directive, we need to discuss your options.

Extension of Time to Pay Employment Taxes

Under the CARES Act, a business can delay payment of applicable employment taxes for the period beginning on March 27, 2020, and ending before January 1, 2021 (i.e., the payroll tax deferral period). Generally, under this provision, the business is treated as having timely made all deposits of applicable employment taxes that would otherwise be required during the payroll tax deferral period if all such deposits are made not later than the “applicable date,” which is (1) December 31, 2021, with respect to 50 percent of the amounts due, and (2) December 31, 2022, with respect to the remaining amounts. For self-employed taxpayers, the payment for 50 percent of the self-employment taxes for the payroll tax deferral period is not due before the applicable date. For purposes of applying the penalty for underpayment of estimated income taxes to any tax year which includes any part of the payroll tax deferral period, 50 percent of the self-employment taxes for the payroll tax deferral period are not treated as taxes to which that penalty applies.

Rental Real Estate

Whether a rental real estate enterprise is considered a passive activity with respect to a taxpayer is important in determining whether losses from the activity are deductible. Generally, passive activity losses are only deductible against passive activity income. However, a deduction of up to $25,000 ($12,500 if married filing separately) may be allowed against nonpassive income to the extent an individual actively participates in the rental real estate activities. However, the deduction is subject to a phaseout for individuals with modified adjusted gross income above $100,000 (or $50,000 if married filing separately).

Rental real estate enterprises operated by individuals and owners of passthrough entities may also qualify for the QBI deduction if certain criteria are met. For example, a taxpayer’s rental activity must be considerable, regular, and continuous in scope. In determining whether a rental real estate activity meets this criteria, relevant factors include, but are not limited to, the following:

  • the type of rented property (commercial real property versus residential property);
  • the number of properties rented;
  • the taxpayer’s day-to-day involvement;
  • the types and significance of any ancillary services provided under the lease; and
  • the terms of the lease (for example, a net lease versus a traditional lease and a short-term lease versus a long-term lease).

A rental real estate activity will be treated as a business eligible for the QBI deduction if certain safe harbor requirements are satisfied, such as:

  • separate books and records are maintained to reflect the income and expenses for each rental real estate enterprise;
  • for rental real estate enterprises that have been in existence less than four years, 250 or more hours of rental services are performed per year with respect to the rental real estate enterprise (with slightly less stringent requirements for rental real estate enterprises that have been in existence for at least four years);
  • contemporaneous records have been maintained, including time reports, logs, or similar documents, regarding the following: (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services.                                                                           

Thus, to qualify for the QBI deduction, it’s important to determine if the safe harbor conditions are met and, if not, whether such conditions can be met by year end. Alternatively, even if the safe harbor requirements are not met, certain actions may be taken to ensure that your real estate business falls within the “trade or business” guidelines for taking the deduction.

Vehicle-Related Deductions and Substantiation Requirements

Deductions relating to vehicles are generally part of any business tax return. Since the IRS tends to focus on vehicle expenses in an audit and disallow them if they are not properly substantiated, it’s important to remind business clients that the following should be part of their business’s tax records with respect to each vehicle used in the business:

(1) the amount of each separate expense with respect to the vehicle (e.g., the cost of purchase or lease, the cost of repairs and maintenance, etc.);

(2) the amount of mileage for each business or investment use and the total miles for the tax period;

(3) the date of the expenditure; and

(4) the business purpose for the expenditure.

The following are considered adequate for substantiating such expenses:

(1) records such as a notebook, diary, log, statement of expense, or trip sheets; and

(2) documentary evidence such as receipts, canceled checks, bills, or similar evidence.

Records are considered adequate to substantiate the element of a vehicle expense only if they are prepared or maintained in such a manner that each recording of an element of the expense is made at or near the time the expense is incurred.

Feel free to contact Gregory J. Spadea at 610-521-0604, if you have any questions.  The Law Offices of Spadea & Associates, LLC prepares individual and business tax returns year round.  

Investment and Income Tax Strategies for Individuals

2020 Year-end Tax Planning Strategies for Individuals

Now is an ideal time to consider year-end strategies that may benefit you, and plan for 2021.

Results of the election on November 3, 2020 may require a need to revisit this checklist. For example, if you anticipate your marginal income tax rates to increase next year, whether due to increased income or changes to tax legislation, you may want to look to ways to accelerate income and defer deductions.

Offset capital gains

Harvest your losses by selling taxableinvestments.

Harvest your gains by selling taxable investment if you have capital loss carryovers or year-to-date losses for the current year. Short-term losses are most effective at offsetting capital gains. Note: wait at least 31 days before buying back a holding sold for a loss to avoid the IRS wash sale rule.

Evaluate if you should delay purchasing mutual fund shares until 2021 to avoid capital gains on brand new investments.

Defer or reduce income (if you anticipate being in a lower taxable income bracket in 2021 or later)

If possible, defer income and the sale of capital gain property until 2021 or later to postpone taxable income to the following year.

Consider using an RBC Credit Access Line to cover any short-term income distribution gaps.

Bunch your itemized medical expenses in the same year in order to meet the threshold percentage of your adjusted gross income to claim such deductions.

In December, make your January mortgage payment (i.e., the payment due no later than January 15) so you can deduct the interest on your 2020 tax return.

Increase your W-2 federal withholding amount in preparation for a significant tax bill or to avoid the under- withholding tax penalty.

If you have concerns that you may be subject to the Alternative Minimum Tax (AMT), speak with your tax advisor before deferring income or accelerating deductions, as your AMT status could limit your ability to benefit from these actions.

If you feel you will be in a lower income tax bracket in the future and can accept the risk of receiving payments over time, use installment sale agreements to spread out any potential capital gains among future taxable periods.

For 2020 only, consider not taking your RMD if you are in a higher income tax bracket in 2020 than you expect to be in 2021 or future years.

Retirement planning

Maximize your IRA contributions. You may be able to deduct annual contributions of up to $6,000 to your traditional IRA and $6,000 to your spouse’s IRA. If you are 50 or older, take advantage of catching up on IRA contributions and certain qualified retirement plans. You may be able to contribute and deduct an additional $1,000.

Take your Required Minimum Distribution (RMD) if you are age 72 or older.

Consider increasing or maximizing your 401(k) and retirement account contributions.

Consider contributions to a Roth 401(k) plan (if your employer allows and you are in a lower income tax bracket now than you expect to be in the future).

Avoid mandatory tax withholding by making a direct rollover distribution to an eligible retirement plan, including an IRA.

Avoid taking IRA distributions prior to age 59½ or a 10% early withdrawal penalty may apply.

Consider setting up a Roth IRA for each of your childrenwho have earned income.

Consider converting from a traditional IRA to a Roth IRA if in a low marginal income tax bracket. Partial Roth IRA conversions are permissible.

Investment and income tax strategies

Explore taking employer stock from tax-deferred accounts (net unrealized appreciation strategy) to take advantage of capital gains tax rules.

Determine the optimal time to begin taking Social Security benefits, which you can apply for between ages 62 and 70.

If you have been impacted by the COVID-19 pandemic as defined by the IRS, you may be eligible to take a COVID-19- related distribution from an eligible retirement plan. The deadline for taking such a distribution is December 30, 2020, and you may withdraw up to an aggregate limit of $100,000 from all eligible plans and IRAs. You have to pay income tax on the COVID-19-related distribution, but the 10% penalty for withdrawals before age 59 ½ does not apply and the taxes can be paid over three income tax years.

If you have business losses that flow through to your individual tax return in 2020, consider a Roth conversion or harvest capital gains to create income that is offset by the business loss.

Make a Roth IRA contribution if under the applicable earnings limitation  for tax  year  2020. If you file taxes as a single person, your Modified Adjusted Gross Income (MAGI) must be under $139, 000. If your married filing jointly your MAGI must be under $206,000.

Gifting strategies

Give to loved ones

Consider making gifts of up to $15,000 per person allowed under federal annual gift tax exclusion. Use assets likely to appreciate significantly for optimum income tax savings.

Make sure that your estate plan is up to date, and that you have a will, revocable trust, health care directive and power of attorney in place.

Give to those in need—charity

Make a charitable donation (cash or even old clothes) before the end of the year. Remember to  keep  all  of your receipts from the recipient charity. If the charitable contribution is made very close to year end, consider using a credit card to record that they can be deducted in the current year.

Use appreciated stock rather than cash when contributing to charities. This may help you avoid income tax on the built-in gain in the stock, while at the same time maximizing your charitable deduction.

If you are over 70½ in 2020 and would like to make a donation to charity from your IRA, you can donate up to $100,000 each year directly to qualified charities using a Qualified Charitable Distribution. You avoid taxes through a direct transfer of funds from your IRA custodian to qualified charities. It is a particularly effective way to direct your required minimum distribution.

Set up a donor-advised fund for an immediate income tax deduction and provide immediate and future benefits to charity over time.

Consider “bunching” several years of charitable contributions into one year with a gift to a donor-advised fund to make your contributions more tax-efficient.

Itemize personal residence and mortgage interest*

Up to $250,000 ($500,000 for married couples filing jointly) of the gain from the sale of your principal residence can be excluded from federal income tax, if you lived in the house for 2 of the last 5 years and other requirements are met.

Interest on up to $750,000 of mortgage indebtedness incurred after December 14, 2017, is allowed as an itemized deduction if used to purchase or improve a home.

For mortgages incurred December 14, 2017, or earlier, interest will be deductible on up to $1,000,000 of debt (the old cap), even if refinanced after December 14, 2017.

Set yourself up for success when doing your 2020 taxes

Send capital gains and investment income information to your accountant for a more accurate year-end projection.

Check your Health Savings Account contributions for 2020.If you qualify, you can contribute up to $3,550 (individually) or $7,100 (family), and an additional $1,000 catch-up if you are age 55 or older. Confirm you’ve spent the entire balance in your Flexible Spending Accounts for the year.

Revisit contribution amounts to your 529 plan college savings accounts.

Review Medicare Part D plan to potentially make a change during open enrollment, which begins in October.

Planning for 2021

Discuss major life events with your tax attorney to ensure you have clarity in your current situation and direction for tomorrow. Thisincludes family, job or employment changes and significant elective expenses (real estate purchases, college tuition payments, etc.).

Ensure your account preferences and risk tolerance and investment objectives are up to date with your financialadvisor.

Double check your beneficiary designations (employer- sponsored retirement plans, 401(k)s, IRAs, Roth IRAs, annuities, life insurance policies, deferred compensation plans, etc.), transfer on death (TOD) designations and payable on death (POD) designations. They should be updated as necessary and align with your estate plan.

Review to ensure you have designated a trusted contact person on each of your accounts to help protect your assets against fraud and financial exploitation.

* Interest on mortgage or home equity debt not used to purchase or improve a personal residence is no longer allowable as an itemized deduction.

The 2020 Coronavirus Aid Relief and Economic Security (CARES) Act

Here’s a highlight of what we perceived as important based on the calls we’ve been getting. 

We have posted the link to the SBA Economic Injury Disaster Loan and attached the application for Payday Protection Program on our resource page.

Coronavirus Covid-19 graphic
  • Recovery Rebates for Individuals – CARES provides direct rebates of up to $1,200 for each qualified adult ($2,400 for married couples) and $500 per child. The full rebate amount is available if you have income at or below $75,000 ($150,000 for married couples), phases out as income increases and is capped with income above $99,000 ($198,000 for married couples). The money should be directly deposited into your account by late April.
  • Pandemic Unemployment Insurance – CARES expands existing state-level unemployment insurance benefits for individuals by the Corona economic downturn. It adds $600 per week to existing state-level benefits through the end of July. For those in need, CARES provides an extra 13 weeks of benefits beyond what states usually permit. Pandemic Unemployment Assistance will even cover many who were typically excluded from a state’s program like independent contractors, free lancers, self-employed individuals, “gig” workers (i.e. Lyft or Uber drivers) and even those laid off from religious institutions. It will not be available to those who are compensated for working remotely or are receiving paid leave.
  • Retirement Plans – CARES waives the normally imposed 10% penalty for premature withdrawals from retirement accounts up to $100,000 and permits 3 years for repayment. If not repaid, income is spread over 3 years. The limit of $50,000 for loans from qualified loans is increased to $100,000. Required Minimum Distributions are suspended for 2020.
  • Student Loans – CARES defers payments on federal student loans through September 30, 2020. Employer payments on employee student loans is a tax-free fringe benefit for 2020 (not to exceed $5,250 decreased by other educational assistance programs).
  • Net Operating Loss Changes – The tax act passed at the end of 2017 eliminated a taxpayer’s ability to carry back an NOL, only to be carried forward (indefinitely) and, even then, limited to 80% of income. For tax years beginning before 1/1/2021, the CARES Act will now allow net operating losses to be carried BACK to offset 100% of income for the prior 5 years (i.e. 2013 thru 2017). YOU SHOULD CONSIDER HAVING US FILE AN AMENDED RETURN FOR BACK TO 2013 TO CLAIM AND RECEIVE A POSSIBLE TAX REFUND. The Act also allows NOLs stemming from tax years beginning after 12/31/2020 to offset 100% of income going forward rather than 80% limitation.
  • Employee Retention Credit – CARES provides employers subject to disruption due to COVID-19 by helping to continue paying employees. Any size employer may be eligible for a 50% refundable tax credit of up to $10,000 of wages plus health insurance paid per eligible employee. Qualified employers will access the funds via a payroll tax credit. The enterprise must have been disrupted by COVID-19 enough to effectively cause a loss of 50% of revenue from the same quarter of the prior year. The retention credit ends when revenue increases to at least 80% of what the business earned in a comparable quarter of the prior year. We found an answer to one question posed – employers are NOT eligible for the credit if they receive a small business loan pursuant to the CARES Act.
  • Payroll Tax Payments – CARES permits employers of any size, even sole proprietors, to delay payment of their 2020 payroll taxes until 2021 and 2022. 50% of the 2020 payments will be due in 2021, and the balance will be due in 2022. Keep in mind, FICA taxes are imposed on both employers and employees’ wages at a rate of 6.2% for the Social Security tax and 1.45% for the Medicare Tax. Self-employed individuals pay a corresponding self-employment tax effectively twice that amount. The CARES Act allows an employer to defer the employer portion of the social security tax.
  • Increased Incentives for Charitable Contributions – The CARES Act attempts to get funds to charitable organizations quickly by allowing both individuals and businesses to claim increased deductions for all cash contributions. Since we’ve so many people now taking the standard deduction, the Act permits an “above the line” deduction of up to $300 during 2020. Limitations for 2020 are relaxed so that individuals can take an itemized deduction for cash contributions of up to 100% of their gross income while corporations can deduct up to 25% of its taxable income. We understand donor advised funds or private foundations do not qualify for these laxed limitations for 2020. Perhaps limited applicability but a pretty neat item for our restaurant/food related clients is that the Act increases the allowable deduction for contribution of food inventory by business made during 2020.
  • Paycheck Protection Program – CARES enable employers (including self-employed individuals) with less than 500 employees to participate in an 8-week loan program for up to 250% of the monthly payroll brought about by the economic uncertainty as long as they maintain their payroll during this COVID-19 emergency. These loans will be made available through Commercial Banks that are authorized SBA lenders on April 3, 2020. No personal guaranties or collateral are required on these non-recourse loans. As long as the employer maintains payroll, there is forgiveness available for the portion of the loans used for covered payroll costs, interest (not principal) on mortgage loans, utilities and interest on any other debt obligations incurred before the covered period. The maximum payroll is $10,000,000 while the loan amount is limited to $100,000 annualized per employee, including wages, vacation, parental, medical, family or sick leave, retirement benefits, tips, health care benefits, etc. Seasonal businesses should calculate the 2.5 months’ payroll using the 12-week period beginning Feb. 15, 2019. Alternatively, the business may choose the period beginning March 1, 2019, and ending June 30, 2019. Seasonal businesses will multiply this average by 2.5. Employers cannot cut employees’ pay by more than 25%. In order to bring back on payroll employees that may have already been furloughed, this loan program is retroactive back to February 15, 2020. The program removes the “Credit Elsewhere Test,” which usually required an extensive analysis to determine whether the borrower had the ability to obtain some or all of the requested loan funds from alternative sources, without causing undue hardship.  That test could also have required them to utilize those alternative sources first before trying to obtain the SBA loan.
  • While the CARES Act includes loan forgiveness, please take note of how much of any such loan will be eligible for forgiveness.  The law refers to the “covered period” meaning the 8-week period starting at the date of the origination of the loan. Loan recipients are eligible for a certain amount of forgiveness but the forgiveness is reduced if the employer reduces its workforce during the 8-week covered period when compared to other periods in 2019 and 2020, or reduces employee salaries by more than 25% during the covered period. These reductions can be avoided when an employer rehires employees and increases pay during the given time period.
  • The loans have a maximum maturity of 10 years with interest rates for any portion of the loan that is not forgiven not to exceed 4%. Lenders are required to give borrowers a complete payment deferral on all principal, interest and fees of not less than 6 months and not more than 1 year on all loans under CARES.
  • Economic Injury Disaster Loan –  Small business owners in all U.S. states, Washington D.C., and territories are eligible to apply for an Economic Injury Disaster Loan advance of up to $10,000. This advance will provide economic relief to businesses that are currently experiencing a temporary loss of revenue. Funds will be made available following a successful application. This loan advance will not have to be repaid.  A link to apply for the loan online is on our website resource page.
  • Please note that any business that receives an Economic Injury Disaster Loan under Section 7(b) of the Small Business Act must reduce the amount received from CARES’ Payroll Protection Program loan.

If you have any questions please call Gregory J. Spadea at 610-521-0604.

Understanding The Tax Rules Relating to Personal Use of Vacation Homes

Understanding the Tax Rules Relating to Personal Use of Vacation Homes

There are three basic rules for treating expenses and income in connection with vacation homes. It all depends on the number of days the home is rented versus the days that it is used for personal purposes.

1) When the personal use of the vacation home exceeds the greater of 14 days or 10% of the days it is actually rented all the expenses are only deductible to the extent of rental income. For example repairs, utilities, insurance, depreciation, and so on are deductible only to the extent of gross income less mortgage interest and property taxes attributable to rental use. However, you cannot claim a loss on the rental, while net income in excess of expenses is taxable.

Gregory Speadea Attorney TAx Lawyer article on Vacation Home

2) When the vacation home is rented out for less than 15 days during the year, there are no tax ramifications. In other words, you don’t recognize rental income or deduct rental expenses.

For example, say you rent a beach house in Ocean City. You and your family use the beach house most of the summer. Then you rent out the place the two weeks after Labor Day. In effect, all of the rental income is tax-free.

Note: You still can claim those itemized deductions you would be entitled to if you did not receive any rental income. This includes mortgage interest limited to all mortgages up to $1,000,000, used to buy, construct, or improve your first home and second home for tax years prior to 2018. Beginning in 2018, this mortgage limit is lowered to $750,000. In addition, for tax years beginning in 2018 there is a $10,000 deduction limit for state and local income taxes and real property taxes.

3) When your personal use of the home does not exceed the greater of 14 days or 10% of the days the vacation home is rented out, the above limits do not apply. All expenses attributable to the rental are deductible – even if you show a loss. However the amount of the loss may be limited by the passive loss rules.

What constitutes a “personal use day” for these purposes? Any day that the home is used by an owner of the family (or family member), someone who pays less than a fair market rental or someone who uses the home under a barter or exchange agreement-even if a fair rental is paid. The amount of time spent at the vacation home doesn’t matter. For instance, if you use the home for just one hour, the whole day is considered a personal use day.

However, a day will not count as a personal day if you spend the time cleaning up or fixing up the place. And that’s true if even if the rest of the family comes along just for the ride.

How do the passive loss rules affect things? In general, losses from so-called passive activities can only be used to offset income from passive activities. The rental activity of your vacation home, by its very nature, will be considered a passive activity.

But there’s still a way to get around the rules. If you “actively participate” in the rental activity, you can use up to $25,000 of loss to offset non-passive income, such as wages and portfolio income. The $25,000 offset is available in full if your adjusted gross income (AGI) is below $100,000. It is phased out until it completely disappears for an AGI above $150,000.

What constitutes active participation? The requirement can be satisfied by regular, continuous and substantial involvement in the rental activity. Examples: participation in management decisions such as approving new tenants, scheduling or supervising repairs, deciding on rental terms, etc. In order to qualify under this exception, you must own at least a 10% interest in the property. Please refer to my blog Understanding What A Real Estate Professional is Under the Passive Activity Loss Rules.

Remember the passive activity loss rules do not come into play at all if your personal use exceeds the 14 days or 10% of the days rented because you cannot deduct the rental loss. If you have any questions contact Gregory J. Spadea at 610-521-0604.

What Records You need to Deduct Business Meals, Travel and Lodging on Your Federal Tax Return

Many of my clients ask me what documentary evidence is adequate to deduct travel and lodging.  I tell them to get a receipt or credit card statement that shows the amount, date, place, and essential character (business purpose) of the expense. I recommend they use the same credit card or business debit card to pay all the business expenses to keep things simple and organized.  I also recommend clients record their travel in their day timer or google or outlook calendar that can be cross referenced with the travel or lodging receipts.

Adequate evidence for Lodging requires a hotel receipt if it has all the following information:

  • The name and location of the hotel.
  • The dates you stayed there.
  • Separate amounts for charges such as lodging, meals, and telephone calls.

Adequate evidence for Travel will include the airline, train or bus ticket that has all the following information:

  • The name of the passenger.
  • The name of your destination.
  • The date and cost of the ticket.

Adequate evidence for Meals requires a restaurant receipt if it has all of the following information:

  • The name and location of the restaurant.
  • The number of people served.
  • The date and amount of the expense.

There is an exception when you do not needdocumentary evidence if any of the following conditions apply.

  • You have meals or lodging expenses while traveling away from home for which you report to your employer under an accountable plan, and you use a per diem allowance method that includes meals and lodging. 
  • Your expense, other than lodging, is less than $75 such as for cab fare or breakfast.

Keep in mind if your spouse is an employee of your company, you can deduct travel and meals for both you and your spouse as long as you discuss business.  

 If you need help setting up an accountable plan or have any tax questions call Gregory J. Spadea at 610-521-0604.  The Law Offices of Spadea & Associates, LLC is located in Ridley Park, PA and prepares tax returns year-round.  

Understanding What Car & Truck Expenses are Deductible For Business

I have a lot of business owners and self-employed clients who ask what records to keep in order to deduct their car or truck expenses incurred in their business. I first remind them to keep track of the total miles they drive during the year as well as the total miles driven for business. The reason is if the business owner uses their car for both business and personal purposes, the expenses must be split. Therefore, they will need to know the total miles and total business miles to calculate deduction based on the portion of mileage used for business.
There are two methods for figuring car expenses:

Using actual expenses which include:
o Depreciation or Lease payments
o Gas and oil
o Tires
o Repairs and tune-ups
o Insurance
o Registration fees

Federal Tax Law Gregory Spadea Lawyer

Using the standard mileage rate. Under this method business owners will keep track of the business miles driven during the year and multiply that total by the current standard mileage rate in effect. However, the business owner must choose to use this method in the first year the car is available for use in their business. In addition, business owners who want to use the standard mileage rate for a car they lease must use it for the entire lease period. The standard mileage rate for 2019, is 58 cents.

No matter which option you select you must keep adequate records. You should keep a diary, travel log or trip sheets documenting where you went, who you met and the mileage and date. You should also keep documentary evidence such as gas receipts, credit card statements and cancelled checks or repair bills to support your expenses. I always recommend paying all the car and truck expenses with the same credit or debit card.

If you have any questions about deducting car expenses call Gregory J. Spadea at 610-521-0604. The Law Office of Spadea & Associates provides estate and tax planning services to business and individual clients including tax return preparation services year-round.

When Can I Deduct Alimony on my Federal Tax Return Ordered Prior to December 31, 2018

When divorce occurs, one ex-spouse is often obligated to make continuing payments to the other spouse. However, for the payments to be deducted by the payer, they must meet the tax-law definition of alimony. For any particular payment to qualify as deductible alimony for federal income tax purposes and meet the tax law definition of alimony, all the following requirements must be met:

  1. The payment must be made pursuant to a written divorce decree or separation agreement such as a temporary support order. Note that payments made in advance of signing a written divorce or separation agreement or before the effective date of a court order or decree cannot be deductible alimony. Such payments are considered voluntary and are therefore nondeductible. The same is true for payment of amounts in excess of what is required under a written divorce decree or separation agreement.
  2. The payment must be to or on behalf of a spouse or ex-spouse. Therefore, payments to third parties, such as attorneys and mortgage companies, are okay if made on behalf of a spouse or ex-spouse and pursuant to a divorce decree or separation agreement.
  3. The divorce decree or separation agreement must state the payments are alimony.
  4. After divorce or legal separation (meaning the couple is considered divorced for federal income tax purposes), the ex-spouses cannot live in the same household or file a joint return for the year they separated or thereafter.
  5. The payment must be made in cash or cash equivalent such as check or money order.
  6. The payment cannot be fixed or deemed child support in the divorce decree.
    Fixed child support simply refers to amounts designated as such in the divorce or separation agreement, so it’s easy to identify. Payments are considered to be deemed child support if they are terminated or reduced by any of the following so-called contingencies relating to a child: a. Attaining the age 18, or the local age of majority.
    b. Death.
    c. Marriage.
    d. Completion of schooling.
    e. Leaving the ex-spouse’s household.
    f. Attaining a specified income level.
  7. The payer’s return is required to include the recipient’s social security number.
  8. The obligation to make payments (other than payment of delinquent amounts) must cease if the recipient party dies. If the divorce decree is unclear about whether or not payments must continue, state law controls. If under state law, the payer must continue to make payments after the recipient’s death, the payments cannot be alimony. Therefore, to avoid problems, the divorce decree should always explicitly stipulate whether a payment obligation continues to exist after the death of the recipient party. Failing this test is probably the most common cause for lost alimony deductions.
  9. There is also an IRS rule that states if alimony payments decrease by more than
    $15,000 per year between years 1 and 2, or years 2 and 3, then part of the payments will not qualify for a tax deduction to the payor (and hence will not be taxable to the payee.) In other words, if alimony payments total more than $15,000 per year then they must last more than one year and cannot be reduced too quickly. The reason for this is because the IRS sees this as a property settlement, not alimony. Because of this rule replacing all monthly payments with a lump sum “alimony” payment that is paid all in one year will often cause a trigger of this recapture rule, since alimony will go down to $0 in year

Keep in mind the Tax Cuts Jobs Act repealed the deduction for alimony paid and the corresponding inclusion of alimony in income by the recipient. The provision is effective for any divorce or separation agreement executed after December 31, 2018, or for any divorce or separation agreement executed on or before December 31, 2018, and modified after that date, if the modification expressly provides that the amendments made by this provision apply to such modification. Thus, alimony paid under a separation agreement entered into prior to the effective date is generally grandfathered.

It is very important to consult a tax attorney like Gregory J. Spadea before signing the marital settlement agreement. You can reach him at the Law Offices of Spadea & Associates, LLC in Ridley Park at 610-521-0604.

Understanding the Accumulated Earnings Tax Before Switching To a C Corporation in 2019

The June 2018 Penn Wharton Budget Model survey indicated that over 235,000 business owners are projected to convert their pass-through businesses to C corporations.  Their primary motivation is to take advantage of the new 21% corporate tax rate under the 2018 Tax Cuts and Jobs Act.  This is particularly important for business owners who can’t fully benefit from the new Qualified Business Income deduction. In fact, the biggest switchers are owners of specified service businesses whose taxable income exceeds $415,000 for married filing jointly filers.

Although the new 21% rate is tempting, C corporations are subject to double taxation. Corporate income is taxed once at the entity level and again when it is distributed to shareholders as dividends. This can be avoided if the corporation retains all of it’s profits to finance growth.  However, this opens the door to the Accumulated Earnings Tax (AET) if profits accumulate beyond the reasonable needs of the business.

The AET is a penalty tax imposed on corporations for unreasonably accumulating earnings. The tax rate on accumulated earnings is 20%, the maximum rate at which they would be taxed if distributed.  The tax is in addition to the regular corporate income tax and is assessed by the IRS, typically during an IRS audit. There is no IRS form for reporting the AET. If imposed, the earnings are subject to triple taxation when eventually distributed to the shareholders. Once at the entity level, then when the AET is imposed and finally when the accumulated earnings are distributed to shareholders.

The AET applies when there is intent to avoid income tax at the shareholder level by accumulating earnings in the corporation. The AET applies even when tax avoidance is not the main reason for the accumulation of income but is only one of several reasons.  Keep in mind the IRS allows for an accumulated earnings credit of $250.000 or $150,000 if you are taxed as a Personal Service Corporation. Therefore, once your retained earnings exceed those limits you need to be concerned about the AET and document why your corporation needs accumulated earnings exceeding that amount.

The fact that a corporation is a holding or investment company is automatically considered evidence of the existence of a tax avoidance purpose unless the corporation can establish it wasn’t formed to avoid tax. A holding company is a corporation in which there is practically no activity other than the holding of investment property. An investment company is one that buys and sells stock, securities, real estate, and other investment property, in addition to holding investment property. If the corporation is not a holding or investment company, a tax avoidance motive is considered present if the corporation has accumulated earnings and profits in excess of the reasonable needs of the business unless it can prove otherwise by a preponderance of the evidence. The IRS regulations identify the following situations that may indicate accumulations beyond the reasonable needs of the business exist:

  1. Loans to shareholders or related parties.
  2. Payments by the corporation that personally benefit the shareholders.
  3. Investments in assets having no reasonable relationship to the corporation’s business.
  4. A weak dividend history.
  5. Retention of earnings to provide against unrealistic hazards.
  6. Working capital levels that appear high in relation to the needs of the business.

7. Salaries paid to shareholder/employees that are either extremely high (avoiding corporate  

     income tax) or extremely low (avoiding shareholder income and employment tax).

The AET is not assessed if accumulated earnings are reasonable in light of business needs. This subjective test can be satisfied by a variety of business reasons including retaining earnings to satisfy the reasonably anticipated future needs of the business.  The IRS regulations provide some broad criteria that can be used to justify that earnings are being accumulated for reasonable business needs. These include:

  1. Providing for a business expansion or plant replacement.
  2. Acquiring a business enterprise through purchasing stock or assets.
  3. Facilitating the retirement of company debt created in connection with its trade or business.
  4. Providing necessary working capital for the business.
  5. Providing for investments in suppliers, or loans to customers or suppliers to maintain the business of the corporation.

6. Providing for contingencies such as the payment of reasonably anticipated losses such as an

    actual or potential lawsuit, loss of a major customer, or self-insurance.

The accumulated amount does not have to be used immediately or within a short period after the close of the tax year, so long as it will be used within a reasonable time depending on all the facts and circumstances relating to the future needs of the business.   

To avoid the AET which is 20% of “accumulated taxable income”, a corporation must be able to demonstrate to the IRS that its accumulations are necessary to meet its business needs. The corporation must have sufficient facts and documentation to substantiate that the plans for present and future business needs require additional funds. A determination of whether the accumulation of earnings and profits is a reasonable business need is based on the facts and circumstances of each case. 

The dramatic reduction in the corporate tax rate from 35% to 21% has sparked renewed interest in the AET. Although it remains to be seen whether flow-through entities will rush to covert to C corporations, those that do will need to pay attention to this tax.  Conversion may be the way to go if owners have no need for distributions and the corporation avoids the AET by proving its accumulations are for the reasonable needs of the business.

If you have any questions, please call Gregory J. Spadea at 610-521-0604.

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