This article was originally published on December 22 but has been updated to reflect final enactment.
As we approach the end of a tumultuous and challenging 2020, Congress has completed a new relief bill in response to the continuing COVID-19 pandemic. To facilitate its passage in Congress, this relief was combined with several other measures into the Consolidated Appropriations Act (CAA). This bill was formally signed into law by President Trump on December 27. The CAA is substantial legislation that includes many provisions to fund government operations through Sept. 30, 2021, as well as to provide economic support to individuals and businesses through a combination of tax benefits, grants, and loans. It also includes several significant changes to federal tax laws that are unrelated to the COVID-19 pandemic.
What does this mean?
The enactment of the CAA is great news for the many businesses and individuals that continue to feel the economic impact of the pandemic. As part of its support, Congress has focused primarily on expanding programs that were first utilized as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act and the Families First Coronavirus Response Act (FFCRA). Since most of these programs are now familiar to taxpayers, Congress’s hope is that implementation can be accomplished quickly. In addition, Congress has extended several non-COVID-19-related tax provisions that were previously set to expire at the end of 2020.
This discussion largely focuses on the federal income tax provisions of the CAA as well as the expansion of the Payroll Protection Program (PPP) providing forgivable loans to certain businesses. However, there are other provisions that will impact businesses across many industries as well as individuals across the country through grants, other lending programs, and various other financial support. Visit our COVID-19 Resource Center for a more detailed analysis of other aspects of the CAA and many other related resources.
PPP business loans
The CAA includes significant changes to the PPP as well as expansion of other lending and grant programs. A key aspect of this is an opportunity for eligible entities to obtain PPP second draw loans (PPP2). PPP2 loans are available to eligible entities that employ not more than 300 employees and had a decline in gross receipts during the first, second, third, or fourth quarter of 2020 by 25% or more when compared to the same quarter in 2019. Special eligibility rules apply to specific industries, including accommodation and food service employers (NAICS Code 72), if they employ not more than 300 employees per location. Entities that received original PPP loans are eligible to apply for PPP2 loans if they meet the above criteria and have used the full amount of the original loan prior to disbursement of the second loan.
The maximum loan amount is the average monthly payroll costs for the one-year period before the date the loan is made (or, 2019 average monthly payroll costs) multiplied by 2.5 (3.5 if the business is classified in NAICS Code 72), but the loans are capped at $2,000,000.
Loan amounts less than $150,000 can be requested by submitting a certification, attesting that the eligible entity meets the revenue loss requirements.
Forgiveness will be granted for funds spent on the following:
- Interest on covered mortgage obligations
- Covered operations expense
- Covered property damage costs
- Payment on covered rent obligations
- Covered utility payments
- Covered supplier costs
- Covered worker protection expenditures
The amount forgiven will be the lesser of the loan amount or payroll costs divided by 60%. The tax implications for PPP2 loans will work in the same manner as the original PPP. Any income resulting from forgiveness is not taxable and, as is discussed further below, expenses paid for with second draw funds will still be deductible.
There are several retroactive modifications to the rules applicable to original PPP loans:
- A simplified loan forgiveness application is provided for loans less than $150,000. A one-page forgiveness application will be made available within 24 days of the enactment of the CAA. The application will include a description of the number of employees the borrower was able to retain, the estimated amount of the loan spent on payroll costs, and the loan amount. The borrower is required to retain support related to employment for four years and other records for three years, as the SBA may review and audit these loans to check for fraud.
- The requirement that PPP borrowers deduct the amount of any EIDL advance from their PPP forgiveness amount is repealed.
- Amounts are set aside to support first- and second-time PPP borrowers with 10 or fewer employees, first-time borrowers that have recently been made eligible, and for loans made by community lenders.
- Expense categories have been expanded to include covered operations expense, covered property damage cost, covered supplier cost, covered worker protection expenditures, group life, and disability insurance benefits. This change could potentially increase loan forgiveness for some borrowers, so businesses may consider waiting to apply for forgiveness until updated forms are available.
Business tax relief
The CAA includes several business tax provisions ranging from the expansion of CARES Act programs to the extension of non-COVID-19-related tax provisions that were set to expire.
Expense deductions funded with PPP loans
One of the most significant tax provisions of the CAA clarifies the tax treatment of expenses funded with PPP loans. The CARES Act provided for forgivable loans to the extent that the funds are used to pay certain payroll, benefits, and other allowable expenditures during the covered period. Under general tax principles, loan forgiveness results in taxable-income recognition to the borrower, unless a specific exception is available. The CARES Act specifically excluded PPP loan forgiveness from taxable income of the borrower. However, it did not explicitly address the tax treatment of deductions that were funded with the PPP loan. The IRS and Treasury Department subsequently issued guidance indicating that the expenditures funded with forgiven PPP loans would not be deductible for tax purposes.
The CAA modifies the CARES Act and overrides the IRS and Treasury Department determination by providing that businesses are able to deduct expenses funded with PPP loan proceeds. To this end, the CAA clarifies that “no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied” by reason of the exclusion of loan forgiveness from taxable income. The CAA also clarifies that in the case of a partnership or S corporation, the excluded loan forgiveness income shall be treated as tax-exempt income that is allocated to the partners or shareholders. This means that pass-through entity owners will not be indirectly harmed by having to reduce their basis in the pass-through entity as a result of the PPP loan. This treatment applies to original PPP loans as well as PPP2 loans.
For example, consider a business that obtained a $1,000,000 PPP loan and used those funds to cover payroll costs during the covered period. The $1,000,000 of debt forgiveness would not be included in taxable income, and the $1,000,000 of payroll expenses would still be deductible. If the business’s effective tax rate was 30%, it would generate a $300,000 tax savings from the PPP loan and the related expenditures on top of the $1,000,000 of cashflow from the loan. For pass-through entity owners, their basis would be reduced by the $1,000,000 of deductible expenses but would also be increased by the $1,000,000 of tax-exempt cancellation of debt income, resulting in no net impact to basis (although there may still be a timing mismatch between those two basis adjustments).
Key takeaway: The allowance of PPP-funded tax deductions is a welcome development for businesses that have faced uncertainty over the course of 2020. As year-end approaches, tax projections can be updated to take these deductions into account, and any fourth-quarter tax payments that are still outstanding for individual owners of pass-through entities can be reduced to take into account these new deductions. Further, allowing these expenditures as tax deductions also avoids open questions about how disallowed deductions would have coordinated with other tax rules, such as the research and development tax credit, qualified business income deduction, and other payroll-based credits. The rule change also provides certainty with respect to financial statement income tax provisions.
Employer tax credits for employee retention
The CARES Act created a new refundable payroll tax credit for employers that retained their employees during 2020 despite the impact of COVID-19. That credit was equal to 50% of the first $10,000 of qualified wages paid by an eligible employer during 2020, leading to a maximum credit of $5,000 per employee. Eligible employers were determined on a quarterly basis to include those that were either: (1) partially or fully shut down due to government orders, or (2) suffered a decline of 50% or more in gross receipts when comparing the 2020 quarter to the same quarter in 2019. For eligible employers that had more than 100 employees, qualified wages only included amounts paid to employees who did not provide services. Conversely, eligible employers with 100 or fewer employees were able to include wages paid to all employees as qualified wages during the applicable quarters. Finally, employers that received PPP loans were ineligible to claim the retention credit. Eligible employers generating the credit as a result of a shutdown were still only able to obtain the credit for the wages paid during the period of the shutdown. The CAA both retroactively changes the CARES Act retention credit but also extends it into 2021 in a substantially modified form. These changes are very substantial and can generate significant amounts of cashflow for eligible businesses.
Retroactive retention credit changes
The CAA makes three modifications to the retention credit that are retroactive to the effective date of the CARES Act. The most significant change removes the restriction that prevents employers that obtained PPP loans from claiming retention credits. Under the modified rule, employers can claim the employee retention credit on any eligible wages not used to support PPP loan forgiveness and any wages that could count toward both provisions can be applied to either, but not both, at the election of the employer. By doing this, employers can maximize both their PPP loan forgiveness and employee retention credit.
Another change clarifies that the gross receipts of a tax-exempt entity include all amounts treated as gross receipts under Section 6033 of the Tax Code. The final retroactive change modifies the determination of qualified wages with respect to health plan expenses. Specifically, group health plan expense not included in gross income of an employee may be allocated and included in qualified wages.
Key takeaway: The retroactive changes to the retention credit, particularly with respect to PPP loan recipients, creates an immediate refund opportunity for these employers. Impacted employers with PPP loans should begin to review how their payroll costs might be covered by both provisions in order to determine which provision to apply. Consideration should also be given to which expenditures are needed to support PPP loan forgiveness to determine how the payroll costs factor into that determination. As noted above, the modifications to the PPP program may retroactively result in certain nonpayroll expenditures being treated as expenses eligible to support loan forgiveness. Where applicable this may expand opportunities to claim retention credits.
Extension and expansion of retention credit
The retention credit has been extended into the first half of 2021, so it will now expire on June 30, 2021, instead of Dec. 31, 2020. The credit has also been increased to 70% of up to $10,000 of qualified wages paid per quarter in 2021. This will allow employers to claim a maximum of up to $14,000 per employee in 2021 if they are eligible in both of the first two quarters of 2021. The test to determine qualified wages remains largely the same, but the threshold separating the two tests has been increased to 500 employees. Thus, eligible employers with up to 500 employees will be able to claim all wages paid to employees during an eligible quarter irrespective of whether the employees provided services. The gross receipts test for determining employer eligibility has also been reduced from a 50% decline to a 20% decline.
These changes together result in a substantially more lucrative credit for many employers, especially those with between 100 and 500 employees. For example, if an employer with 400 employees satisfies the 20% decline in gross receipts for each of its first two quarters of 2021 and each of its employees have at least $10,000 of compensation in each quarter, including allocable healthcare expenses, then it would generate the maximum credit of $7,000 per quarter for each employee. This would create $5,600,000 of refundable credits over the first six months of 2021. Alternatively, if an employer with 200 employees does not satisfy the gross receipts test but is partially shutdown as a result of a government order during January 2021, it would also be eligible for the retention credit but only for qualified wages paid to its employees during the period it was partially shut down. If its employees averaged $3,500 of compensation and health benefits in January, it would be eligible a credit of $490,000.
The CAA also removes the prohibition that employers receiving PPP loans are ineligible for the retention credit in the same manner as discussed above.
Key takeaway: The retention credit has provided helpful support for businesses during 2020 but was limited in its availability for businesses that met the $5,000 per employee limit and for businesses with more than 100 employees who were not paying employees that were not working. By substantially enhancing the amount of the retention credit and opening up the more favorable rules to employers with up to 500 employees, it will become a significant source of cash flow for many more businesses in 2021.
Employer credits for paid sick and family leave
The FFCRA provided refundable payroll tax credits to employers that were required to provide paid sick leave and paid family leave (see our discussion from enactment of the FFCRA). Specifically, employers with fewer than 500 employees were required to provide two forms of paid leave. First, paid sick leave was required for employees that were forced to stay home due to quarantining or to care for a family member. Second, qualified family leave was required for employees staying home to care for a child if the school or place of care was closed. The required amount of paid leave was capped depending on the reason for such leave on a per day basis, up to a per-employee maximum. Employers were eligible for a 100% payroll credit of the amount of paid leave that was required. Special rules were also included for self-employed individuals. However, the requirement to provide such paid leave was scheduled to terminate on Dec. 31, 2020.
The CAA expands the required paid sick leave and paid family leave program through March 31, 2021. For employers and self-employed individuals that are required to provide such leave in 2021, the 100% credit will remain in effect. The per-employee daily and maximum amounts of required leave remain the same, so employers may have already exhausted these requirements. Any voluntary sick leave or family leave paid in excess of the required amounts will not be eligible for the FFCRA credits but may be eligible for the general paid leave credit.
100% deduction for certain business meals
Business expenses for food and beverages are subject to specific rules that generally limit deductions to 50% of the amounts incurred. The 50% limitation includes “de minimis” fringe deductions, meals provided for the convenience of the employer, and company cafeteria expenses. Very limited exceptions allow for 100% deductions in the cases of meals for employee recreational, social, and similar activities or in the case of food provided to the public.
The CAA modifies existing rules by making 100% of business meals deductible where the food and beverages are provided by a restaurant, and the expenses are paid or incurred between Jan. 1, 2021 and Dec. 31, 2022. This change is expected to increase business tax deductions for the next two years while also providing support to a restaurant industry that continues to face significant challenges due to COVID-19.
Election to waive farming loss carrybacks
The tax treatment of net operating losses (NOLs) depends on the nature of the losses and the tax years in which they are incurred. Thus, different rules apply to general business losses, farming losses, and losses sustained by insurance companies. The CARES Act made significant changes to the treatment of NOLs that are incurred in 2018, 2019, or 2020. Such losses are now carried back to the five years preceding the year of the loss unless the taxpayer waives the carryback.
The CAA modifies the CARES Act with respect to farming losses by providing a special rule for the waiver of the five-year carryback. Specifically, this provides that taxpayers will be treated as waiving the NOL carryback where a waiver was included with their previously filed 2018 or 2019 tax returns. If those taxpayers wish to revoke such elections and take advantage of the CARES Act changes, they can amend their previously filed returns. The amendments are due prior to the due date for their first tax return due after enactment of the CAA.
Non-COVID-19 disaster relief
The CAA includes a disaster employee retention credit that applies to areas covered by federal disaster declarations between Jan. 1, 2020, and 60 days after enactment of the CAA. Qualified disaster areas for this purpose do not include COVID-19-related disaster declarations. This credit is similar to the employee retention credit described above but differs in several significant ways (although it is identical to the disaster-related employee retention credit that has been enacted several times in the past for specific disasters). An eligible employer for this credit is any employer that operated an active trade or business in the disaster zone and which is inoperable at any time during the period beginning on the first day of the disaster and ending upon enactment of the CAA. The maximum credit is equal to up to 40% of qualified wages of up to $6,000 per employee. This results in a maximum credit of $2,400 per employee. Differing from the employee retention credit, the disaster credit is available irrespective of whether employees provide services. However, qualified wages for the disaster credit do not include any wages taken into account for the employee retention credit.
Other business tax changes
The CAA includes several other provisions that extend or modify existing tax incentives. Those include:
- Work Opportunity Tax Credit (WOTC) – The WOTC is a credit that is available to employers that hire individuals from certain targeted groups. This was set to expire on Dec. 31, 2020 but has now been extended until Dec. 31, 2025. Earlier legislative proposals considered an expansion of WOTC, but the final form of the CAA merely extends the effective date without any other substantive changes.
- New Markets Tax Credit (NMTC) – The NMTC is an investment incentive program that provides federal tax credits in exchange for investments in low-income communities. These credits are authorized by Congress but are then allocated by the Treasury Department to Community Development Entities (CDEs). The CDEs pass these credits along to investors that make investments into qualifying development projects. The NMTC was set to expire on Dec. 31, 2020, but it has been extended until Dec. 31, 2025. The carryover period for the unused NMTC limitation has also been extended through 2030.
- Excise taxes on beer, wine, and spirits makers – The CAA makes permanent the lowered excise taxes that were implemented as part of the Tax Cuts and Jobs Act. These were set to expire on Dec. 31, 2020.
- One-year extension of expiring credits and deductions – Certain tax credits and depreciation rules set to expire on Dec. 31, 2020 have been extended for one year. Those include the Indian Employment Credit, accelerated depreciation for business property on Indian reservations, the three-year recovery period for race horses, and income tax and excise tax credits related to biofuel producers, fuel cell motor vehicles, alternative fuel refueling property, and alternative fuel excise tax credits.
- Extension of accelerated depreciation and expensing – Several rules related to depreciation and expensing that were set to expire on Dec. 31, 2020, have now been extended until Dec. 31, 2025. Those include the seven-year recovery period for motorsports entertainment complexes and expensing of qualified film, television, and live theatrical production costs.
Individual tax relief
The CAA includes several changes that will benefit individual taxpayers. These include direct payments, expansion of deduction provisions, and extensions or modifications of tax credits.
The CARES Act included a direct payment program for individual taxpayers through the creation of advanced tax rebates. Individual taxpayers were eligible to receive $1,200, married couples who file jointly were eligible to receive $2,400, and parents were eligible to receive an additional $500 for each of their children under the age of 17. Such payments were also subject to an income-based phaseout.
The CAA expands the recovery rebate program albeit in modified form. Individual taxpayers are eligible for an additional $600 per individual, plus $600 per qualifying child. Thus, for example, married taxpayers with two dependent children would be eligible for up to $2,400. These payments are subject to phase-out based on the adjusted gross income (AGI) of the taxpayer for the 2019 tax year. Taxpayers with the following adjusted gross income are completely phased out of this benefit: single filers with AGI of $87,000, head of household filers with AGI of $124,500, and joint filers with AGI of $174,000.
Disaster relief and retirement funds
The CAA provides relief to individuals with respect to federally declared, non-COVID-19 disasters that occurred during 2020. In particular, special rules are provided for early withdrawals from retirement accounts and their repayment. Any income that is attributable to an early distribution in these circumstances will be subject to tax over a three-year period, and the taxpayer will be allowed to recontribute the distributed funds to an eligible retirement plan within three years.
The CARES Act created an above-the-line deduction of up to $300 for cash charitable contributions made by taxpayers during 2020 if the taxpayer does not claim itemized deductions. Such contributions can generally be made to charitable organizations but exclude private foundations and donor-advised funds. The CAA extends this above-the-line deduction into 2021 and increases the deduction to $600 for married taxpayers filing jointly.
The CARES Act also increased the limitations on deductions for charitable contributions made by individuals who claim itemized deductions. Generally, an individual taxpayer can’t claim charitable contribution deductions in excess of 60% of such taxpayer’s AGI. The CARES Act increased that limitation to 100% of AGI for the 2020 calendar year allowing individuals to offset all of their income with charitable contribution deductions. The CAA extends that treatment through 2021.
Unreimbursed medical expenses
The CAA includes a permanent extension of the deductibility of unreimbursed medical expenses that exceed 7.5% of adjusted taxable income. This deduction has been subject to change recently, with a 10% of adjusted taxable income threshold previously set to take effect in 2021. By permanently setting the threshold at 7.5%, taxpayers will be eligible to claim itemized deductions for more medical expenses.
Employer-paid student loans
The CARES Act allowed employers to provide tax-free student loan repayment benefits to its employees. Specifically, employers were permitted to contribute amounts up to $5,250 toward an employee’s student loans per year, with such amounts being excluded from the employee’s taxable income. The capped amount of $5,250 is combined with any other tax-free educational assistance that the employer already provided, such as tuition, fees, books, and more. This provision applied to any student loan payment that was made by an employer directly to an employee or on an employee’s behalf beginning on March 28, 2020, and ending on Dec. 31, 2020. However, the CAA extends this treatment to qualifying payments made through Dec. 31, 2025.
Deferral of employee payroll taxes
In late August, the IRS and Treasury Department issued Notice 2020-65, which allowed for the voluntary deferral of the 6.2% Social Security tax paid by employees. Under this program, employees could retain the 6.2% payroll tax on wages paid between Sept. 1, 2020 and Dec. 31, 2020. However, the deferred payroll taxes would then be paid between Jan. 1, 2021 and April 30, 2021, through additional withholding by the employer. Any deferred taxes not paid by May 1, 2021, would be subject to penalties. Participation in the deferral program involved complicated considerations for both employers and employees (see our discussion), so many employers chose not to participate.
The CAA provides for an extended repayment period for any deferred payroll taxes under this program. Accordingly, employees that deferred any amounts will now have a full calendar year, from Jan. 1, 2021 to Dec. 31, 2021 to repay the deferred amounts, still via additional withholding by the employer. This extended period will be expected to reduce the per-paycheck impact of the repayment period.
Educator expense deductions for PPE
Elementary and secondary school teachers are eligible to deduct up to $250 per year against their gross income for certain education-related expenses. Those include expenses for professional development courses, books, supplies, computer equipment, and other equipment and materials. The CAA expands that definition of educator expenses to include personal protective equipment, disinfectant, and other supplies to prevent the spread of COVID-19.
Support for families
- Earned Income Tax Credit (EITC) and Child Tax Credit (CTC) – The CAA includes a special provision allowing individual taxpayers to utilize their 2019 earned income in place of their 2020 earned income when determining application of the EITC and CTC. This is expected to increase the amount of available credits for individuals that earned less income in 2020 due to the impact of the pandemic.
- Rollover of FSA Benefits – The CAA also allows for individuals to rollover unused benefits from a health flexible spending arrangement and dependent care flexible spending arrangement from one plan year to the next. This applies to plan years ending in both 2020 and 2021.
What to do now?
The CAA contains many provisions that can provide significant cash flow to individuals and businesses. Some provisions will provide this cash automatically while others require taxpayers to take specific actions or to specially plan to take advantage of certain provisions. Taxpayers should be sure that they begin to evaluate each of these areas to develop a plan to ensure that they are maximizing benefits available to them.
Given the speed with which the CAA was enacted and the sheer magnitude of the legislation at close to 6,000 pages, the full extent of some of the provisions are still being unpacked. Visit our COVID-19 Resource Center for continued analysis of the CAA and other COVID-19-related matters.