Over the course of the COVID-19 pandemic, Congress enacted several packages of stimulus legislation, including the Families First Coronavirus Response Act (FFCRA), the Coronavirus Aid, Relief, and Economic Security (CARES) Act, the Consolidated Appropriations Act, 2021 (CAA) and the American Rescue Plan Act of 2021 (ARPA). Each of these laws contained targeted tax modifications to relieve some of the economic burden caused by the coronavirus. Many changes delayed the implementation of Tax Cuts and Jobs Act of 2017 (TCJA) provisions, while others granted temporary relief from long-standing tax statutes.
As we approach the end of 2021, it’s important to incorporate the impact of any changing or expired provisions in the year-end tax planning process.
Business interest limitation
The TCJA significantly altered IRC section 163(j), creating the business interest expense deduction limitation, which has quickly become one of the most complicated provisions of recent tax law reform. The limitation caps business interest expense deductions at the sum of the taxpayer’s business interest income, plus 30% of adjusted taxable income (ATI), plus floor plan interest financing expense.
Temporary relief
The CARES Act provided temporary and retroactive relief for 2019 and 2020 in several ways:
For taxpayers other than partnerships: The 30% of ATI limitation rose to 50% for both 2019 and 2020.
For partnerships: The 30% of ATI limitation increased to 50% for 2020 only. Partners who were allocated excess business interest expenses in 2019 were automatically able to deduct 50% of that amount as an interest deduction on their 2020 return, without limitation.
For all taxpayers: An election was available to use 2019 ATI when calculating the 2020 section 163(j) limitation, allowing taxpayers experiencing declines in income to receive an increased business interest deduction in 2020.
In addition to the above, a set of final regulations provided a temporary reprieve to manufacturers and other taxpayers required to capitalize depreciation and amortization to inventory under section 263A. For 2020 and 2021 only, affected taxpayers may add back capitalized depreciation and amortization when computing ATI, resulting in a larger allowable interest deduction. Beginning in 2022, addbacks for depreciation or amortization will no longer be allowed, resulting in lower ATIs and, thus, potentially smaller interest deductions.
As we close out 2021, tax planning will need to include the impact of any potential business interest limitations. With the calculation reverting to allowing deductions supported by 30% ATI, down from 50%, more taxpayers will see portions of business interest expense disallowed and carried forward to future years. Interest rates currently remain at near-historic lows but the Federal Reserve is signaling potential interest rate increases in 2022. If interest rates should rise, we would likely see a further increased impact on section 163(j).
Net operating loss changes
The TCJA made considerable changes to the treatment of net operating losses (NOLs) effective as of Jan. 1, 2018. The changes were generally unfavorable for taxpayers — removing the two-year carryback option and allowing NOLs to offset only 80% of taxable income when carried forward. The only favorable change was removing the 20-year limit on NOL carryovers to make them indefinite.
The CARES Act altered the NOL rules to help affected taxpayers access cash. For NOLs generated in tax years 2018 through 2020, the carryback provision was reinstated and extended to five years, allowing NOL generated in these years to offset 100% of taxable income to the extent they were carried back.
In 2021 and all subsequent years, we revert to the TCJA treatment of NOLs. All NOLs generated can only be carried forward and those incurred in tax years 2018 or after may only offset 80% of current-year taxable income. Taxpayers with an NOL must wait until a future year with taxable income to realize the tax benefits.
Payroll tax deferral
The CARES Act allowed employers to defer deposit and payment of the employer’s portion of Social Security taxes and self-employed individuals to defer their equivalent portions of self-employment taxes otherwise due between March 27, 2020, and Dec. 31, 2020. Deferred deposits must be made by the following dates to be treated as timely (to avoid penalties and interest charges):
50% of deferred amounts due Dec. 31, 2021
Balance of deferred amounts due Dec. 31, 2022
Any taxpayers who utilized the deferral must deposit the first 50% (or more) of the amount deferred by the end of the calendar year. It is important to note the IRS recently determined that a failure to deposit any portion of the deferred taxes by the applicable installment date would result in a section 6656 failure to deposit taxes penalty on the entire deferred amount going back to the original due date. To avoid costly penalties, employers and self-employed individuals with deferred payroll deposits or payments should pay a minimum of 50% no later than Dec. 31, 2021.
Excess business loss limitation
The CARES Act retroactively delayed the implementation of section 461(l) excess business loss limitation until 2021 and provided additional clarification on some outstanding issues. The loss limitation provision will apply to noncorporate taxpayers for the 2021 tax year. See our related article for more information.
Employee retention credit
The employee retention credit (ERC) was one of the hallmark tax provisions included in the CARES Act, incentivizing employers to continue paying employees despite operations being affected by COVID-19. The payroll tax credit has been available to eligible trades or businesses as follows:
2020: ERC of 50% of qualified wages of up to $10,000 per employee (for the year)
2021: ERC of 70% of qualified wages of up to $10,000 per employee per quarter - Important note! The proposed bipartisan Infrastructure Investment and Jobs Act (IIJA), if enacted, will remove the fourth-quarter eligibility for most taxpayers, ending the credit as of Sept. 30, 2021
Third and fourth quarter 2021: Recovery startup businesses (broadly, qualifying employers that began operating a trade or business after Feb. 15, 2020, and meet additional requirements) are eligible for an ERC of 70% of qualified wages of up to $10,000 per employee per quarter, subject to a limit of $50,000 per quarter
Though the IIJA is likely to terminate the ERC for employers other than recovery startup businesses after Sept. 30, businesses that are eligible in any calendar quarter from the first quarter of 2020 through the third quarter of 2021 may still apply. The credit is claimed via quarterly payroll tax filings and can be obtained by filing adjusted returns as long as the statute of limitations remains open, which is generally three years from the filing due date. Businesses that experienced a full or partial suspension, or modification of operations due to a governmental order or a significant decline in gross receipts (measured differently in 2020 and 2021), should consult their Baker Tilly advisor about their eligibility. Claiming the ERC for 2021 wages will impact your 2021 income tax filing. For more, see our related article on the tax credit.
Retirement plan changes
The CARES Act brought about two retirement plan changes, both of which expired at the end of 2020:
Waived required minimum distributions (RMDs): This relief only applied to 2020. RMDs are compulsory for 2021 for taxpayers 72 and older. RMDs must be withdrawn by the end of 2021 to avoid potentially significant penalties.
Retirement account hardship withdrawals: The CARES Act allowed for hardship withdrawals from eligible retirement accounts of up to $100,000 per participant without incurring the 10% withdrawal penalty through 2020. Taxpayers could choose from one of two treatments: (1) take the distribution as taxable income with the election to pay tax over a three-year period, or (2) repay the distribution amount over a three-year period. Taxpayers who made such withdrawals will need to make a repayment or recognize taxable income in 2021, accordingly.
For more, see our update on employee benefits and executive compensation.
Emergency paid sick leave and expanded family and medical leave
The FFCRA created and the CAA broadened new emergency paid sick leave (ESPL) and expanded family and medical leave (EFML) payroll tax credits. Both credits expired on Sept. 30, 2021. For more information, see our update on employee benefits and executive compensation.
Business meals
The CAA provided a temporary 100% deduction for business meals provided by a restaurant, applicable for 2021 and 2022 expenses. While this provision is not immediately expiring, all indications from Congress currently point to the expiration of this provision after 2022.
Above-the-line charitable contributions
In 2020, the CARES Act allowed a one-time $300 above-the-line charitable contribution deduction for taxpayers who donated to qualified charities. This allowed taxpayers who do not otherwise itemize deductions, a group that has drastically increased in size since the implementation of the new standard deduction and state and local tax limitation by the TCJA, to realize a tax benefit for their donations.
The CAA continued the program for 2021 — expanding the benefit to a maximum of $600 for joint filers and maintaining $300 for single or other filers who do not itemize.
In addition, both the CARES Act and CAA suspend the 60% charitable contribution deduction limitation for qualified cash contributions in 2020 and 2021, allowing taxpayers to offset up to 100% of their current-year adjusted gross income (AGI) via itemized charitable contribution deductions.
Finally, corporations, typically limited to a 10% charitable contribution deduction, may offset up to 25% of taxable income with qualified charitable deductions in 2020 and 2021.
Exclusion of unemployment benefits from taxable income
ARPA allowed taxpayers with a modified AGI of less than $150,000 to exclude up to $10,200 of unemployment compensation received from taxable income in 2020. Though unemployment benefits continued into the third quarter of 2021, no such exclusion exists for the 2021 tax year. Taxpayers who received unemployment compensation in the current year will need to include these benefits in taxable income.
Expanded child tax credit and child and dependent care credit
ARPA increased several tax credits — with two key expansions of the child tax credit (CTC) and child and dependent care credit (CDCC). The following expansions apply to the 2021 tax year only:
Child tax credit: expanded credit amounts for taxpayers and phased out
Increase in credit to $3,000 from $2,000 ($3,600 for children 5 and under)
Children up to 17 qualify for the credit
Phase-out range: $150,000 for joint filers, $112,500 for head-of-household filers, $75,000 for all other filers
Those over the phase-out range: revert to existing (non-expanded) CTC amounts and ranges
Provided monthly payment mechanism for last 6 months of 2021
Child and dependent care credit: expanded qualifying mechanism for last 6 months of 2021
Increase in qualifying expenses to $8,000 for one child and $16,000 for two or more children from $3,000 for one child and $6,000 for two or more children
Reimbursement rates that previously ranged from 20% to 35% now range from 0% to 50% and don’t begin phasing down until a much higher level of income is attained
Though the expansion of these credits is currently set to expire after 2021, they are a central piece of President Biden’s Build Back Better agenda, and we may see their renewal in the pending budget reconciliation.
For more information on this topic, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
2021 year-end tax planning
Want to read the full 2021 year-end tax letter? Interested in signing up for the webinar series?
