The COVID-19 pandemic and resulting economic uncertainty of 2020 left many business owners and individuals steering an unpredictable course; and though the instability is less, key questions remain in 2021. When considering issues of liquidity, workforce planning and individual tax planning, there are nine tax issues individuals and business owners should know.
Managing significant tax changes despite the uncertainty will ensure individuals and businesses are best positioned for success throughout the remainder of 2021 and beyond.
1. Paycheck Protection Program (PPP): Launched in early 2020, with a second round of funding issued in December, PPP has been a key program for assisting many businesses in making ends meet during the pandemic. Upon enactment as a part of the CARES act, Congress made the income from this forgivable loan nontaxable, but the IRS originally considered qualifying expenses to be nondeductible. Congress corrected this issue in December, and taxpayers that received funding through this mechanism should now receive truly tax-free assistance at the federal level provided they qualify for forgiveness. At the state level, however, the treatment of PPP remains murky, with many states still without guidance and some still following the IRS’ pre-correction approach.
2. Employee Retention Credit (ERC): The ERC provides a payroll tax credit for certain taxpayers subject to a government shutdown or experiencing a significant reduction in revenues. The credit is equal to up to $5,000 per eligible employee in 2020 and $7,000 per quarter for the first two quarters of 2021. The calculation is based upon wages and certain other benefits paid during the qualification period. Originally, this benefit was unavailable to companies that received PPP funding; however, this changed in December. Taxpayers cannot double dip paying for wages out of PPP funds and get the credit on those wages. At first glance, the qualification parameters may make you shy away from exploring this credit; however, with a little work you may qualify.
3. Net operating losses (NOL): The passage of the Tax Cuts and Jobs act in 2017 did away with the ability to carryback NOLs to prior periods and limited losses from flow through businesses to individuals. These limitations have been temporarily lifted and taxpayers are allowed a five-year carryback of NOLs arising in tax years beginning after December 31, 2017 and before January 1, 2021. These temporary rules allow taxpayers the ability to carryback NOLs to years prior to rate reductions due to the Tax Cuts and Jobs Act, creating a permanent tax savings of up to 14 percent for corporations and approximately ten percent for individuals. With increases in tax rates expected in future years, taxpayers will have to weigh cash today versus potential greater future savings
4. Recovery Rebate Credit/Economic Impact Payments: The US Treasury began issuing economic impact payments in April and December of 2020. The maximum first payment was $1,200 per individual taxpayer and $500 per qualifying child and the second payment was $600 per individual taxpayer or qualifying child. In order to qualify for payments you must be issued a Social Security Number, or be a married member of the armed forces with at least one Social Security Number. The first and second payments phase out at Adjusted Gross Income levels over $150,000 in the case of a joint return for 2018 and 2019, respectively. For information on qualification please see the following articles CARES Act, Consolidated Appropriations Act of 2021.
Economic Impact Payments were issued based upon Income levels in 2018 and 2019. If you did not receive the full amount of these payments you may qualify for a Recovery Rebate Credit based upon your 2020 Adjusted Gross Income. This credit is claimed by filing your 2020 income tax return and including the calculated amount. Some taxpayers not ordinarily required to file a tax return may benefit because of this credit.
5. State tax footprint: As a rule of thumb, a business is taxable in a state if it has employees working there. While some states have said that employees forced to work remotely because to the pandemic will not subject a company to state taxation, these types of relief provisions were the exception and not the norm, and have mostly come to an end. What this means is that, as the effects of the pandemic linger and employees continue to work outside the office or businesses move to a more permanent virtual employment dynamic, their footprint will expand as their employees settle in new remote locations. The impact of this expanded footprint may be felt across a wide spectrum of state and local level taxes, which may require substantially more attention from owners and management.
The unsuspecting business owner may think, “it is only one employee the exposure can’t be that great”, but state-specific sourcing rules may result in significant tax swings, particularly in relation to large transactions in circumstances where key employees, managers, and owners have moved away from the business’ historical headquarters. To protect your business it will be important to understand and assess the state and local tax risk of where your employees are waiting out the pandemic, or settling permanently if your business goes virtual. Additionally, it’s important to understand that key employees, managers, and owners may be more limited than other employees in their states of choice in the event of a permanent virtual transformation.
It isn’t all bad though. Employee movement may have net positive results. For example, historically single state businesses may be able to apportion income for the first time, and application of throwback and throwout rules may be reduced. Further, for those businesses that have decided to move permanently to a work from home environment, some states are starting to offer tax credits and incentives in relation to employees that decide to move within their boundaries as work from home employees. There may be an opportunity here to examine where you want your employees to reside, and give them options going forward.
6. Residency issues: Anytime a business shifts to a remote environment, whether temporarily or permanently, employees and owners may end up with additional nonresident tax filings or even residency issues. For example, an employee who lived in their vacation home away from their state of residence for a few months during the pandemic may be required to pay tax to that state on wages earned while working there. If that employee’s time at that vacation home lingered on, they may find that they have run afoul of that state’s statutory residency rules, and may have to pay tax to two states as a resident of both. It is important to catch these issues early, as there are significant implications related to the employee’s credit for taxes paid to nonresident states and, potentially, the business’ tax withholding requirements. These types of complicated tax situations should not be taken lightly.
General individual planning
7. Charitable contributions: Individuals who itemize in 2020 and 2021 may elect to deduct qualified charitable contributions (QCCs) of up to 100% of AGI with any excess being carried over for 5 years, deductible up to 60% of AGI. The QCC definition does not include cash contributions to most donor advised funds, a supporting organization or a private non-operating foundation. Taxpayers should be aware of situations where it is more advantageous to carry forward their QCCs and utilize other deductions on Schedule A.
In 2020, individuals who do not itemize can receive an ‘above-the-line’ deduction for QCCs up to $300. This deduction has been extended into 2021 with an increase for joint filers up to $600.
Corporations making cash contributions for 2020 and 2021 have an increased limitation to 25% from 10%.
8. Roth conversion: With the amount the government is spending trying to stabilize the economy, historically low tax rates, and messaging from the current administration there is a belief that tax rates will increase sometime in the near future. With this in mind, many taxpayers are considering converting their traditional IRA into a Roth IRA. This can also create a powerful estate planning tool without requiring the contributing individual to take distributions during their life. This increases the amount of time tax free appreciation can occur.
Another consideration many are making is do you convert an IRA to a Roth IRA and also offsetting the income effect with QCCs up to 100 percent of 2020 or 2021 AGI.
9. Estate planning: The Biden administration has messaged that they are reviewing options for changing the transfer tax system in the United States. Three major changes being considered are:
- Decreasing the current $11.7 Million exemption to historic levels (without any action by congress this will happen by law on Decece ber 31 2025)
- Increases in transfer tax rates from the current 40 percent rate
- Elimination of the step up in basis for transfers at death
Other considerations include potential changes to discounting rules and term limits on Grantor Retained Annuity Trusts. These considerations are causing many taxpayers to consider utilizing their $11.7 Million exemption today or update estate planning to ensure they can minimize the effects of potential changes. It is important to take your time and plan these things out. Ensure that you aren’t doing something today that you will regret five years from now.
There is no telling what the next session of Congress will produce. If you are concerned about possible changes to the tax laws and the impact this may have on you, your family, or your business, now is a great time to meet with your advisors, attorneys, and CPAs to discuss the ever-changing environment.