The Consolidated Appropriations Act, 2021 (Act), signed into law on December 27, 2020, amends certain tax provisions of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and the Families First Coronavirus Response Act (FFCRA). It also clarifies the tax treatment of Paycheck Protection Program (PPP) loan forgiveness, extends certain deferred payroll taxes and expands the deduction for business meals, among other provisions.
While the Act is helpful in extending and expanding current tax benefits, as well as providing new tax relief to businesses, certain benefits may not be realized until the 2021 tax year.
Forgiveness of PPP Loans
The Act provides that with respect to original and second draw PPP loans allowed to certain small business under the Act “no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of the exclusion from gross income [of forgiven PPP loan amounts].”
Under the CARES Act, PPP loan forgiveness does not result in taxable cancellation of indebtedness income, or a loss of tax attributes. The Internal Revenue Service (IRS) previously stated that expenses paid with PPP loan proceeds were not deductible for U.S. federal income tax purposes. The Act reverses the IRS’s position and allows taxpayers whose PPP loans are forgiven to deduct otherwise deductible expenses paid with PPP loan proceeds. The Act also provides additional allowable and forgivable uses for PPP funds such as covered operations expenditures, property damage costs, supplier costs, and worker protection expenditures.
With respect to partnerships and S corporations, the Act clarifies that any amount excluded from income due to PPP loan forgiveness will be treated as tax-exempt income and will increase an S corporation shareholder’s stock basis and a partner’s basis in their partnership interest. This basis increase does not appear to occur until the loan is forgiven. Therefore, if a PPP loan is not forgiven until 2021, the deduction for expenses paid with PPP loan proceeds in 2020 may be limited due to inadequate tax basis.
Assume that an S corporation obtained a PPP loan for $500,000. The S corporation has one shareholder who has a stock basis of $0. The S corporation used the $500,000 to pay eligible expenses such as payroll, rent, and utilities and intends to deduct such expenses on its 2020 U.S. federal income tax return. As a result of the deductions, the S corporation will recognize a $500,000 loss for the year. The S corporation requested PPP loan forgiveness from its lender and anticipates that the loan will be forgiven. However, the S corporation is not informed of the loan forgiveness until 2021. In this scenario, it appears that the S corporation will not recognize tax-exempt income until the loan is forgiven in 2021. The S corporation shareholder will not be permitted to increase his or her stock basis until 2021 when the S corporation recognizes tax-exempt income as a result of the PPP loan forgiveness. As the $500,000 loss incurred in 2020 is in excess of the shareholder’s stock basis ($0), the shareholder will not be permitted to claim the loss until he or she has sufficient stock basis, which will not occur until 2021.
State Tax Treatment of PPP Loan Forgiveness
There is some question as to whether particular states will follow the provisions in the Act in permitting taxpayers both non-taxable treatment of PPP loan forgiveness and the deduction of expenses paid with PPP loan proceeds. Typically, states either conform to the Internal Revenue Code on a rolling basis (i.e., as changes are enacted) or on a static basis (i.e., as of a certain date). States that have rolling conformity are likely to permit both the deduction of expenses incurred with PPP loan proceeds and the non-taxable treatment of PPP loan forgiveness. To the extent that states with static conformity do not explicitly adopt the recent changes, they may not allow taxpayers either or both of these benefits. Finally, certain states (e.g., California and Pennsylvania) adopt certain provisions of the Internal Revenue Code as of a specified date. Businesses should continue to monitor state revenue department guidance to determine whether they may avail themselves of the tax benefits provided in the Act.
Employee Retention Credit
As originally enacted in the CARES Act, the Employee Retention Credit was generally available to all employers regardless of size, including tax-exempt organizations, but excluding (i) government employers, and (ii) small businesses that receive a Paycheck Protection Program (PPP) loan under the CARES Act, unless the loan was repaid by May 14, 2020. The credit was limited to 50 percent of qualified wages that employers pay their employees after March 12, 2020 and before January 1, 2021. The maximum credit was $5,000 per employee, allowable against the employer’s share of social security taxes.
The Act extended and expanded the Employee Retention Credit for calendar quarters beginning after December 31, 2020. Under the extension, qualified wages must be paid before July 1, 2021 (instead of January 1, 2021). Additionally, beginning on January 1, 2021, the credit is increased from 50 percent to 70 percent of qualified wages and qualified wages are increased from $10,000 for the year to $10,000 per quarter (increasing the annual cap from $5,000 to $28,000).
The Act further amended the CARES Act retroactively to permit PPP loan recipients to claim the credit. For PPP loan recipients, the Act provides that a recipient must either (1) exclude “qualified wages” that qualified for PPP loan forgiveness from its payroll costs; or (2) exclude “qualified wages” that allowed the employer to claim the credit from its payroll costs in determining its PPP loan forgiveness amount. These two restrictions ensure that a PPP loan recipient is not receiving a double benefit by claiming the credit for wages that were paid with PPP loans that are ultimately forgiven.
The Act also decreased the required year-over-year gross receipts decline from 50 percent to 20 percent, and added a safe harbor allowing employers to use the immediately preceding calendar quarter to determine their eligibility, both as of January 1, 2021. Under the Act, an employer qualifies for the Employee Retention Credit for the period beginning in a calendar quarter in which the employer’s gross receipts are less than 80 percent of gross receipts for the same calendar quarter in 2019 and ending with the first calendar quarter that follows the first calendar quarter in which the employer’s 2021 quarterly gross receipts are greater than 80% of its gross receipts for the same calendar quarter in 2019.
Prior to amendment, the CARES Act provided that an employer with more than 100 full-time employees could only count qualified wages of employees who were not providing services due to either (1) a full or partial suspension of operations by order of a governmental authority due to COVID-19, or (2) a significant decline in gross receipts. As January 1, 2021, the Act increases the employee threshold from 100 to 500 full-time employees for 2021. This increase permits employers with 500 or fewer employees to claim the credit for qualified wages paid to employees who continue to provide services.
In addition, employers are now permitted to claim the Employee Retention Credit for bonus pay to essential workers due to the removal of the 30-day wage limitation (which provided that wages were only qualified wages for the purposes of the Employee Retention Credit if they did not exceed the amount such employee would have been paid for working an equivalent duration during the 30 days immediately preceding the wage period).
The Act further expands eligibility for the credit by permitting public colleges and universities, public healthcare and medical providers and federal credit units to claim the Employee Retention Credit in 2021.
Paid Sick and Family Leave Credit
The FFCRA originally provided an eligible employer with refundable payroll tax credits to cover wages paid to employees while they take time off under the FFCRA paid sick and family leave programs between April 1, 2020 and December 31, 2020. The Act amended the FFCRA by extending the period during which employers may claim credits for emergency paid sick leave and paid family leave to March 31, 2021.
Deferred Payroll Taxes
On August 8, 2020, President Trump issued a presidential memorandum permitting employers to defer withholding, deposit and payment of the employee portion of Social Security taxes for any employee with pre-tax wages or compensation during any biweekly pay period that were less than $4,000 between September 1, 2020 and December 31, 2020. Employers were required to withhold and pay the deferred payroll taxes from wages paid between January 1, 2021 and April 30, 2021. The Act extends the deferral of the withholding, deposit and payment of the employee portion of Social Security taxes to December 31, 2021.
Business Meals Deduction
Taxpayers were permitted under the Tax Cuts and Jobs Act of 2017 to deduct 50 percent of business meal expenses. The Act now increases the credit amount to permit businesses to deduct 100% of business meals expenses during 2021 and 2022.