IRS to Issue Advanced Child Tax Credits

The American Rescue Plan Act (ARPA) of 2021 expands the Child Tax Credit (CTC) for the tax year 2021. Payments for the increased child tax credit will begin on July 15th.

Child Tax Credit Increase

For the tax year 2021 only, families claiming the CTC will receive up to $3,000 per qualifying child between the ages of 6 and 17 at the end of 2021. They will receive $3,600 per qualifying child under age 6 at the end of 2021. The credit will include children who turn age 17 in 2021. Under the prior law, the amount of the CTC was up to $2,000 per qualifying child under the age of 17 at the end of the year. Taxpayers must have a primary home in the United States for more than half the year.

The increased CTC is phased out for taxpayers with income over $150,000 for married taxpayers filing a joint return and qualifying widows or widowers, $112,500 for heads of household, and $75,000 for all other taxpayers.

The credit is fully refundable. Taxpayers may receive the credit even if they do not have earned income or owe income taxes.

Advanced Payments

Taxpayers may receive part of their credit in 2021 in advance of filing their 2021 tax return. The IRS will begin issuing advanced payments between July and December. Eligible taxpayers do not need to take any action now other than to file their 2020 tax returns.

The total of the advance payments will be up to 50 percent of the CTC. The IRS will estimate advance payments from information included in 2020 tax returns or 2019 tax returns if 2020 returns are not filed and processed yet. Taxpayers are urged to file their 2020 tax returns as soon as possible to ensure they are eligible for the appropriate amount of the CTC. Filing electronically with direct deposit may speed refunds and future advance CTC payments.

Eligible taxpayers who do not want to receive an advance payment of the 2021 CTC will have the opportunity to decline to receive advance payments. Taxpayers will also have the opportunity to update information about changes in their income, filing status, or the number of qualifying children.

Update: The IRS recently opened up an online site, the Child Tax Credit Non-Filer Sign-up Tool, for taxpayers to report qualifying children. For more information,  visit the IRS website.

Author, Beeta Lecha

Principal, Spiegel Accountancy Corp

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

IRS Pushes Tax Deadline

Taxpayers now have more time to compile their 2020 income taxes as the Internal Revenue Service (IRS) moves this year’s tax-filing deadline to May 17th, offering taxpayers and their accountants a huge sigh of relief. This move comes following many pleas from lawmakers and accountants to extend the deadline amid recent changes to U.S. tax laws. More than 100 House members signed a letter earlier this week urging the IRS to institute the delay.

“This extension is absolutely necessary to give Americans some needed flexibility in a time of unprecedented crisis,” said House Ways and Means Oversight Subcommittee Chairman Bill Pascrell Jr., D-N.J., and House Ways and Means Chairman Richard Neal, D-Mass. in a statement on Wednesday, March 17.

This move by the IRS and the U.S. Treasury Department comes following the $1.9 trillion stimulus package passed last week that added even more changes to an already complex tax-filing year. The extension also allows the agencies more time to process tax returns while simultaneously completing the task of sending another round of stimulus checks to many Americans.

The IRS emphasized the extended deadline only applies to federal tax returns and encouraged taxpayers to check with their state. Not all states follow the federal filing deadline and may set their own.

Many accountants are still awaiting guidance from the IRS on items that affect the current tax season. Jeff Spiegel, CPA and Founding Principal of Spiegel Accountancy Corp. says, “The IRS and tax software systems still have not completed their programs and forms for all of the changes from the many bills that have passed over the past 12 months.”

Last year, the IRS extended the filing season to July 15 due to issues related to the COVID-19 pandemic.

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Mortgage Lenders Look to Public Filing and SPACs

The mortgage industry was exceptionally lucrative in 2020 due to a surge in refinance loans triggered by historically low interest rates. Loan refinancing comprised over 50 percent of loan originations in 2020. According to data provider Black Knight, the mortgage industry originated more than $4.4 trillion in loans in 2020, about $300 billion more than predicted by industry analysts. This is a 45 percent increase from 2019, according to the Mortgage Bankers Association.

With this housing resurgence, many mortgage banks saw profit margins at record highs. Last fall, numerous mortgage lenders began considering initial public offering (IPO) filings to fund growth and raise equity, with many lenders beginning the process of regulatory filing with the Security and Exchange Commission (SEC). Rocket Mortgage, formally Quicken Loans, one of the nation’s largest mortgage companies, expressed its decision to go public as a way to reward employees with stock options among other benefits.

Access to More Capital

Home Point Capital and loanDepot are two of the most recent mortgage companies to file registration statements with the SEC in January 2021. Public stock offerings are one way for mortgage banks to solve the continual problem of raising capital, with loanDepot looking to raise over $300 million in equity. Mortgage banks are unlike traditional banks that have the advantage of relying on customer deposits to fund their loans. The anticipated extra capital injected into the mortgage banking industry through IPOs is projected to make for an even better year with more than $4.5 trillion projected originations in 2021.

One primary benefit of raising equity capital through an IPO is that it removes the obligation for repayment, unlike debt capital that would also sustain an annual interest rate. Instead, the shareholders’ investments are recompensed based on the stock’s performance in the market. The drawback to equity capital is that having shareholders dilutes ownership of the company and requires significantly more governance and rules.

Special Purpose Acquisition Companies

Many lenders are looking at utilizing a hot trend registration vehicle: a special purpose acquisition company (SPAC). A SPAC has no commercial operations and is structured strictly to raise funds through an IPO to purchase another company. One can look at a SPAC as the reverse of a traditional IPO. A SPAC goes public first – usually with a highly regarded executive team able to raise money from large institutional investors – with the intent to acquire a private company to put in its shell within about 24 months.  Essentially, a SPAC would acquire an existing mortgage bank following its fundraising IPO.

Unlike most other non-performing shell corporations, SPACs typically have cash. In most cases, the cash in a typical SPAC will not be less than $5 million, but the money is helpful to create immediate capital appreciation and value for the target in the transaction.

Financial Statement Reporting Considerations

As part of the public filing process, management will need to have its financial statements audited under Public Company Accounting Oversight Board auditing standards. In addition, SEC independence rules are much more restrictive than the American Institute of Certified Public Accountants with respect to the auditors providing bookkeeping, financial statement preparation, and tax preparation for officers of the company. These are issues that should be discussed with the auditors as part of the public offering process.

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Economic Recovery and Stimulus

President Donald Trump signed into law the Consolidated Appropriations Act, 2021 (“the Act”). The Act is made up of the Additional Coronavirus Response and Relief Act (ACRRA) and the Taxpayer Certainty and Disaster Relief Act of 2020. The approximately $900 billion of pandemic stimulus provides emergency relief for both individuals and businesses, and consists of a multitude of items, including PPP loans, EIDL grants, employee retention credits, economic impact payments, unemployment benefits, the addition of new tax provisions, and the extension of expiring provisions.

The Act’s most notable item is the reopened Paycheck Protection Program (PPP), providing a second round of additional funding for struggling businesses through March 31, 2021. The Act creates “second draw” loans for the smaller, harder-hit businesses, and simplifies the loan forgiveness application process. Perhaps the largest win for businesses was resolving the conflict between Congress and the IRS on the deductibility of expenses funding forgiven PPP loans. While Congress had intended for the PPP loans not to be taxable, the IRS had issued revenue rulings maintaining the position that expenses related to forgiven PPP loans would not be deductible. The Act clarified Congress’ position overriding the IRS, allowing the expenses to be tax-deductible.

Additional Coronavirus Response and Relief Act

The ACRRA was designed to assist individuals and businesses during the pandemic and help the economy recover. While a full summary of the Act is not feasible in this briefing, a summary of key items includes:

  • Economic Impact Payments – a second round of one-time economic stimulus payments of up to $600 per taxpayer, or $1,200 for married filing jointly, plus $600 per dependent under age 17 at the end of 2020. The payments begin phasing out for taxpayers with AGI over $75,000 Single, $150,000 married filing jointly, or $112,000 head of household.
  • Unemployment benefits – extends federal pandemic unemployment compensation by $300 a week for individuals from December 26, 2020 to March 14, 2021.
  • Deductibility of PPP expenses – overrides the IRS position on taxability of PPP loans by clarifying that business expenses used in obtaining Paycheck Protection Program (PPP) loans are tax-deductible.
  • Small business loans – more than $284 billion for additional PPP loans for small businesses.
  • Eviction moratorium, rental assistance – extends the temporary eviction moratorium through January 31, 2021, and provides $25 billion in tax-free rental assistance.
  • Tax credits – tax credits for companies offering paid sick leave.
  • Child care assistance – $10 billion to state revenue funds to supplement child care assistance for low-income families.
  • Broadband – several billion dollars to fund increased broadband access to assist employees in working remotely.
  • Transportation – support for transportation services, including $2 billion for airports and $16 billion in payroll support for airline workers and contractors.
  • Vaccine distribution – over $8 billion for activities to plan, prepare for, promote, distribute, administer, monitor, and track coronavirus vaccines to ensure broad-based distribution, access, and vaccine coverage.
  • Vaccine development – over $22 billion shall remain to develop and purchase vaccines, therapeutics, diagnostics, and necessary medical supplies.
  • COVID testing – $22.4 billion for expenses related to testing, contact tracing, surveillance, containment, and mitigation to monitor and suppress COVID-19.
  • Clinical research – over $1 billion for research and clinical trials related to long-term studies of COVID-19.
  • Health care reimbursement – $3 billion to reimburse, through grants or other mechanisms, eligible health care providers for healthcare-related expenses or lost revenues attributable to the coronavirus.
  • Mental health services – over $4 billion for mental health services and substance abuse and mental health services and suicide prevention programs.

Taxpayer Certainty and Disaster Tax Relief ACT of 2020

Included in the Consolidated Appropriations Act, 2021 is the Taxpayer Certainty and Disaster Relief Act of 2020 (TCDTRA). Several new provisions were added in the TCDTRA, and certain Internal Revenue Code provisions were extended either through 2021, or 2025, while other provisions were made permanent. Key tax items of interest are summarized below:

Full Deduction for Business Meals

Businesses may now claim a 100% deduction instead of 50% for food or beverages provided by restaurants. The meals may be for dine-in, delivery or takeout, for purchases paid or incurred between January 1, 2021, through December 31, 2022.

Charitable Contributions

Individuals may claim a $300 above-the-line deduction ($600 married filing joint) for cash contributions made to qualified organizations for 2021. A 50% accuracy-related penalty will be imposed on an underpayment of tax arising from an overstatement of the deduction.

The AGI limitation on charitable contributions was increased to 100% and extended to include the 2021 tax year.

Contributions must be made in cash to qualified organizations. Contributions cannot be made in property or be paid to private foundations or donor-advised funds.

Retirement Plan Relief

Individuals may take penalty-free withdrawals up to $100,000 from qualified retirement accounts, reduced by other amounts treated as qualified disaster distributions for prior taxable years. The $100,000 limitation is applied separately for individuals affected by more than one disaster. The amount withdrawn is recognized in gross income ratably over a three-year period beginning with the year of withdrawal, unless the taxpayer elects to have it recognized in the year of the withdrawal. The distributions are not subject to withholding.

Individuals with plans accepting rollover contributions may repay the distributed amounts within a three-year period, beginning on the date on which the distribution was received. The distribution repayment will not be counted against the one rollover per year limitation.

Flexible Spending Account Carryovers

The “use it or lose it” nature of health and dependent care plans were temporarily modified. Individuals may carry over unused 2020 benefits remaining in health and dependent care FSA accounts to their 2021 accounts without disqualifying their cafeteria plan. Unused 2021 benefits may be carried over to 2022. Health care FSA will provide post-termination reimbursements for persons terminated in 2020 or 2021 throughout the end of the plan year, including the 12 month grace period.

The age limit on dependent care FSA accounts was increased from 13 to 14 years old during the plan year if there were unused amounts from the preceding year.

Participants in health care and dependent care flexible spending plans may prospectively modify their employee contribution amounts for the 2021 plan year. Employers may retroactively amend their cafeteria plans to the beginning of the previous calendar year.

Employee Retention Credit

The TCDTRA retroactively amended the CARES Act to allow previously ineligible PPP loan recipients the ability to claim the employee retention credit. The eligibility period was extended by six months to qualified wages paid before July 1, 2021. In addition, the allowable percentage increased from 50% to 70% of qualifying wages. The maximum allowable credit per employee was increased from $10,000 qualified wages annually to $10,000 per quarter.

Taxpayers may not receive a double tax benefit. Wages used to determine Work Opportunity Credits, Empowerment Zone Employment Credits, and Employer Credits for Paid Family and Medical Leave, and other credits, may not also be used to claim the employee retention credit.

Disaster-Related Employee Retention Credit

Eligible employers in qualified disaster zones whose businesses were inoperable during the disaster period ending on December 27, 2020, may claim a disaster-related employee retention credit. The credit amount is equal to 40% of the qualified wages paid to each employee, capped at $6,000 per year, per employee, such that the maximum credit amount is $2,400 per employee.

The disaster-related employee retention credit is separate from and not related to the employee retention credit in the previous section, but similarly may not receive a double tax benefit on wages used to determine other credits.

Other Provisions

Highlights of other new provisions included from the TCDTRA include:

  • Pension plans are permitted to make distributions to employees who reached age 59 1/2 and are still working.
  • Allows earned income credit and child tax credit to be based on 2019 earned income rather than 2020 earned income.
  • Taxpayers electing real property trades or businesses under the business interest limitation rules may depreciate the pre-2018 residential rental property over 30 years, regardless of when the property was placed in service.
  • Minimum 4% of low-income housing credit.

Provisions Made Permanent

The following key tax provisions were made permanent through the TCDTRA:

  • Reduces the medical expenses deduction from 10% to 7.5% of AGI.
  • Repeals the deduction of qualified tuition and related expenses, and transitions to an increased income limitation on lifetime learning credits.
  • Section 179D energy-efficient commercial building deduction, with modifications.
  • Excludes benefits provided to volunteer firefighters and emergency medical responders from income.

Provisions Extended Through 2025

The following key tax provisions were extended through the 2025 tax year by the TCDTRA:

  • New markets tax credit.
  • Work opportunity credit.
  • Empowerment zone tax incentives.
  • Employer credit for paid family and medical leave.
  • Exclusion from gross income of discharge of qualified principal residence indebtedness, with a modification reducing the maximum amount from $2 million to $750,000.
  • Exclusion for certain employer payments of student loans.

Provisions Extended Through 2021

The following key tax provisions were extended through the 2021 tax year by the TCDTRA:

  • Treatment of mortgage insurance premiums as qualified residence interest.
  • Credit for health insurance costs of eligible individuals.
  • Nonbusiness energy property.
  • Credit for new qualified fuel cell motor vehicles.
  • Credit for alternative fuel refueling property credit
  • Two-wheeled plug-in electric vehicle credit
  • Energy-efficient homes credit
  • Extension of excise tax credits relating to alternative fuels

 

Author, Beeta Lecha

Principal, Spiegel Accountancy Corp

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Guidance for PPP 2.0

The latest stimulus bill passed by Congress allocates $284 billion to small businesses through the Paycheck Protection Program (PPP). This new legislation is said to have tighter requirements with more relaxed tax regulations. PPP round two reopens the program for first-time borrowers provides better flexibility for spending PPP funds, and, under certain conditions, allows prior loan recipients to apply for a second loan.

Who Qualifies?

For borrowers to be eligible this round, their business must have operated before February of 2020 and must have fewer than 300 employees, which is down from the previous requirement of 500. Qualified borrowers will have loans capped at $2 million, which is down from the $10 million cap in the first round. The lending guidelines for requested funds still have the amount set at 2.5 times monthly payroll, with restaurants and hotels allowed to request 3.5 times their average monthly payroll. Designed to support employees and prevent layoffs, this new bill requires 60% of the loan be used for salaries.

The first round of PPP loans established the covered period for the borrower, depending on when they received their loans. PPP 2.0 allows borrowers to choose between an 8-week or 24-week covered period. This slight change offers borrowers more control over the handling of potential workforce reductions once the PPP funds are depleted.

Chance for Second Loan?

 A recent study by the National Federation of Independent Business (NFIB) reported one-in-four small business owners reported they will soon be closing their doors if current economic conditions do not improve. The NFIB also stated that the majority of PPP borrowers (91%) have spent all their loan funds. Fortunately, these business owners may apply for a second loan also known as a “second draw.” To qualify, these borrowers must have depleted their first round of PPP and show a 25% reduction in revenue in at least one quarter of 2020 compared to the same in 2019.

Eligibility for Non-profits

Stimulus round two made provisions for 501(c)(6) not-for-profit organizations eligibility for PPP loans. These previously forgotten non-profits are often professional organizations, such as chambers of commerce, boards of trade, small business associations, tourism and hospitality coalitions, and social welfare groups. Such organizations can apply for PPP provided they do not receive more than 15 percent of their revenue from lobbying activities and have fewer than 300 employees.

 Spending Allowances & Tax Breaks

 PPP 2.0 allows for funds to be spent on business expenditures other than wages and rent, unlike the first pass. Borrowers are permitted to pay for supplies, software, accounting expenses, and personal protection equipment. Also covered are costs related to property damage or vandalism, which occurred in 2020, due to looting or public disturbances that were not covered by insurance.

Similar to prior legislation, PPP funds will be tax-exempt. Furthermore, the new legislation also stipulates that expenses paid with proceeds of a PPP loan that is forgiven to be considered tax-deductible. This applies to both new and existing former PPP loans. This reverses IRS and Treasury guidance issued this past November that declared borrowers could not deduct PPP expenses if the loan had been forgiven.

 Loan Forgiveness

 Revisions to the new PPP legislation creates a more streamlined loan forgiveness process. Borrowers who receive no more than $150,000 are now offered a simple one-page application. Round one offered this process for loans up to $50k. The simplified form requires borrowers to provide a description of the number of employees the business was able to retain due to the PPP loan, along with an estimate of the total amount of PPP proceeds spent on payroll costs. Borrowers who choose to submit this simplified application should carefully check their calculations and responses due to penalties for producing false statements. It would be prudent to consult with an accounting advisor, especially considering such expenses are now tax-deductible under the new bill.

 How to Get a PPP Loan

 In an effort to address previous criticism of the PPP initiative, minority-owned or economically disadvantaged businesses will be offered the first crack at PPP loans on Monday, January 11, 2021. The SBA is seeking to ensure that small, vulnerable businesses can access this new round of money before larger businesses claim the funds as happened in the first PPP offering. So-called community financial institutions will have access to the $60 billion set aside for businesses that had been previously shut out, with an emphasis on those with 10 or fewer employees or those in low-income areas.

The second round of loan applications is scheduled to begin on January 13th with the deadline to apply on March 31st.  However, keep in mind, applications will no longer be received once the initial second round of funds is depleted.

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

IRS Changes to Schedule K-1

The Internal Revenue Service (IRS) made significant changes to the Schedule K-1 for the 2020 tax year to improve the quality of information reported by partnerships. This consists of modified instructions for partnerships required to report capital accounts to partners. All partnerships, including limited liability companies taxed as partnerships, are required to report partners’ capital in Box L on the Schedule K-1.

Prior to 2020, a partnership could report partners’ capital using one of the following methods: tax basis, GAAP basis, Section 704(b) basis, or other method. With Notice 2020-43, all partnerships, including limited liability companies taxed as partnerships, are required to report partners’ capital on a tax basis starting with the 2020 tax return. Notice 2020-43 outlines two methods of reporting tax basis capital: Modified Outside Basis Method and Modified Previously Taxed Capital Method. The preliminary instructions for the 2020 Form 1065 provide a third option under consideration: Transactional Approach.

Modified outside basis method. The amount to report as a partner’s beginning capital account under the modified outside basis method is equal to the partner’s adjusted tax basis in its partnership interest as determined under the principles and provisions of subchapter K including, for 1) the partner’s share of partnership liabilities under section 752 and (2) the sum of partner’s section 743(b) adjustments. For purposes of establishing a partner’s beginning capital account, you may rely on the adjusted tax basis information provided by your partners. .

Modified previously taxed capital method. The amount to report as a partner’s beginning capital account under the modified previously taxed capital method is equal to the following: The amount of cash the partner would receive if you liquidated after selling all of the assets in a fully taxable transaction for cash equal to the fair market value of the assets; increased by the amount of tax loss determined without taking into account any section 743(b) basis adjustments that would be allocated to the partner following such a liquidation; and decreased by the amount of tax gain determined without taking into account any section 743(b) basis that would be allocated to the partner following such a liquidation. Instead of using the assets’ fair market value, you may determine the partnership’s net liquidity value, and gain or loss, by using such assets’ bases as determined under section 704(b), as determined for financial accounting purposes, or on the basis set forth in the partnership agreement for purposes of determining what each partner would receive if the partnership were to liquidate, as determined by partnership management.

Transactional approach. The amount to report as a partner’s beginning capital account under the transactional approach is (1) increased by the amount of cash and the tax basis of property contributed by the partner to the partnership (less liabilities assumed by the partnership or to which property is subject) as well as allocations of income or gain made by the partnership to the partner, and (2) decreased by the amount of cash and the tax basis of property distributed by the partnership to the partner (less any liabilities assumed by the partner or to which the property is subject) as well as allocations of loss or deduction made by the partnership to the partner.

The partnership is required to use one of the methods, and the method selected must be used by all partners for the year. While the capital on the K-1 may look different for 2020, the change to tax basis reporting does not cause an economic consequence to the partner. This is strictly a reporting requirement. However, partnerships that do not comply with the new reporting requirements will be subject to late filing penalties for failure to show all required information. For 2020, the late filing penalty is $210 for each month or part of a month, for a maximum of 12 months, multiplied by the total number of persons who were partners in the partnership during any part of the partnership’s tax year.

Check your 2019 K-1 statement to determine the prior method for basis reporting. Many partnerships will opt for the modified previously taxed capital method due to the availability of information. Please contact your Spiegel team with any questions or to discuss your options.

 

Author, Peter Lloyd

Senior Tax Manager, Spiegel Accountancy Corp

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

2020 COVID-19 Tax Credits for the Workplace

Tax credits for paid sick and family leave

The Families First Coronavirus Response Act (FFCRA) provides two self-employed tax credits to help cover the cost of taking time off due to COVID-19. While most of the text in these laws apply to businesses with employees, it also applies to self-employed individuals.

The tax credit for paid sick leave applies to eligible self-employed taxpayers who are unable to work (including telework or working remotely) due to:

  • Being subject to a federal, state, or local quarantine or isolation order due to COVID-19.
  • Being advised by a health care provider to self-quarantine due to COVID-19. Experiencing COVID-19-related symptoms and seeking a medical diagnosis. If you meet all the requirements, you would be eligible for qualified sick leave for each day during the year that you were unable to work for the above reasons (up to 10 days). The tax credit is worth the lesser of $511 per day or 100% of your average daily self-employment income for the year per day.
  • The only days that may be considered in determining the qualified sick leave equivalent amount are days occurring during the period beginning on April 1, 2020 and ending on December 31, 2020.

Under the expanded Family and Medical Leave Act (FMLA) provision of the FFCRA, you would be eligible for qualified family leave for each day that you were unable to work because you were caring for someone else impacted by COVID-19 (up to 10 days), or your child’s school or childcare provider was closed or unavailable due to COVID-19 (up to 50 days). You can claim a tax credit for the lesser of $200 per day or 67% of your average daily self-employment income for the year per day.

 How do I calculate and claim these tax credits?

The “average daily self-employment income” is calculated as your net earnings from self-employment during the tax year, divided by 260. An individual can claim a credit for both qualified sick leave and qualified family leave, but not both for the same time periods. You can claim both the tax credit for paid sick leave and the tax credit for paid family leave on your 2020 Form 1040 tax return. However, you do not have to wait until the next tax-filing season to benefit from these credits

 Employee Retention Credit

 If you have employees, the Employee Retention Credit (ERC) can help you cover the cost of keeping idle workers on your payroll during the pandemic. The tax credit is worth half of what you spent on wages and employee health plan costs after March 12, 2020, and before January 1, 2021, up to $10,000 per worker.

To qualify, your business must have one of the following:

  • A full or partial suspension of its operations due to governmental orders limiting commerce, travel, or group meetings due to COVID-19.
  • A sufficient decline in gross receipts compared to 2019. The decline begins when there is a 50% drop in a calendar quarter compared to the same quarter in the prior year. The decline does not end until a calendar quarter reaches 80% of the same prior-year quarter. This means that if a quarter drops to less than 50% and the following quarter is at 70%, there is still a decline.

You can claim this credit by reducing your payroll tax deposits. If your employment tax deposits are not enough to cover the full credit, you can get an advance from the IRS by filing Form 7200.

If you received a Paycheck Protection Program loan, you cannot also claim the ERC. You can claim both the paid leave credits and the ERC but not on the same wages.

For more information, contact your tax advisor and/or visit the U.S. Department of Labor website: https://www.dol.gov/agencies/whd/pandemic/ffcra-employer-paid-leave

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

The 12-Month Rule – Determining the Deductibility of Prepaid Expenses

Taxpayers seeking additional business deductions before the end of the year might consider adopting the 12-month rule by prepaying some business expenditures before year-end. Certain expenses such as insurance, rebates, and licenses can be prepaid before year-end without needing to be capitalized for tax purposes, thus allowing a tax deduction for the current tax year. The 12-month rule must satisfy the requirements of economic performance in order to be utilized. The recurring item exception may provide some relief if the economic performance standard isn’t met.

Basics of the 12-Month Rule

Under normal circumstances, IRS regulations require taxpayers to capitalize (i.e., not deduct) amounts paid for certain prepaid assets. In other words, let’s say you spend $1,000 of your hard-earned money in October on a license that lasts one year. This doesn’t necessarily mean the entire amount is deductible in the tax year the payment is made. Cash-out = tax deduction. Those more familiar with accounting principles will argue that the matching principle needs to be applied, meaning that the deduction should be applied to the period in which it provides a benefit. Meaning, you would deduct 3/12 of the expense in the year the payment is made and 9/12 in the following year. This would be the IRS’ approach (See Reg. Sec. 1.162-3(d)). Taxpayers may be allowed to deduct the full $1,000 amount in the year in which it was paid by applying the 12-month rule. To apply this rule, we must look to Reg. Sec. 1.263(a)-4(f) which states that:

Except as otherwise provided in this paragraph, a taxpayer is not required to capitalize amounts paid to create any right or benefit for the taxpayer that does not extend beyond the earlier of:

  • 12 months after the first date on which the taxpayer realizes the right or benefit; or
  • The end of the taxable year following the taxable year in which the payment is made.

Let’s apply this to our license example. A license that lasts one year was purchased in October of the current year and it is set to expire in September of the following year. The payment creates a right that does not extend 12 months after it is initially created, thus satisfying the first condition. Also, it does not extend past the following taxable year since it ends in September, which satisfies the second condition. If the right had extended beyond September of the following year, the 12-month rule would no longer be satisfied, and the license would need to be deducted ratably over the life of the license.

Exception to the Exception: Understanding Economic Performance

The 12-month rule cannot be universally applied in all situations. If another regulation or code section specifically states that a certain type of prepaid asset is disallowed, the 12-month rule will not apply. Cash basis taxpayers will have slightly different results from accrual basis taxpayers. The rules for cash-basis taxpayers are relatively straight-forward: make the payment, and as long as the conditions above for the 12-month rule are satisfied, the taxpayer is eligible for the deduction. However, in order for this to always be true, economic performance must be satisfied. This is also true for accrual-basis taxpayers, but unlike cash basis taxpayers, accrual basis taxpayers will accrue certain expenses at year-end that a cash basis taxpayer will not.

In basic terms, economic performance is the timing of when a liability owed by a taxpayer is truly treated as being incurred. All of the necessary events need to have happened to determine that a) a liability is fixed, b) the amount can be determined with reasonable accuracy, and c) a specific action or event has taken place. For example, economic performance occurs for the following liabilities:

  • Rent Expense – generally, ratably over the period the taxpayer is entitled to use the property
  • Services – occurs as services are provided
  • Insurance – occurs when payment is made

This means that for prepaid services and prepaid rent, economic performance isn’t satisfied until the property is used or until the service is provided to the taxpayer, respectively. As such, merely paying the liability doesn’t mean the payment can be deducted. However, payment for an insurance premium in the event that needs to take place for economic performance. Assuming the 12-month rule is satisfied, prepaid insurance will be deductible upon payment. A more comprehensive list of prepaid assets and their respective economic performance traits can be found at the end of the article.

Exception to the Exception to the Exception: The Recurring Item Exception

What happens if economic performance hasn’t occurred, but you really want that tax deduction? It’s at the top of your wish list and you’ve been good all year. Surely Santa will step in on your behalf. Well, congratulations! The recurring item exception exists! Reg. Sec. 1.461-5 states that economic performance will be treated as having occurred with respect to liability if:

  1.  The liability is recurring in nature and is either not material, or provides for better matching of income and expense,
  2.  And economic performance will occur before the earlier of 8 1/2 months after year-end, or the filing of the tax return.

For example, a taxpayer accrues an expense for an insurance premium year-end. The premium covers October of the current year to September of the following year. The taxpayer makes the payment on January 15th of the following year. Even though this satisfies the 12-month rule, economic performance has not occurred before year-end since payment has not been made. However, under the recurring item exception, the deduction may be taken since insurance premiums are recurring in nature. It is not material, and payment was made within 8 ½ months of year-end.

Note: The recurring item exception cannot be applied to interest, rents, worker’s compensation, tort, breach of contract, and violation of law.

Bringing It All Together

To see how all of these concepts work together, let’s go through two examples:

Example 1:  Prepaid Advertising

On December 15th, a taxpayer pays a marketing firm $10,000 for advertising services that the taxpayer believes will be performed over the next 3 months. The marketing firm completes the advertising service by February 28th of the following year.

  • 12-Month Rule – The conditions for the 12-month rule are satisfied because the benefit to the taxpayer is realized within 12 months of the payment.
  • Economic Performance – For services, economic performance is satisfied as services are provided. The amount of the liability is fixed and determinable at year-end. However, the services were not provided by the end of the year so economic performance is not satisfied. Economic performance rules trump the 12-month rule, so it’s not looking good for the taxpayer thus far.
  • Recurring Item Exception – The taxpayer argues that they regularly engage marketing firms and the amount paid is not material to their financial statements. Also, the payment was made before filing the tax return.
  • Conclusion – The recurring item exception allows the taxpayer to apply the 12-month rule and the taxpayer is able to take the deduction. Note that for prepaid services, services must be provided within 3 ½ months of the payment being made. Other prepaids, such as prepaid interest, can be paid within 8 ½ months of year-end and still be deductible.

Example 2:  Prepaid Interest

On December 15th, a taxpayer pays an interest obligation of $10,000 related to business debt covering the second half of December and the first half of January of the following year.

  • 12-month Rule – The conditions for the 12-month rule are satisfied because the benefit to the taxpayer is realized within 12 months of the payment.
  • Economic Performance – For interest, economic performance is satisfied as the borrower has use of the money. The amount of the liability is fixed and determinable at year-end. However, the taxpayer cannot “use” the money for January in December, so economic performance is not satisfied. Again, economic performance rules trump the 12-month rule; so, it is still nondeductible.
  • Recurring Item Exception – The taxpayer argues that they regularly pay interest and the amount paid is not material to their financial statements. Also, the payment was made before filing the tax return. However, prepaid interest is one of the exclusively carved out items that cannot be applied by the recurring item exception.
  • Conclusion – Even though the 12-month rule is satisfied, economic performance and the inability to apply the recurring item exception prevent the taxpayer from deducting the prepaid January interest.

As you can see, these concepts work together to provide some relief to taxpayers while still trying to prevent abuse by others who would seek to make large prepayments before year-end for the sole purpose of lowering their tax liability. When determining the deductibility of prepayments for tax purposes, every situation is unique and requires a fair bit of analysis and understanding to make sure the taxpayer takes a defensible position. One should always consult with their tax advisor on their own circumstances to determine best practices.

Prepaid Expenses and Economic Performance

Prepaid Expense Economic Performance
Prepaid Insurance Payment

 

Prepaid Warranty and Service Contracts Payment

 

Prepaid License or Permit Fees Payment

 

Prepaid Taxes Payment

 

Prepaid Dues and Fees Payment

 

Prepaid Rebates Payment

 

Prepaid Rent Ratably over the period of time the taxpayer is entitled to use the property

 

Prepaid Services As services are performed

 

Prepaid Interest Ratably as the taxpayer has use of the money being borrowed

 

Prepaid Goods As the goods are provided to the taxpayer

 

Author, Jonathan Smith, Senior Tax Manager, Spiegel Accountancy Corp

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Paycheck Protection Program Tax Treatment

More than 500 like-minded stakeholders are calling on Congress to overturn an Internal Revenue Service rule and allow Paycheck Protection Program (PPP) loan forgiveness to be fully tax-free.

In a December 3, 2020 letter to leaders of the House and Senate, the groups, led by the Associated General Contractors of America, urged lawmakers to enact legislation before the end of the year to correct the tax treatment of loan forgiveness under PPP.

IRS Notice 2020-32 states that “normally deductible business expenses will not be deductible if the business pays the expense with a Paycheck Protection Program loan that is subsequently forgiven,” which the coalition believes is a misinterpretation of the Coronavirus Aid, Relief and Economic Security Act. Section 1106(i) of the CARES Act states business expenses are “includible in gross income of the eligible recipient by reason of forgiveness” and “shall be excluded from gross income,” for purposes of the Internal Revenue Code of 1986. The coalition wants Congress to clarify this contradiction.

“At the onset of the COVID-19 pandemic, Congress responded with speed, cooperation, and an eye to preventing the worst potential economic outcomes. We ask that you bring that same spirit of urgency and cooperation before the end of this session to prevent an avoidable catastrophe for millions of small businesses that, without Congressional action, will face a surprising, and, in many cases, insurmountable tax bill next year,” the groups wrote. Spiegel Accountancy Corp Founding Principal, Jeff Spiegel, says, “Congress needs to act to get this resolved to allow expenses to be deducted.”

“The terms of the PPP are simple: if qualifying small businesses use a federally-guaranteed loan to pay their employees and cover certain non-payroll expenses, the loan will be forgiven,” the letter continued. “From April 3rd, when the program launched, through August 8th, when its authorization expired, the Small Business Administration guaranteed $525 billion in PPP loans to 5.2 million qualifying small businesses nationwide, preserving tens of millions of paychecks for their employees as the pandemic spread throughout the country.”

The coalition noted that if unchanged, the IRS ruling could increase small businesses’ taxes up to 37%.

“Since the IRS issued Notice 2020-32, Congress has signaled that it intends to reverse the ruling,” the letter said. “The Democratic and Republican Chairs of the House Ways and Means and Senate Finance Committees issued public statements saying that the IRS Notice, and, more recently, the IRS Revenue Ruling, is flawed and contrary to Congressional intent.”

The coalition added that the “most recent IRS revenue ruling” has created a renewed sense of urgency for Congress to address the issue before the end of the year.

“Allowing the IRS position to remain unchallenged will result in a significant tax increase on small business owners already suffering from the effects of COVID-19 shutdowns,” the groups wrote. “This tax will hit small business owners after their PPP loan has already been spent, and just as many states are re-imposing mandatory closures of thousands of businesses in the face of spiking numbers of COVID-19 cases. Many PPP loan recipients retained employees on their payrolls, even when there was little to no work to perform, in compliance with the intent of the program to keep people employed and off the unemployment rolls. The IRS changed the rules after businesses took out PPP loans, and business owners are now being asked to pay what amounts to a surtax on their workforce.

“Without Congressional action, businesses will face an unexpected tax bill when they file their taxes for 2020, as they continue to struggle with government-mandated shutdowns or slowdowns. Many of those businesses will close and never re-open. This senseless tax policy stands both the letter and spirit of the PPP on its head,” the letter concluded.

 

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Time to Apply for PPP Loan Forgiveness?

The 24-week period for many of the original Paycheck Protection Program (PPP) loans ended during the month of November. Those who elected for an 8-week program, or have exhausted their funds, may have begun the process of applying for forgiveness even though there is plenty of time left. Fortunately, the application process for loan forgiveness has operated much more smoothly than the original loan application period.

PPP loans were created to incentivize small businesses to retain employees by helping cover payroll costs as many businesses were forced to shutter during the COVID-19 lockdown. These loans also covered mortgage interest payments or rent, along with utilities to help businesses stay afloat. Treasury Secretary Steve Mnuchin stated, “The PPP has provided 5.2 million loans worth $525 billion to American small businesses, providing critical economic relief and supporting more than 51 million jobs.

PPP Loan Forgiveness Application Deadlines

 While borrowers who received their loan prior to June 5, 2020 could have elected for an 8-week or 24-week covered period, loans funded on or after June 5th meant waiting until November (or later) to apply for forgiveness. Keep in mind that loan payments may be deferred for up to 10 months following the end of the established loan period. It is also important to note the covered period begins the day the loan was funded.

In October, the Small Business Administration (SBA) released a new loan forgiveness application, making it easier for those with PPP loans of $50,000 or less. Banks have begun the initial phase of accepting these PPP applications from borrowers even though the time to apply depends on the bank and when the PPP covered period ends. For example, Bank of America will not take submissions until the covered period ends, while other banks will accept applications after the PPP funds have been exhausted. Most banks encourage borrowers to prepare the application for loan forgiveness immediately following the end of the loan period and collect the necessary documentation in preparation. The SBA has provided a fillable questionnaire to assist the application process.

According to the SBA, there are an estimated 3.57 million outstanding PPP loans of $50,000 or less, totaling approximately $62 billion of the $525 billion in PPP loans. The SBA suggests borrowers contact their PPP lender to obtain the correct form. They will provide either the SBA Form 3508, SBA Form 3508EZ, SBA Form 3508S, or a lender equivalent. The expiration date listed on the application forms has created some confusion. Essentially, it is a temporary date required by the SBA’s Paperwork Reduction Act, and each month a new expiration date is placed on the forms.

Borrowers may apply for forgiveness any time before the maturity date of the loan, which may be two to five years from loan origination. However, applying after the 10-month deferment means a borrower must begin making payments on the loan. While the SBA has 90 days to review and approve the applications, lenders have seen a much faster turnaround time.

PPP Loan Integrity

Businesses holding loans that exceed the $50,000 threshold require additional documentation to apply. Borrowers are encouraged to maintain close contact with their lenders as each may have developed its own evaluation and process procedures in addition to those required by the SBA. Businesses that received $2 million or more in PPP loans must complete one of two required loan necessity questionnaires, SBA Form 3509 and SBA Form 3510. The SBA recently offered additional guidance on these sizable loans. (See Rev. Rul. 2020-27 on PPP Loans and Taxes)

The U.S. Treasury maintains that all loans above the $2 million mark will be subjected to additional scrutiny under the current audit plan. Additionally, the Department of Justice established a fraud team as soon as PPP loan applications became available. Any amount of fraud has been strongly discouraged. It is important for borrowers to consult with their tax accountant, in addition to their lender, to ensure the application process completed accurately.

For more information on the Paycheck Protection Program, visit the SBA website.

 

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.