Tax Treatment of Financial Assistance Programs
ARPA provides funding for a variety of already-enacted programs offering loans, grants, and other assistance to businesses impacted by coronavirus (COVID-19). The new law effectively extends certain provisions of the Consolidated Appropriations Act of 2021 (CAA), enacted in December 2020, which confirmed that certain types of loan forgiveness will be nontaxable. This favorable tax treatment extends to the following:
- The Paycheck Protection Program (PPP)
- The SBA’s Economic Injury Disaster Loan (EIDL) advances up to $10,000
- Funding under the Shuttered Venue Operator Grant (SVOG) program for operators or promoters, theatrical producers, live performing arts organization operators, museum operators, motion picture theatre operators, and talent representatives.
For all of these programs, debt relief will avoid taxation and expenses will be tax-deductible to the extent otherwise allowed. ARPA also applies similar tax treatment to the following:
- Targeted Economic Injury Disaster grants to small businesses located in low-income communities
- Restaurant Revitalization Fund grants to small and independent restaurants.
State income tax treatment may agree with federal assistance under ARPA. On January 13, 2021, New York adopted conformity with federal rules: PPP loan forgiveness will be tax-free and expenses covered by loan forgiveness will be deductible under the usual rules. New Jersey Governor Phil Murphy announced similar tax treatment in February. Connecticut has “rolling conformity” with federal rules, which means that federal tax treatment applies unless its legislature says otherwise. No ARPA-related decoupling has occurred, so the federal tax treatment may apply in that state as well; state laws should be carefully reviewed.
Employee Retention Credit
This credit had been set to expire on June 30, 2021, but has been extended through December 31, 2021. A severely financially stressed employer—defined as having gross receipts down by 90% or more from the corresponding quarter in 2019—can claim the credit on all wages paid to employees who continue to work during the applicable quarter.
The credit can be used as an offset to the employer share of Medicare tax, which is a portion of Federal Insurance Contributions Act (FICA) payroll tax.
ARPA extends the statute of limitations from three years to five years for the IRS to assess amounts related to the employee retention credit.
Paid Sick Leave and Family Leave Credits
These credits, which were supposed to expire on March 31, 2021, have been extended through September 30, 2021. Unlike the credit included in the Coronavirus Aid, Relief, and Economic Security (CARES) Act, however, such paid sick leave is now voluntary, not mandatory. For employers that choose to offer paid leave, the credit amount for family leave has been increased from $10,000 to $12,000 of wages per employee, limited to 10 days. Again, these credits can be used as an offset to the employer share of Medicare tax.
Self-employed individuals impacted by COVID-19 in the same way as employees may claim equivalent income tax credits for sick and family leave.
ARPA provides that individuals who have been involuntarily terminated or who have seen their work hours reduced and opt for Consolidated Omnibus Budget Reconciliation Act (COBRA) coverage do not have to pay premiums, nor the administrative fee, from April 1, 2021, through September 30, 2021. There is an extended election period for such individuals.
During this period, COBRA premiums must be paid by employers; employers recoup their cost for this subsidy through a new tax credit against their Medicare taxes [Internal Revenue Code (IRC) section 6432]. This credit may be received on an advanced basis; penalties for failure to deposit the Medicare taxes are waived. But this credit is reduced by the employee retention credit and paid leave credits claimed.
Employers are required to provide notice to employees about this new COBRA option and to follow up with another notice when the subsidy ends. The IRS, along with the Departments of Labor and Health and Human Services, will provide model notices to be used for these purposes. Employers that fail to provide required notice may be subject to a penalty of $250 or more for each failure (IRC section 6720C).
Dependent Care Programs
Employees may exclude from gross income up to $10,500 in certain benefits. These benefits include salary reduction contributions under a cafeteria plan (IRC section 125) or an employer’s dependent care assistance plan (IRC section 129). Employers need to amend their plans to reflect the new dollar limit, which applies only for 2021.
ARPA provides that individuals who have been involuntarily terminated or who have seen their work hours reduced and opt for Consolidated Omnibus Budget Reconciliation Act (COBRA) coverage do not have to pay premiums, nor the administrative fee, from April 1, 2021, through September 30, 2021.
Excess Business Losses
Owners of pass-through entities may not deduct losses in excess of a threshold amount [IRC section 461(l)]. This limitation was suspended for 2018, 2019, and 2020, but applies again in 2021. Any excess loss that is not currently deductible becomes part of an owner’s net operating loss.
Under prior law, this cap on business loss deductions was scheduled to expire at the end of 2025; it has been extended through 2026.
Single Employer Pension Plans
Defined benefit plans, which must actuarily compute how much to contribute in order to meet promised pensions, had been required to amortize any funding shortfalls over seven years. ARPA gives plans a fresh start in 2022; essentially, outstanding installments under the prior amortization rules will be reduced to zero and all shortfalls will be amortized over 15 years. In addition, plan sponsors may elect to use this rule retroactively for plan years beginning in 2019, 2020, and 2021.
Changes have also been made in stabilization percentages used on actuarial computations, effective for 2020 plan years. Plan sponsors may elect to defer these changes to 2022.
Third-party Reporting on Form 1099-K
Currently, third-party payment networks—processors of credit/debit card payments or electronic payment transfers—are required to report annually on Form 1099-K if the merchant has more than 200 transactions for goods and services totaling over $20,000. Starting with transactions in 2022, which are reported in 2023, the same $600 threshold used for Form 1099-NEC issued to independent contractors will apply to third-party payment networks [IRC section 6050(W)(e)]. The lower threshold applies even if there is only one transaction; this change will likely impact the reporting of payments to gig workers who transact business through such platforms.
Worldwide Allocation of Interest
An affiliated group of corporations was supposed to have been allowed a one-time election in 2021 to determine the foreign source taxable income of the group, then allocate and apportion the interest expense of the domestic members on a worldwide basis [IRC section 864(f)]. This provision has been repealed, however.
More to Come
Businesses may be in for additional tax changes soon, with possibilities including an increase in the corporate tax rate and a reduction in certain tax breaks for pass-through entities. Which changes might be made and when they might become effective remain to be seen.