On December 27, 2020, President Trump signed into law The Consolidated Appropriations Act, 2021 (the CAA). The CAA contains multiple income and employment-tax related provisions that will impact both corporate and individual taxpayers and also contains welcomed resolution to certain issues created under the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”).[1]
In particular, the CAA:
- overturns the position of the IRS reflected in Notice 2020-32 by permitting taxpayers to claim a deduction for otherwise deductible expenses paid with loan proceeds from a covered loan under section 7(a)(36) of the Small Business Act (as added by section 1102 of the CARES Act) (a “PPP Loan”) that qualify the PPP Loan to be forgiven tax-free;
- extends the time period for which employers may claim employment tax credits for (i) paid sick or family leave under the Families First Coronavirus Response Act (the FFCRA) and (ii) qualified wages paid under the employee retention credit program set forth in section 2301 of the CARES Act;
- provides helpful guidance to taxpayers that have claimed employee retention credits (or have had affiliates claim such credits) that acquire another entity that received a PPP Loan (or was affiliated with another employer that received a PPP Loan). A taxpayer that has received a PPP Loan will be eligible to claim the employee retention credit for qualified wages paid in 2020 and 2021, so long as the taxpayer does not claim PPP Loan forgiveness for the qualified wages for which it claims the employee retention credit; and
- extends certain provisions of the Internal Revenue Code of 1986, as amended (the “Code”),[2] that were set to expire at the end of 2020.
Tax Treatment of PPP Loan & Economic Injury Disaster Loan Forgiveness
PPP Loan Forgiveness
Section 11102 of the CARES Act provides that all or a portion of a PPP Loan received by a taxpayer may be forgiven to the extent that the taxpayer (i) uses the proceeds of the PPP Loan to pay payroll, employee healthcare costs, interest on mortgage obligations, rent and utilities within 24 weeks from the date that the PPP Loan was received; and (ii) satisfies certain other requirements.
Section 1106(i) of the CARES Act provides that any amount that would otherwise be included in gross income as cancelation of indebtedness income under section 61(a)(11) as a result of the forgiveness of a PPP Loan is excluded from the taxpayer’s gross income. In Notice 2020-32, the IRS took the position that no deduction should be allowed for an otherwise deductible expense if the payment of the expense results in the forgiveness of a PPP Loan and such forgiveness is excluded from the taxpayer’s gross income.[3]
The CAA overturns the IRS’s position in Notice 2020-32 and provides that a taxpayer that incurred otherwise deductible expenses that qualify the PPP Loan for forgiveness will be permitted to deduct such expenses. Additionally, such taxpayer’s tax basis in its assets will not be reduced as a result of the forgiveness of the PPP Loan. This provision is effective as of the date of enactment of the CARES Act.
Furthermore, the CAA provides that a taxpayer that receives loan repayment assistance under the CARES Act will not be required to include any amounts in gross income and will not have any deductions disallowed as a result of the receipt of loan repayment assistance. This provision is effective for taxable years ending after March 26, 2020.
EIDL Forgiveness
In addition, the CARES Act provides for additional access to Economic Injury Disaster Loans (EIDL). Similar to the treatment of the PPP Loans, the CAA provides that a taxpayer that receives an EIDL (i) is not required to include in its gross income cancellation of indebtedness income arising from the forgiveness of an EIDL; and (ii) is entitled to deduct otherwise deductible expenses that were paid with the proceeds of an EIDL (and will not be required to reduce its tax basis in its assets as a result of the forgiveness of a EIDL). This provision is effective as of the date of enactment of the CARES Act.
Reporting of PPP Loan and EIDL Forgiveness
Furthermore, under section 6050P, a lender that discharges at least $600 of a borrower’s indebtedness is required to file a Form 1099-C and furnish a payee statement to the borrower. The CAA allows the Treasury Department to waive the information reporting requirements for any discharges arising from the forgiveness of a PPP Loan or an EIDL.
Extension of the CARES Act Employee Retention Credit
The CARES Act provides that “eligible employers” may receive a refundable employee retention credit in an amount equal to 50% of all “qualified wages” that are paid to employees between March 12, 2020 and December 31, 2020 if the employer either (i) had its trade or business operations partially or fully suspended due to an order from a governmental authority limiting commerce, travel or group meetings due to the COVID-19 pandemic; or (ii) experienced a decline of gross receipts for any quarter of more 50% (determined by comparing the gross receipts during such quarter with the same quarter in the preceding year) (referred to as “a significant decline in gross receipts”). For employers that averaged more than 100 full-time employees in 2019, the credit is limited to wages paid to an employee that is not providing services to the employer due to either (i) the employer’s operations being fully or partially suspended due to orders from a governmental authority; or (ii) a greater than 50% decline in the employer’s gross receipts. The amount of qualified wages that can be taken into account for each employee is limited to $10,000 in the aggregate, resulting in $5,000 of employee retention credits being available per employee.
Additionally, the CARES Act provides that if an employer (or any other person that is treated as a single employer with such employer under an aggregation rule) received a PPP Loan, such employer would not be entitled to claim the employee retention credit. This rule has created a significant amount of uncertainty as to whether the acquisition of the equity of an entity that received a PPP Loan (or was affiliated with another entity that received a PPP Loan) would cause the acquiring entity or any of its affiliates to be ineligible to claim the employee retention credits under the CARES Act or cause previously claimed employee retention credits to be recaptured.[4]
The CAA makes multiple taxpayer-favorable changes to the rules applicable to the employee retention credit. First, the CAA extends the employee retention credit to cover qualified wages paid through June 30, 2021 (instead of December 31, 2020). In addition, the CAA provides that, with respect to wages paid between January 1, 2021 and June 30, 2021, the following changes apply:
- the credit is increased from 50% of qualified wages to 70% of qualified wages;
- the per-employee wage cap is increased from $10,000 for all calendar quarters in 2020 to $10,000 for each quarter in 2021 (resulting in up to $14,000 of credits being available to a qualified employer for qualified wages paid to each employee during 2021);
- the requisite reduction in gross receipts for an employer who experienced a significant decline in gross receipts is reduced from more than 50% to more than 20%;
- an employer may elect to determine its eligibility for the employee retention credit as a result of a significant decline in gross receipts based on a decrease in its gross receipts in the prior quarter instead of the current quarter;
- the full-time employee threshold that applies for purposes of determining whether an employee needs to be providing services in order for wages paid to such employee to be treated as qualified wages is increased from more than 100 full-time employees to more than 500 full-time employees;
- certain governmental employers (including organizations described in section 501(c)(1), colleges and universities and organizations the principal purpose or function of which is providing medical or hospital care) are eligible to claim the employee retention credit;
- with respect to any employer that was not in existence in 2019, the gross receipts test can be applied by looking to the gross receipts in the corresponding quarter in 2020; and
- employers are generally not entitled to receive advance payments of the employee retention credit. However, under rules provided by the Secretary, an eligible employer that averaged 500 or less full-time employees during 2019 may elect to receive an advance payment of the employee retention credit in an amount not to exceed 70% of the average quarterly wages paid by such employer in 2019.
Finally, the CAA eliminates the rule in the CARES Act providing that an employer is not eligible to claim the employee retention credit if such employer (or one of its affiliates) received a PPP Loan. In lieu of this overly-broad employee retention credit disallowance rule, the CAA provides that section 7(a)(12) of the Small Business Act will be amended to provide that payroll costs taken into account in determining the amount of PPP Loan forgiveness will not include any payroll costs for which the employee retention credit was claimed; however, an employer has the ability to waive the employee retention credit with respect to any wages in order to obtain forgiveness for PPP Loan proceeds. Accordingly, employers that received PPP Loans may now also claim the employee retention credit, so long as such employer does not claim PPP Loan forgiveness with respect to payroll costs for which the employee retention credit was claimed, and such employers should consider filing amended employment tax returns in order to claim the credit for wages paid in 2020. This change is effective as of the effective date of the CARES Act.
Expansion of Employment Tax Credit for COVID-Related Sick Leave and Family Leave
The FFCRA requires that employers with fewer than 500 full-time and part-time employees provide (i) up to 80 hours of paid sick leave at the employee’s regular rate of pay, up to $5,110 in the aggregate where such employee is unable to work for specified reasons related to COVID-19; and (ii) up to 80 hours of paid sick leave at 2/3 of the employee’s regular rate of pay, up to $2,000 in the aggregate, where such employee is caring for others impacted by the COVID-19 pandemic or because of the closing of a school or other care facility.
Sections 7001 and 7003 of the FFCRA provide that an employer that provides paid sick leave or family leave to an employee under the FFCRA is entitled claim a refundable tax credit against the employer’s social security tax liability for an amount equal to the paid sick leave or family leave (or related health plan expenses and Medicare taxes attributable to such leave pay) that the employer was required to pay under the FFCRA at any time between April 1, 2020 and December 31, 2020. However, an employee retention tax credit (discussed in more detail below) may not be claimed with respect to wages that gave rise to an employment tax credit under the FFCRA.
The CAA extends the refundable employment tax credit to COVID-related sick leave or family leave pay (along with related healthcare expenses and Medicare taxes) that (i) is paid at any time through March 31, 2021; and (ii) is required under the FFCRA (or would have been required under the FFCRA if the FFCRA so applied).
Furthermore, the CAA also provides a mechanism through which self-employed individuals can claim a credit for COVID-19 related sick leave and family leave.
Finally, the CAA excludes COVID-related sick leave and family leave payments from the definition of “wages” for purposes of determining the employer’s share of the social security tax.
The provisions discussed herein are each effective as of the date of enactment of the FFCRA.
Extension of Due Date for Deferred Employee Payroll Taxes
On August 8, 2020, President Trump issued a Presidential Memorandum instructing the Treasury Department to defer, without penalties or interest, the withholding, deposit and payment of the employee’s portion of the social security taxes with respect to wages paid to certain eligible employees between September 1, 2020 and December 31, 2020. The deferred amounts must be repaid ratably during the period beginning on January 1, 2021 and ending on April 30, 2021. Such payroll tax deferral is limited to employees whose wages during any biweekly paid period is less than $4,000.
The CAA extends the period for which the deferred employee’s portion of the social security taxes must be withheld and deposited from the period beginning on January 1, 2021 and ending on April 30, 2021 to the period beginning January 1, 2021 and ending on December 31, 2021.
Energy-Related Provisions[5]
Carbon Oxide Sequestration Credit
Under section 45Q(a), a taxpayer is entitled to claim a credit of $20 per metric ton of qualified carbon oxide that is (i) sequestered by the taxpayer using carbon capture equipment placed in service at a “qualified facility” prior to February 9, 2018; (ii) disposed of by the taxpayer in secure geological storage; and (iii) not used as a tertiary injectant in a qualified enhanced oil or natural gas recovery project. In order to be classified as a qualified facility, construction must have commenced at such facility prior to January 1, 2024. The CAA extends the commencement date for construction of a qualified facility to January 1, 2026.
Renewable Energy Production Tax Credit
Sections 45 and 38 allow a taxpayer to claim an income tax credit for electricity produced from qualified energy resources (wind, closed-loop biomass, open-loop biomass, geothermal energy, solar energy, small irrigation power, municipal solid waste, qualified hydropower production and marine and hydrokinetic renewable energy) at qualified facilities. In order for facilities that generate electricity using closed-loop biomass, open-loop biomass, geothermal energy, landfill gas and trash, hydropower and marine and hydrokinetic energy to be qualified facilities for this purpose, construction on such facilities was required to have commenced before January 1, 2021.
The CAA extends the requisite date by which construction of a qualifying facility must commence to before January 1, 2022 for wind facilities, qualifying closed-loop biomass, open-loop biomass, geothermal energy, landfill gas and trash, qualified hydropower and marine and hydrokinetic renewable energy facilities.
Extension and Phaseout of Energy Investment Tax Credit
Section 48 allows for energy investment tax credits for solar, fiberoptic solar, qualified fuel cell and qualified small wind energy properties in an amount equal to the “energy percentage” of the basis of the energy property placed in service during the applicable taxable year. The energy percentage for the energy solar, fiberoptic solar, qualified fuel cell and qualified small wind energy properties is 30%; however, such percentage is subject to reduction. In particular, for any property (i) with respect to which construction commences after December 31, 2019 and prior to January 1, 2021; and (ii) that was placed in service prior to January 1, 2024, the energy percentage is 26%. The energy percentage is 24% with respect to any property (i) with respect to which construction commences after December 31, 2020 and prior to January 1, 2022; and (ii) that was placed in service prior to January 1, 2024. Finally, the energy percentage is 10% for any solar property the construction of which commences before January 1, 2022 and which is placed in service on or after January 1, 2024.
The CAA extends the requisite dates of construction for solar, fiberoptic solar, qualified fuel cell, qualified small wind energy and waste recovery properties by two years. In particular, under the CAA, the energy percentage will be 26% if (i) the construction of such property commences after December 31, 2019 and prior to January 1, 2023; and (ii) the property is placed in service prior to January 1, 2026. Furthermore, the energy percentage is 22% for property if (i) construction of such property commences after December 31, 2022 and prior to January 1, 2024; and (ii) the property is placed in service prior to January 1, 2026. Finally, the energy percentage is 20% for any solar property with respect to which construction commences before January 1, 2024 and which is placed in service on or after January 1, 2026. However, no credit is available (i.e., the energy percentage is 0%) with respect to fiberoptic solar, qualified fuel cell, qualified small wind energy and waste recovery properties if such properties are not placed in service prior to January 1, 2026.
Extension of Election to Claim Energy Tax Credit in lieu of Electricity Production Credit for Offshore Wind Facilities
Section 48(a)(5) permits a taxpayer to elect to claim the energy tax credit under section 48 in lieu of the electricity production credit under section 45 if such property is placed in service after 2008 and the construction of such facility begins before January 1, 2021. Wind facilities for which an election was made under section 48(a)(5) are subject to phaseout rules under section 48(a)(5)(E).
Under the CAA, a taxpayer may continue to elect to claim the energy tax credit under section 48 in lieu of the electricity production credit under section 45 for an offshore wind facility (a wind facility located in the inland navigable waters of the United States or in the coastal waters of the United States) if the construction of such facility begins before January 1, 2026. Furthermore, qualified offshore wind facilities are not subject to the phaseout rules set forth in section 48(a)(5)(E).
Waste Energy Recovery Property Treaty as Energy Property for Purposes of the Energy Tax Credit
Prior to the CAA, waste energy recovery property was not included in the definition of energy property for purposes of the energy tax credit under section 48.
The CAA amends section 48(a)(3)(A) of to include “waste recovery property” in the definition of energy property. For this purpose, waste recovery property is defined as waste energy recovery property as property that generates electricity solely from heat from buildings or equipment; provided that (i) the primary purpose of the applicable building or equipment is not the generation of electricity; (ii) the property does not have a capacity in excess of 50 megawatts; and (iii) construction of the waste recovery property begins prior to January 1, 2024. The energy tax credit is subject to the phaseout discussed above.
Tax Extenders
Reduction in Medical Expense Deduction Floor
For tax years beginning before January 1, 2021, individuals that itemize their deductions are entitled to claim an itemized deduction for unreimbursed medical expenses to the extent that the medical expenses exceeded 7.5% of the individual’s adjusted gross income. The CAA makes the 7.5% of adjusted gross income threshold permanent for taxable years beginning after December 31, 2020.
Deduction for Energy Efficient Commercial Buildings
Section 179D allows a taxpayer to deduct the cost of “energy efficient commercial building property” (not to exceed $1.80 for each square foot of the building). However, section 179D was previously only applicable to property placed in service prior to December 31, 2020. The CAA permanently extends the energy efficient commercial building property for all property placed in service after December 31, 2020.
Look-Through Rule for Related CFC Payments
For tax years beginning before January 1, 2021, section 954(c)(6) provides that a dividend, interest, rent or royalty that is received by a controlled foreign corporation from a related controlled foreign corporation is not treated as foreign personal holding company (a category of subpart F income) in the hands of the recipient controlled foreign corporation to the extent that such payment was not properly allocable to income of the payor controlled foreign corporation that is neither (i) subpart F income nor (ii) income that is effectively connected with the conduct of a United States trade or business. The CAA extends the related controlled foreign corporation look-through rule to taxable years beginning before January 1, 2026.
Exclusion from Gross Income of Qualified Principal Residence Indebtedness
Section 108(a)(1)(E) allows individuals to exclude from gross income up to $2 million ($1 million in the case of married individuals filing separately) of cancellation of indebtedness income that arises from the discharge of qualified principal residence debt that is discharged prior to January 1, 2021. The CAA extends the exclusion under section 108(a)(1)(E) to principal residence indebtedness that is discharged before January 1, 2026.
Extension of New Markets Tax Credit & Work Opportunity Tax Credit
The Code provides for a New Markets Tax Credit equal to 39% of capital invested in a qualified community development entity, a for-profit or a non-profit entity that loans to, or invests substantially all of such capital in, qualified businesses that operate in low-income communities. A $5 billion allocation was made for the New Markets Tax Credit in 2020, but no allocation was made for later years. Under the CAA, a $5 billion New Markets Tax Credit allocation is made for each of 2020 through 2025.
An employer that hires individuals who are members of certain specified groups are entitled to receive a Work Opportunity Tax Credit. The Work Opportunity Tax Credit was based on first-year wages paid to any specified employee that begins work prior to January 1, 2021. The CAA extends the Work Opportunity Tax Credit to specified employees that begin work prior to January 1, 2026.
Empowerment Zone Incentives
If an area is designated as an “empowerment zone,” businesses located within such zone are entitled to receive certain tax incentives, including expanded expensing under section 179, a wage credit under section 1396, and tax-exempt bond financing under section 1394. The empowerment zone designations were scheduled to expire on December 31, 2020.
The CAA extends the empowerment zone designations through December 31, 2025.
Employer Tax Credit for Paid Leave
For taxable years beginning on or before December 31, 2020, section 45S permits an employer to elect to claim a general business credit for paid family and medical leave provided to employees in an amount equal to 12.5% of the paid leave provided if the rate of payment is equal to 50% of the recipient’s regular pay; provided that the credit is increased by 0.25% (but not above 25%) for each 1% above 50%.
The CAA extends the employer tax credit under section 45S for wages paid in taxable years beginning on or before December 31, 2025. In order to avoid taxpayers claiming double benefits, a taxpayer is not entitled to claim a credit under section 45S if such employer claims an employee retention credit with respect to such wages. Furthermore, an employer is not entitled to claim a credit for wages paid under the FFCRA if a credit is claimed under section 45S with respect to such wages.
Other Noteworthy Changes
Additional 2020 Recovery Rebates for Certain Individuals
A second direct payment (referred to as the “additional 2020 recovery rebate”) is provided in the CAA to eligible individuals though a refundable tax credit in the amount of $600 per taxpayer ($1,200 for married taxpayers filing jointly) plus an additional $600 for each qualifying child. However, the additional 2020 recovery rebate begins phasing out at $75,000 of modified adjusted gross income ($150,000 for married taxpayers filing jointly) at a rate of $5 per $100 of additional income. The CAA instructs the Treasury Department to issue advance payments of the additional 2020 recovery rebate to taxpayers based on the information set forth in their 2019 tax returns. If the taxpayer is entitled to a greater additional 2020 recovery rebate based on its 2020 adjusted gross income, the taxpayer may recover the excess of the additional 2020 recovery rebate to which it is entitled to receive over the amount of the advance payment received as a refundable tax credit. However, if a taxpayer receives an advance payment that exceeds the amount of the additional 2020 recovery rebate that it is otherwise entitled to receive on the basis of its 2020 adjusted gross income, the taxpayer will not be required to repay the excess.
Extension of CARES Act Changes to Charitable Contribution Rules
Under the CARES Act, Individuals that do not itemize deductions may claim a $300 above-the-line deduction for cash contributions to qualified charitable organizations made at any time within 2020. The CAA extends this rule for cash contributions made to qualified organizations that are made any time during 2021.
For 2020, the CARES Act increases the limitation as to the amount of itemized deductions that an individual may claim as a result of donations of cash to certain charitable organizations described in section 170(b)(1)(A) (so-called 50% charities) to 100% of the individual’s adjusted gross income. The CAA extends this suspension with respect to any cash donations made during 2021. Accordingly, an individual can deduct up to 100% of its adjusted gross income as a result of making a cash contribution to a 50% charity at any time during 2020 or 2021.
Limitation on Food & Beverage Expense Deduction Suspended for 2021 and 2022
Under section 274(n)(1), a taxpayer may generally deduct only 50% of the otherwise deductible food and beverage expenses that are incurred in connection with the operation of the taxpayer’s trade or business (including food and beverage expenses incurred for meals consumed while traveling away from home or food and beverage expenses incurred in connection with a meal with a client or customer).
The CAA provides that the 50% limitation does not apply for otherwise deductible food and beverages that are provided by a restaurant in 2021 and 2022.
Depreciation for Residential Rental Property
The CAA reduces the alternative depreciation system recovery period for residential real property from 40 years to 30 years for tax years beginning after December 31, 2017 if the real property is (i) held by an electing real property trade or business (within the meaning of section 163(j)(7)(B); and (ii) the property was not subject to the alternative depreciation system prior to January 1, 2018.