What to know about recent pandemic tax law changes
A number of tax law changes were passed in 2020 to help individuals and businesses weather the pandemic. These included changes made by the CARES Act and the Consolidated Appropriations Act of 2021. Most of the changes were temporary, meaning individuals and businesses must now use the old tax rules or the revised rules to calculate taxes for 2021. Here’s a look at some of the changes for 2021 tax filings that result from the laws related to COVID-19. Since many of the rules triggered by the pandemic were temporary, the IRS only provided informal guidance on these rules through notices and FAQs.
People adjusting to life during the pandemic may have received various benefits from the government or their employers, or relief from other sources. Be sure to note the rule changes from 2020 to 2021 and what action to take.
Calculate economic impact payments. In early 2021, EIP3, the third round of economic impact payments, was paid to individuals based on information available to the IRS from 2020 filings, or 2019 filings if 2020 were not yet filed. People who received less than the amount to which they were entitled (for example, their income in 2020 was higher than in 2021; they had a new dependent at the beginning of 2021), can calculate a recovery rebate credit using 2021 information (2021 adjusted gross income and number of dependents) and obtain a tax refund. If, as a result of these changes, individuals received a higher EIP3 than they would have been entitled to, no refund is required.
Reimbursement of qualified coronavirus distributions. In 2020, individuals were allowed to receive qualified coronavirus distributions of up to $100,000 in 2020 from qualified retirement plans and IRAs. There is a three-year window to return the funds to the account. The income resulting from the distribution has been spread over three years until the person chooses to report everything in 2020. If there is a refund in 2021 of part or all of the distribution that was taken last year, an amended return must be filed for 2020 to claim a refund of taxes paid on last year’s distribution.
Take the required minimum distributions. Required Minimum Distributions (RMDs) have been suspended for 2020. The suspension does not apply to 2021, so RMDs for 2021 must be taken in accordance with normal rules. People born after June 30, 1949 have a new starting age of 72 (instead of 70½); those born after this date and before January 1, 2022 have their first RMD in 2021. Employees who own no more than 5% can defer RMDs until retirement (this rule does not apply to IRAs) . Beneficiaries who inherited the accounts of people who died after 2019 are subject to a new 10-year rule that prevents them from spreading distributions over their life expectancy. However, the 10-year rule does not apply to eligible designated beneficiaries (e.g. spouses, minor children, beneficiaries more than 10 years younger than the account holder) by spreading distributions over their expected life based on an IRS chart. Note: New life expectancy tables, announced at the end of 2020, are used to calculate RMD from 2022; they do not apply to 2021 RMDs.
Excluding cancellation of mortgage debt. The income exclusion for cancellation of mortgage debt, which was scheduled to expire at the end of 2020, has been extended to 2025. However, the exclusion limit is reduced to $750,000 for 2021 to 2025 (at instead of $2 million); half of the limit applies to married persons filing separately.
Declaration of unemployment benefits. For 2020, up to $10,200 in unemployment benefits was excluded from gross income. For 2021, there is no exclusion; all unemployment benefits are included in income. Those who received an automatic refund from the IRS because they did not claim the exclusion on a 2020 return should review that return to determine if an amended return should be filed. The reduction in adjusted gross income due to the exclusion may entitle a person to claim other tax brackets not taken into account in the automatic refund.
Payments related to COVID-19. Some payments were new for 2021, while others were a continuation of 2020 payments.
- Paid sick leave and paid family leave. Payments made from January 1, 2021 through September 30, 2021 to eligible employees – those with certain COVID-19 related issues – are treated as taxable compensation. Eligible self-employed individuals can claim a tax credit that essentially equals these payments (see instructions for IRS Form 7202).
- Premium COBRA support. If employers were subject to COBRA, involuntarily terminated employees as well as those with reduced work hours received COBRA premium assistance from employers from April 1, 2021 through September 30, 2021. These payments are not included in gross income.
Personal tax credits. A number of tax credits have been radically changed for 2021. These include Child Tax Credit (half of which was payable in advance via monthly installments from July to December 2021), Credit for children and dependents (fully refundable in 2021), the earned income tax credit and the premium tax credit.
During the pandemic, some businesses closed, some struggled to survive, and others thrived. A number of tax rules in 2021 for businesses are different from those in 2020.
Government grants and other payments. As a general rule, debt cancellations and grants are included in gross income. However, the law states that the forgiveness of Paycheck Protection Program (PPP) loans, as well as grants under the Closed Venue Operator Program and grants under the Restaurant Revitalization Program, do not are not taxable. However, they are still treated as gross receipts, even though they are tax exempt (Rev. Procs. 2021-48, 2021-49 and 2021-50). This means that they are taken into account in the gross receipts test used for various purposes (for example, the gross receipts test to determine whether a business is “small”, as explained later, and can use the accounting method checkout).
Net operating losses. Net operating losses incurred in 2020 were subject to a five-year carry-back and an unlimited carry-forward; they could be used to offset up to 100% of taxable income. In 2021, the NOL rules created by the Tax Cuts and Jobs Act come into effect. This means no carryback (other than a two-year carryback for agricultural businesses). There is an unlimited carryover, but it can only be used to offset up to 80% of taxable income.
Limitation of excess business losses. This rule prevents unincorporated taxpayers (i.e. owners of flow-through entities) from writing off business losses. These are net trading losses plus a threshold amount depending on the owner’s filing status (Code §461(l)). This limit has been suspended for 2018, 2019 and 2020. It applies for 2021 and the thresholds have been adjusted according to inflation. Note: The limitation was set to only work until 2025, but was extended by the American Recovery Plan Act from 2021 to 2026.
Limitation of interest charges. A business interest deduction is limited to the sum of his business income, a percentage of adjusted taxable income (ATI), and floor plan financing interest (Code §163(j)). For 2019 and 2020, ATI’s percentage was 50%, but for 2021 it is 30%. Small businesses (for 2021, these are businesses that meet a gross revenue test where the average annual gross revenue over the preceding three years does not exceed $26 million), as well as agricultural businesses and selected real estate companies, are exempt from this limitation.
Business meals. In 2020, a deduction for business meals was limited to 50% of the cost. For 2021 and 2022, the deduction is 100% for business meals served in restaurants. The term “restaurants” is defined in Notice 2021-25. The 100% limit can also be used to justify the cost of business meals as part of a per diem (Notice 2021-63).
Qualifying Business Income Deduction (QBI). The basic rules of the QBI deduction for owners of flow-through entities have not changed from 2020 to 2021 (Code §199A). However, there are two important points to note: first, the taxable income thresholds at which the deduction can be reduced or removed have been adjusted for inflation in 2021. second, if 2020 was a year of loss, that loss has a negative impact on the QBI Deduction amount for 2021.
The Build Back Better Act would make some changes to a few of the rules discussed above, such as extending child tax credit advance payments. These changes would likely apply to 2022 and not impact 2021 returns. But you never know…
Sidney KessCPA lawyer, is an attorney at Kostelanetz & Fink and a senior consultant at Citrin Cooperman & Company.