On-Demand: Annual Business & Individual Federal Tax Update
Our panelists discussed the important federal tax changes for individuals and businesses—including the CARES Act.
Welcome, everyone. I'm Tom Cardinale, partner in our large corporate tax group. I'll be joined today by my colleague, Ben Aspir, senior manager and also in our tax group to walk you through this year's personal and business tax update. We certainly look forward to showing you a lot of happenings over the last year which goes without saying was a wild one.
Thomas Cardinale:We had two major pieces of legislation in the last year where the focus in the news was mostly on PPP loans and the stimulus checks, of course. But the new laws were also littered with new tax changes on both the individual and business side. I'm sure you're going to learn quite a few things today. We actually have about a thousand people in this webinar which is a record for us. So, we will answer as many questions as possible at various intervals maybe during the polling questions, but probably mostly toward the end of the session where we could fill up our one-hour time slot. We'll do as the best we can. As Lexi said, we'll address any of your questions after the webinar is over.
With that, I'm happy to pass the mic to my colleague, Ben, to first go over the individual tax update. Then, I will go over the business update. Ben, take it away.
Benjamin Aspir:Thanks, Tom. My name is Ben Aspir. I'm a senior tax manager with EisnerAmper's tax group. I'll be covering the individual tax portion of today's update, and Tom will be covering the second half, the business tax update. As Tom mentioned, there's a couple of obviously major changes. We had the CARES Act which passed at the beginning of the pandemic back in March. Then, we had the Consolidated Appropriations Act which passed in mid-December which also contained many provisions in it and many tax provisions to aid in COVID relief.
To start out, we're going to just show you the 2020 individual tax brackets here. Just more informational, the tax brackets aren't changed. The thresholds that they kick in are slightly adjusted for inflation. Our lowest bracket is still 10%, and the top individual tax bracket is still 37% which has decreased a couple of years ago. Originally, it was 39.6%. Then, in 2018 as part of the Tax Cuts and Jobs Act, it was reduced from 39.6 to 37%.
I would point out for those of you, if you look at the bottom of the screen, you see the 37% bracket, and it's interesting. If you look from the left column to the right column, the left column taxpayer is filing a single. And the right column is taxpayers filing jointly. The 37% tax rate kicks in for single tax payers at 518,000. But for married filing jointly taxpayers, it kicks in at $622,000.
You notice it looks odd because it should be doubled. That's commonly referred to as the marriage tax penalty where it can cost more in tax to file jointly than if two single people filed a tax return. So, just something to keep an eye on to be aware of.
The standard deduction which was significantly increased a couple of years ago also as part of the Tax Cuts and Jobs Act, it was adjusted for inflation, but last year was about $12,000 for marriage filing single. The 2020 tax year and 24,800 from married finally jointly for the 2020 tax year.
With the doubling of the standard deduction, a lot of tax payers are no longer itemizing the deductions. And we'll talk about also with the state and local tax cap which limited the deduction on real estate and personal income tax deductions. I had a maximum of $10,000 to someone like myself. My home state is New Jersey, a high-tax state. We pay a lot of real estate taxes and professional income taxes. This was obviously a big hit on the $10,000 cap.
But Tom and I will talk about the what's called the SALT-Cap Workaround for some of the states that have passed the entity level taxes on if you held a partnership interest or an S-corp interest. We'll go into further detail a little bit later on.
One of the big changes from the CARES Act that passed this past March was the suspension of the excess business loss limitations for taxpayers other than corporations. This is under section 461L. What is the excess business loss limitation? The excess business loss limitation was enacted as part of the Tax Cuts and Jobs Act, and it was effective from 2018 and beyond prior to CARES.
What this disallowed is no more than $500,000 of losses can offset non-business income. To give you an example, if you owned company A that had a $2 million loss and company B had a million dollars of income, so you have the million dollars of income offset by the $2 million loss. You still have a million dollar loss left over.
Under the excess business loss rules, you can only use $500,000 of that million dollars to offset other, let's say, if the taxpayer had significant amount of interest in dividends. Let's say, they had a million dollars of interest in dividends, they would only be able to offset $500,000 of income and the remaining $500,000 would turn into a net operating losses. Thomas would go into more detail on the net operating loss rules.
With the CARES Act, these excess business loss rules were repealed, but they were suspended for 2018, 2019 and 2020 to provide a relief due to the pandemic. It does go back into effect for 2021. What are the benefits of this suspension? If you do have losses generated in 2018, 2019 and 2020 that were limited due to this excess business loss, you can go back and amend. You can look back to 2018. If you have a 1040, your personal tax return was limited under this excess business loss rule.
You can go back and amend. And not only that, if you have additional losses because it creates a net operating loss, you can actually go back five years. You can go all the way back to 2013 to see if that loss would help you and generate a refund or you can just elect the forego that the net operating loss carry back and just carry forward.
Additionally, since you no longer have the excess business loss rules, you have this net operating loss which is not subject to the 80% income limitation which was in effect from 2018. Again, Tom will go into greater depth on that, but basically, under the new rules prior to CARES Act, if you had a million dollars of a net operating loss, that could only carry over. It could only offset 80% of income.
Just keep in mind, deductions for losses in the sale or exchange of a capital asset are not taking into account and increasing your 461 limitation. Like I mentioned, this 461 excess business limitation goes back into effect. It's not repealed. It was suspended. It goes back into effect January 1st, 2021 and thereafter.
The calculation excludes items that are attributable to the trader business performing services as an employee. Think of like W-2 income, something like that.
Another major provision from the CARES Act was the effect on early retirement plan distribution. Typically, unless you meet the narrow rules and narrow exceptions for early retirement plan distributions, you are subject to a 10% penalty if you took an early retirement plan distribution before the age 59 and a half.
The CARES Act decided to provide relief to individuals to take up to a $100,000 in early distributions and we'll walk through what the requirements are. You can take up to $100,000 from eligible retirement accounts penalty-free. You still have to pay tax on this, just remember. It's just you're not subject to the 10% penalty.
How do you qualify for this? It's for individuals and immediate family members diagnosed with COVID-19 or if they experience adverse financial consequences as a result of quarantine, furlough, layoff, work reduction, inability to work due to lack of child care as we know a lot of the daycares and schools were closed during this past year. Lastly, an owner or operation of a business was forced to reduce hours due to COVID-19, and they would be eligible for the penalty exception.
This rule applied to aggregate distributions of up to 100,000 that were taken out from 1/1/2020 through December 1st, 2020 from 401(k), from IRAs with certain deferred compensation plans and other tax deferred retirement plans. Multiple distributions allowed. It didn't require a one-time distribution, but the aggregate have been a max of a $100,000.
Another perk of this rule is generally if you have a 401(k) distribution, you have to pay the tax in the year that the cash is taken out. Under the CARES Act rules, if you have one of these COVID-related distributions, it can be randomly paid over three years. It takes the tax bite out of it a little bit. It's three years from the date of distribution.
Additionally, if you do not want to pay tax on it, and you want to recontribute it back into the 401(k) plan or the IRA, distribution can't be contributed back to a retirement plan anytime during the three-year period following a distribution date. That will be treated as a tax-free rollover.
Additional changes to retirement plans for 2020 from March 27, '20 which is the effective date of the CARES Act through December 31st, '20, loans were affected as well. If a person wanted to take a loan out, they didn't want to have a taxable distribution. They could have taken a loan out. The threshold was increased on that. Prior to the CARES Act, the maximum amount loan you could take out from, let's say, you have a pre-tax 401(k), plan the maximum was 50% of your invested balance or% 50,000, the lesser of. They doubled that limit to $100,000. You were able to take out a $100,000 loan or a 100% of your invested balances.
Lastly, before we get to the next polling question, individuals with existing loans with a repayment due date from March 27, '20 through December 31st, '20 could have deferred payment for one year.
Benjamin Aspir:While we're waiting for the polling responses, someone had a question. What bracket does the marriage penalties start? It hits at the 37% bracket. Someone had a question about the repeal of the excess business losses. It's for non-corporate taxpayers. Anyone that receives losses from corps or sorry from S corporations and partnerships that have NOLs or even if you have a schedule C, it's also affected.
Continuing on with the retirement plan distributions, this actually wasn't related to the CARES Act, but it was worth mentioning it didn't get a lot of press, but as part of the SECURE Act which passed a little over a year ago, taxpayers that have a baby or adopting a child can take payouts from their IRAs and 401(k)s of up to $5000. That's per parent without having to pay that 10% penalty that I mentioned earlier. It's tough to pay tax on it, but if they take it out within 12 months of following the birth or adoption of a child, they can avoid the 10% penalty. It may be worth it depending on timing, but one parent takes out $5000 prior to year-end. Then, the other parent takes it out right after year-end so that they're not paying tax on the full $10,000 in the same year depending on their tax bracket it may be worth looking at.
Charitable contributions, the CARES Act also provided a new above-the-line deduction for cash contributions up to $300. Typically, prior to the CARES Act, you have to itemize your deductions and have enough of them to deduct charity. This allowed an above-the-line deduction which means that you didn't need to itemize your deductions and you could take a deduction of $300 for charity.
Then, the Consolidated and Appropriations Act which was passed about a month ago extended this and increased it. It extended this above-the-line deduction through 2021 and increased it from 300 to $600. They also changed the limitation on charity, the adjusted gross income limitations. Typically, there's a limit of how much charity you can deduct in a current year.
It was previously 60%. If a taxpayer had joined income of a $100,000, they're only able to deduct up to 60 or $60,000 of that against that income. Those rules were suspended. A taxpayer could technically donate up to 100% of their charity and not have it limited or carried over. They could deduct 100% of their AGI or adjust the gross income and take the deduction in the current year.
There were many provisions that were expiring and were set to expire at the end of '19 or at the end of '20. And we call them the zombie tax provisions or the extenders because they come back to life every year. These temporary tax provisions are passed by Congress for a variety of reasons to stimulate parts of the economy. From year-to-year, they generally get extended for a year or two. They don't necessarily get permanent extensions. Hence, the name tax extenders.
The one permanent extension was the unreimbursed medical expenses deduction. The floor on that is 7-1/2%. Instead, it was scheduled to increase the 10%. What that floor means is again using that $100,000 example, the 7-1/2% floor means that if you have a $100,000 income, 7-1/2%, only the amounts over $7500 every dollar over that would be deductible. You obviously have to have enough medical expenses if you wanted to itemize over that that 12,000 or $4000 standard deduction threshold.
Tax provisions that were extended another year through December 31, 2021, the residential energy efficient property credit, the non-business energy property credit. Think of if you installed exterior doors that were energy efficient or windows or insulation in your attic, a lot of people aren't aware of this credit. That's a few hundred dollars, but it's a few hundred dollars in your pocket. If you've done any work on your house in 2020 or plan on doing it in 2021, there's a tax credit they can claim on your personal tax return.
Lastly, on the provisions extended through 2021, the mortgage insurance premiums deduction for anyone that's taking out a mortgage or thinking about thinking about taking out a mortgage or buying a house, typically if you put less than 20% down, you have to have mortgage insurance premiums paid. That's deductible through 2021. There are phase outs, but just to be aware that it's still in effect at least for another year. Probably, I wouldn't be surprised if it got extended again.
The provisions that were extended through 2025, so the exclusion from gross income of discharge of qualified principle indebtedness. What that exclusion allows is if a person has their mortgage reworked due to financial hardships or their house is sold through a short sale and they have a certain amount of debt forgiveness from that sale or if the mortgage is reworked, so the exclusion is now $750,000 or 375 from taxpayers filing as single because, typically, if you have cancellation at that and there's certain exceptions, but if you have cancellation of debt, that's considered taxable income. A lot of people are not aware of this.
If a person has cancellation of debt from their principal residence, if a certain portion of their mortgages were given by the bank, so up to these thresholds, up to 750 for married filing jointly or 375 for a taxpayer filing a single, they can exclude from that income.
Another employee perk, for an employer perk, for employees, they can offer tax-free payments of student loans up to certain annual amounts. That was also extended through 2025. And the deduction that's actually expired after December 31st, 2020 was the above-the-line deduction for qualified tuition and related expenses.
Typically, if you have a graduate school tuition or undergraduate school tuition, you have several options to take the tax benefits of that. You can take a tax credit. You could itemize your deductions or you're able to take an above-the-line deduction. This above-the-line deduction is no longer available after 2020. Again, above-the-line deduction means you don't need to itemize to take the tax benefit from it.
This item, recovery rebates, also known as stimulus checks, there was one part of the CARES Act. Now, there was one a few weeks ago as part of the Consolidated Appropriations Act. This last round, these recovery rebates allowed $600 per taxpayer plus an additional $600 for qualifying child. How do they know this is subject to certain income limits? How did the IRS know who to give the checks to?
No one had filed a 2020 tax return yet. What the IRS did was they look back at your 2019 income from your file tax return. And based on that, they issue checks to people, but there are people that have lower income in 2020 than 2019. If a person had joint income of $300,000 in 2019 but their 2020 income was less than half that, the IRS wouldn't have known that. They wouldn't have issued the person the check, the recovery rebate direct deposit or check.
There will be a form on the 1040 that reconciles all this. If you really were entitled to a recovery rebate and didn't receive it, you will get it in the form of a refundable tax credit. It will reconcile this on your 2020 tax return.
Now, related to the CARES Act or the CAA, this IRS notice 2020-75 passed about two months ago. Why was it so important? This goes back to what I mentioned earlier. You have this $10,000 state and local limitation on deductions. That was passed a few years ago. The states came up with a clever workaround for this limitation on deductions.
They came up for pass-through entities like an S-corporation or partnership. Why don't we make an entity level tax and then the taxpayer will get a state tax deduction under federal return and then, we'll pass through to them the credits when they file their state tax return?
Connecticut, it was one of the first states to enact this. That was a mandatory. If you filed a partnership in Connecticut and you had Connecticut source income, you had to pay this pass-through withholding tax which get then passed on to your state, Connecticut state tax return, but you got the benefit of a federal state and federal tax deduction of state taxes that wasn't subject to the $10,000 limit.
What this notice allowed was it basically blessed these state-level tax regimes. The IRS said we're going to issue regulations. We're going to propose regulations to clarify that these state and local income taxes paid by partnerships or by S-corps are fully deductible.
Tom will talk about the New Jersey level state tax debate, the business alternative income tax that New Jersey recently enacted that, but the difference between the New Jersey entity level tax and the Connecticut tax was New Jersey was elected, whereas Connecticut was mandatory. There's a lot of questions surrounding that prior to this notice.
There were several states that issued entity level taxes, not all them, but Connecticut, as I mentioned, New Jersey, Louisiana, Oklahoma, Wisconsin and Maryland. I'm sure now that the IRS has blessed it, I'm sure several other states are going to jump on the bandwagon because it's really another skin off of their back, if they can get additional cash upfront instead of waiting till the taxpayers file the 1040 and the taxpayers benefit because if they own a business, if they own an S corporation or a partnership, they can take the tax deduction there.
Thomas Cardinale:Looks like we got a couple dozen questions now. We'll answer just a couple quick ones that I recognized. One is about the PPP loan debt cancellation, is that considered income? The answer is no. That's not going to be considered taxable income upon forgiveness of any PPP loan. Someone asked this is more of a political question, so I'm going to hedge my bet. What is the likelihood that the $10,000 SALT limitation will be repealed with the Biden tax platform?
I can tell you this. As we speak right now on this webinar, there are three or four new brand new COVID relief packages being written up right now. AND the rumor is that one of them does include the SALT repeal, the 10,000. That's not a guarantee, but just letting you know it could be in the works. I think a lot of it's just going to come down to the votes.
Benjamin Aspir:79% said true, and 21% said false. The correct answer is true. The excess business loss rules were suspended for tax years 2018 through 2020. This was a change that also didn't get a lot of press. The kiddie tax rules were restored under the old regime. What that kiddie tax is, is if a parent has a dependent that has unearned income in excess of certain amounts over a couple thousand dollars each year, that is taxed at either the higher or the parents rate or the child's tax rate. They enacted these rules to keep parents from shifting income to their dependents and then, avoiding paying tax on it.
That was prior to 2018. Then, part of the Tax Cuts and Jobs Act, they changed the kiddie tax. They said it's determined based on the state and trust income tax brackets which are not favorable at all, the high rates kick in a lot faster. They realize there was a heavy tax burden here. They got rid of those rules and taxpayers can elect to apply these rules for 2018-2019 and is already effect into '20, but these rules changed in '20.
If the taxpayer did pay a lot of kiddie tax in '18 or '19, they may want to consider evaluating whether it's worth amending to go to change under the old rules for the kiddie tax. February 12th, the IRS announced its official start date of the filing season to file your 1040 for the 2021 tax season.
Typically, the following season is significantly earlier, but due to IRS staffing shortages and all the last minute tax changes, they announced February 12th was the start of the IRS filing season. The 2021 deadline for filing 1040s is still April 15th. Tax professionals hope it stays that way. And another just a reminder of the SECURE Act that allows owners of traditional IRAs to make contributions past seven and a half in 2020.
Then, beginning in 2020, for your students or your graduate students and post-doctoral students, if they have fellowships and stipends, similar payments even those, a lot of times, it won't be taxed, but it would be favorable. It's treated as compensation for purposes of IRA contributions because you do need compensation to make those contributions.
Before I turn it over to Tom to cover the business tax side, we have participants from around the country. I only have New York and New Jersey out here. More to just make a point as far as all the COVID-related packages, it's great to have all these federal provisions, but a lot of the states are not following them.
New York announced for personal income taxes that they're not going to follow the COVID-related tax deductions for the COVID-related relief provisions that were put into effect after March 1st, 2020. This applies to tax years prior to 2022. New York has also proposed raising the top personal income tax rate from 8.82 to 10.86. This is not official. It was proposed.
What is official is New Jersey, it was effective for 2020 tax year retroactive that the top tax rate of 10.75 kicks in at a million dollars instead of $5 million. Just be aware as I've always been taught, don't forget about the states. There's a lot of federal changes, but the states may or may not be following it. At this point I'm going to turn it over to Tom to cover the business tax side.
Thomas Cardinale:All right. Thank you, Ben. I know that was quite a bit of info going through pretty quickly, but the idea of this session is purely to be an executive summary to you so you know what's out there, you know the high level bullets of these provisions out there because there's quite a few.
This could be a two-day seminar easily. We're going to do our best to get as many issues and questions answered. We got 33 questions right now. We'll answer a few more by the end of this, but we're probably going to have to email you the answer after the webinar. I appreciate your patience with that.
Onto the business tax update. Before I get into the actual provisions, it's beneficial for everyone to know. And Ben brought it up before of the three major legislations we've had impacting taxes in the last few years. The Tax Cuts and Jobs Act everyone should be aware by now passed at the end of 17 which was revamping the corporate rate and tons of other provisions that's what put the SALT cap in and then, the last year, the CARES Act and more recently a few weeks ago the Consolidated Appropriations Act which were mostly pandemic COVID-relief oriented, but they also altered some of the provisions in the TCJA. They're all interlinked in a way. I'm going to walk you through what those changes were.
First thing we'll talk about is interest expense. This was definitely one of the least popular provisions passed at the tax reform act of '17 that limits your annual interest expense deduction on businesses to what we'll call 50% of tax EBITDA, tax basis EBITDA or I'm sorry the original was 30%. What the CARES Act did is to give some wiggle room to deduct interest expenses. They bumped up the 30% threshold of EBITDA to 50%. That's only for 19 and 20 only. Could it get extended even more? Possibly. Like I said, there's a new round of COVID relief packages being written right now. So, we'll keep an eye on that.
Overall, the 163 J limit for this interest expense does not apply if you're a company with average gross receipts of 25 million or less prior three years of receipts. That's a universal rule on a lot of provisions. They consider you in the tax size as a small business. As long as you average under that three-year revenue, you're fine.
NOLS, Ben went over the personal side and removing the 500,000 limitation for the excess business loss. They also did some good things on the carryback of NOLs and other NOL adjustments on the C-corp side. The TCJA, and this was another unpopular change for struggling businesses, is they repealed NOL carryback claims. You couldn't bring back your NOL to offset a profit year and claim that tax refund.
The CARES Act reinstated it. It's like, "Okay. We'll put it back in, but just for the 2018, '19 and '20 years." You could carry it back five years. That's significant because under the prior rules, it was only two years. The CARES Act not only reinstated the carry back regime, but they also allow you to go but as back as five years. With an '18 NOL, you go back to '13.
The annual deduction limitation, this is again brief background on the Tax Cuts and Jobs Act. The annuals generated in 2018 and later, once they eventually became utilized by a corporation, your annual deduction was limited. Your NOL deduction was limited to 80% of taxable income for that period.
The CARES Act is essentially suspended at 80% limitation for 2018, '19 and '20. No limitation at all. You could see I just put a very, very simple example at the bottom where under the old TCJA rule, you have a million of income. In a prior year, you are a loss. You roll that forward. With the 80% limit, you would still be left with 42,000 of federal tax on a million dollars of income. Under the CARES Act, it would be completely washed out and leave no tax.
A qualified improvement property, this was an interesting saga here. Back in the Tax Cuts and Jobs Act, the Senate Conference Report which goes over all the intricacies of what the Senate and the House agree on with the tax provisions, they inserted their intent to put in a brand new 15-year recovery period for qualified improvement property. Qualified improvement property, in its simplest sense, is interior improvements to commercial property. It can't be an expansion building or a new building and only is for improvements placed in service after the building is placed in service can't be at the same time.
But, guess what, they forgot to write the 15-year rule into the tax code. Big mistake, big oversight. As accountants, we were struggling. It's like, "Well, their intent was the 15 year to put in the 15-year. They didn't. What do we do?" We had to play it right in the conservative approach was to treat that same property as 39-year property. It was terrible difference.
On top of that, it could not qualify for bonus appreciation. If you're under 20 years or less in tangible personal property, generally, you can qualify for bonus depreciation and write it off all at once. By putting this in under the CARES Act, they finally fixed it, this drafting error. There is now a 15-year qualified improvement property period.
Now, big question is, "Well, what do I do if I already filed under the 39-year in the pre-prior year?" You could do two things. You could file a form 3115 which is a change in income tax accounting method. What that basically does is it trues up your beginning balance of whatever the adjustment was.
When we talk about things like depreciation, you're talking about the beginning accumulated depreciation balance. You could actually true it up on a current year return through a form 3115 filing. It does the catch-up adjustment. The other option is just to do an amended return, change the 39-year property to 15-year. If you want to apply bonus depreciation to it, you can do that. That was a very nice fix that they finally took care of with CARES Act.
All right. This next slide, everyone's been talking about, PPP loans and tax treatment. The CARES Act, unfortunately, had no detailed guidance on a couple of things, primarily the deductibility of qualified expenses like payroll. You're supposed to use PPP funds for payroll and other qualified operating costs in hopes that you would qualify to get the PPP loan forgiven.
Back then, the IRS said because it really wasn't written in the CARES Act, the IRS said, "Well, guess what? You're not going to be able to deduct those expenses because you'd be getting a double benefit because it was already written in the law that the taxable income or non-taxable income on the forgiven loan was already part of the CARES Act." It's not taxable, but the expenses would be disallowed. The IRS's position was basically saying, "Hey, we're giving you one benefit already. We're not going to give you the other. You're not going to be able to deduct those expenses."
Incomes that Consolidated Appropriations Act recently and it was unbelievable because now they basically squashed the IRS position and said, "Forget it." These business owners are hurting. We're in a once-in-a-generation pandemic. They deserve those deductible expenses also on top of tax-free treatment of a forgiven PPP loan.
It's a double benefit. It's written clearly in the law. It's in two provisions right in the law, non-taxable, income unforgiveness and no deductions shall be denied with regards to loans expenses paid by PPP fund. Big, big win for any company that has PPP laws from a tax perspective.
A small point regarding pass-through entities, just be wary of potential basis issues on the timing because as a loan, from the government, it's really not a partnership or S-corp basis to you. Upon forgiveness which could be in the following year, then it could be a basis issue. It could be a little tricky just dealing with your tax return and when you have basis, when you don't have basis because you could have a one-year carryover, a period on that.
Thomas Cardinale:Okay. We got a couple similar questions on the PPP loan which I anticipated on state treatment state treatment is really a case-by-case basis. A lot of states are broken out in two sections, rolling conformity states and static. Rolling conformity is we follow the federal provision by default unless they have to write up a separate legislation saying, "We follow federal except for this, and we're going to decouple from it."
If it's a rolling conformity state, then I would say by default, the PPP loan is going to be forgiven in that state, the forgiveness of the taxable income, but that's not a guarantee. Some states are sucking wind right now for tax revenue. They may put in a provision saying, "No, we're going to tax them on any PPP loan funds." That's just a case-by-case scenario.
Benjamin Aspir:Someone had a question about basis in the timing of the forgiveness. The basis isn't increased until the year of forgiveness. Just keep that in mind.
Thomas Cardinale:Okay. Another great benefit from the CARES Act that actually recently got bolstered and it's a big, big, big deal is the employer retention tax credit. The employer retention tax credit was almost like a second option if a company could not qualify for the PPP loan. If they were doing their best retaining their employees and they were affected by the pandemic due to a shutdown, a government order shutdown, or they've had a substantial reduction in revenue and they didn't get a PPP loan, you could get a very lucrative employee retention tax credit which is basically a refundable payroll tax credit that companies would get.
It would be reported on a form 941. It is a payroll process related filing, is like a worksheet behind the 941. And you compute this credit. That was a great backdrop for companies to get something out of it if they couldn't get the loan. But you had to have one of these two options as I stated. You had to have been partially or fully suspended from the COVID of '19 pandemic or had a significant drop. I'm going to go over the actual percentages in a minute because those changed between the CARES Act and the Consolidated Appropriations Act.
The Consolidated Appropriations Act, the number one thing is they expanded then bolstered several provisions of this credit up till Q2 of this year. They extended it for six more months. The original one was only for like a eight or nine-month period in '20 to year end. Now, you can do it up to Q2.
What I think is helpful for everyone is to really pay attention to this chart because this really lays out how they amplified the benefits of this credit, so between the CARES Act and the CAA. You can see the measurement period we just went over. It's going into two quarters of '21 under the new CAA. The limitations on the credit was increased. It used to be 50% of qualified wages. Now, it's 70% of qualified wages.
What does this mean? Means you could claim this credit $7000 per quarter. It's only two quarters but it's $7000 per quarter per employee. That's $14,000 credit to each employee. It's a refundable credit. That's the key word. This is money back into business owner's pockets. It's a refundable credit. And a large corporation employer has been jacked up to 500. If you're less than 500 and you meet those other conditions of the pandemic shutdown or you had a substantial decrease in revenue, you could qualify for this.
Here's another good change. Even if you had a PPP loan, does that deny you from getting this second round of this credit, this second level credit? The answer is no. You are not disqualified from getting the second round credit, but you would be ineligible for the first round in the first column under the CARES Act.
They also changed the substantial gross revenue reduction. They now consider an adversely impacted business. If you had a 20% decrease in revenue from a quarter in 2021 versus 2019 and you can see the measurement in the CARES Act was a '20 quarter versus a '19 quarter. Now, it's not looked down on an annual basis. It's looked down on a quarter.
Let's just look in Q1 '21. If you measure that A1 versus the Q1 in '19 and you had just a 20% reduction in revenue, you could claim that you're substantially impacted by the pandemic. You would be eligible beating all these other criteria of a small business, et cetera. If you meet those conditions, and I'm talking to the business owners out there, you got to work with your payroll companies, get this worksheet computed for the credit. It goes against social security taxes first, but any excess gets refunded.
It's not like you're just limited to the social security taxes. It's a big, big credit. You can just do the math of this. If you're getting 14,000 per employee up to 500, you just do the math, 14,000 times 500 is seven million. It's a big number. Please, keep this in mind, and I will promote that we have a separate seminar in this You'll get an invite next week or an email blast next week on it. I would get encouraged if you find an interest in this to sign up for. It's going to be on February 18th. And the invite will be next. I don't have the exact time. I just have the date, February 18th.
I would highly recommend you go to that. It's going to cover what business is qualified. It's going to go into all the intricacies. You already have six questions on this. It's going to go into all those intricacies. I would highly advise you go to that. This is meant to give you just a primer of what's out there of this benefit. It's something we're keeping a close eye on because it's just a significant cash benefit. It could wind up being more than the PPP benefit. It's quite extraordinary.
Moving on to business meals, this is kind of a funny one. Everyone knows the deal about meals and entertainment. It was normally just a 50% deductible item. You take your favorite client out to a lunch. You could deduct 50%. You talk about business, et cetera. Then, comes in the Tax Cuts and Jobs Act. They left the 50% business meal intact, but they made all entertainment non-deductible.
That includes taking a client out to a sporting event. You might have a buffet at the sporting event. That was all 100% non-deductible. What they did in the recent CAA is they are now allowing a 100% meals deductible, not entertainment. Meals. I put a few bullets in here what it's limited to business, travel, meals, corporate events, general meals with contacts.
But last bullet I wanted to talk about a little bit is because if you provide meals to your employees for the convenience of the employer which in so many words is saying, "Hey, let's work overtime tonight, and we'll bring in dinner," so you could be more productive, you can now deduct that 100% of those meals instead of the current law is 50%. They extended this for two years. It starts January 1st of this year all the way through the end of 2022.
But the only catch is that it needs to come from a restaurant. The food must come from a restaurant. The term restaurant is fairly expensive in the tax world. It can include grocery stores. It can include food establishments in other industries, hotels, parks, theaters, et cetera. It's pretty expensive, so don't worry about that.
This is again just for C-corps, the charitable contribution limitation. The old rule has been you cannot deduct charitable contributions in excess of 10% of your C-corporate income. 10% has now been increased to 25% to give corporations a little more room to deduct charitable contributions. It's only for 2020 only.
Okay. The next item is the payroll tax deferral. A lot of this is already in history now, but just making you aware. There was two extensions of the payroll taxes. It got a little confusing because there was a lot of proposals. One was the employee portion of taxes. The other was employer.
President Trump last year signed an executive order. Let's just defer the employee taxes. The IRS said, "Well, since the law wasn't written, we better get a notice out how this is treated." They postponed the date of the FICA employee portion, the 6.2% measured from September 1st '20 to year end. The original extended date was they gave you up till April of '21 to pay those taxes back.
Remember, it wasn't a forgiveness. It was just a deferral. Now, the CAA just added another eight months to that to when you can pay back those suspended or deferred employee portion of the FICA taxes. The above, all these items are separate from the employer portion of deferral taxes instituted from the CARES Act which are deferred in two installments. You can see the first few bullets is really about the presidential executive order. And the last bullet is about the separate CARES Act on the employer portion which is deferred to installments.
Business tax credits, a lot of these are not as interesting, but just putting them out there because a couple of these I deal with. They could be a pretty big credit. They extended several credits for the next five years. I did not put every credit in the world here. There was actually 30 credit extensions, but they're extremely rare.
The new markets tax credit, if you invest in a company that's considered in a low economic development zone and that money is being used for business economic development purposes, you can get a credit up to 39% of your investment. I think it's paid over five or seven-year period. That was extended five years, but at the same time, it's a risky credit because you're putting your money to work in a low economic zone.
The work opportunity credit, very popular. If companies hire certain disadvantaged employer groups for veterans, disabled, disabled veterans, long-term unemployed, you can get a pretty lucrative payroll tax credit on that. That was extended for five years. The energy investment or solar tech credit was also extended for a couple of years through 2023.
Thomas Cardinale:Okay. I'll try to answer a couple quick questions here. The second PPP loan is on declines for quarterly declines or year-over-year. It's quarterly. It's measured on a quarterly basis. You're measuring a quarter from now to the prior measurement period which is a quarter in 2019. It's not looked at as a year.
Here's another thing I forgot to mention on top of that. For the Q1 of 2021, if you want to go with the bolstered tax credit, the employee retention credit, you could actually make an election to go back one quarter and use that period instead which is 12/31/20. You measure that against 12/31/19.
There's a bit of an overlap of that quarter Q4 of '20. There's an overlap. If you can meet that 20% test in that quarter in Q4 of 20 versus '19, you would be eligible for the credit. There are a couple of questions on business meals. The 100% entertainment or entertainment expenses are still non-deductible. This was purely an accommodation for meals, business meals that is 100% deductible. Entertainment is 100% non-deductible.
Benjamin Aspir:That's effective 1/1/21, correct, Tom, the meal change? Someone had a question on that.
Thomas Cardinale:It's effective for two years. All of 2021 and 2022 on a counter year basis. It's measured from those periods. If you're a physical company, you got to track it in that period. All right.
Okay. We're going to switch gears just for this one slide on partnerships which is the brand new requirement of tax basis reporting by the IRS. That's important because if you have a loss on your partnership return, the immediate question is, "Do I have enough basis? Do I have enough tax bases to stop this loss?"
K1 s were very wide open in how you would report it. There was four or five different basis calculations, but there was no requirement just for one standalone tax basis computation to put on a K1. The IRS is basically coming on saying, "We want tax basis reporting on all members and partners." This includes losses and income. It's not just on lost companies which was in effect a couple of years ago.
You have to compute using a transactional method. That's more of the default method to do tax basis. you contribute cash to a partnership, the adjusted basis which is tax bases of contributed property to a partnership. That's not fair market value. That's the carryover tax basis.
734(b) adjustments on property basis, that's specifically on basis adjustments for property, not 743(b) which is mostly used when you have partnership sales or exchanges. You may have a 743(b) adjustment. That is not part of the computation. Then, you got your allocable income and loss. You get to deduct non-deductible items for basis purposes. You include non-taxable income items less your drawers.
That's just a very quick and dirty of how you would compute your tax basis if you're a partnership that now has to be reported on the K1s. going forward. There is a curative option. A lot of people say, "What about my beginning balance?" I use the modified accrual method or 704(b) method. They allow you several curative options to true up the beginning balance. That's beyond the scope of this session, but they are allowing several options to correct the beginning balance.
If you're a very small partnership, 250,000 of receipts and less than one million of assets, you do not fall into this requirement for reporting. The IRS, I think, this is just going to be a one and done kind of relief by the IRS. They know this is a big change. They will not impose penalty on businesses if they make a reasonable attempt to report the basis. They're not defining reasonable. That's facts and circumstances, but just keep that in mind that the IRS, in so many words, they're saying, "We'll work with you. Do your best to get the tax basis reported."
On the international side, I know this isn't a super common thing, but I wanted to bring it up because it got swept under the rug last year. Everyone hopefully has heard of the term guilty global intangible low-taxed income which was basically a way to force foreign companies almost like a deemed pass-through income inclusion to its US owners.
As a tax practitioner, it's a nightmare to compute all those intricacies to doing the guilty inclusion. There's a foreign tax credit piece. There's a qualified business, or the QBAI, piece which is based on fixed assets. What they said, "All right. I'll tell you what. You can get rid of all the guilty components of your return, no guilty inclusion at all under this high tax exclusion election."
It removes all those components of guilty from your foreign subs, and it wouldn't be taxed to the US company. If you have a foreign effective tax rate of 18.9% or higher on that foreign country, if you have that, you can consider it a selection. It's an annual election. The old allowance was for a five-year locked-in period that made it extremely unfavorable when you're locked into five years. No one likes that. They changed it to an annual election only. That's good.
It's effective for years beginning on or after July 23rd. That's when the regs came out. You can do a retroactive application to 118 if the consistency and other requirements are met. The question I always get is, "Well, why should I do it? What's the big factor to do an HTE election or high-tax exclusion election?" Well, when you do a guilty computation, sometimes, you can run it to severe foreign tax credit limitations especially if there's excess interest.
If you're going to be left with a residual guilty after all the pluses and minuses and you're going to be taxed on it, then it sounds like a no-brainer that if you're going to be taxed in one piece and your second option is not to be taxed at all, the HTE election would be advisable. You think about state income tax savings. We talked before about the PPP loan. Do states recognize it or not as taxable income on a PPP loan forgiveness?
Well, it depends on the state if they have rolling conformity to follow the fed or not. This is a similar situation. A lot of states, tax guilty. If you're taking it off the federal side, you could automatically be taking it off the state side if they're ruling conformity state.
Last couple of slides here, just on the SALT update, Ben already touched on a lot of these, but I think I must have got four or five questions on the PPP loan for state purposes. You have the deductions for loan forgiveness allowed for federal, but may not be allowed at the state. Always think about the state level. That's going to come down to a role in conformity if the state's like, "Hey, we can't afford this. We're already treating the forgiven loan as non-taxable."
Now, they want all these deductions from it. Don't be surprised if you see several states right up below and say, "Well, we'll give you the one, the forgiveness non-taxable income, but we're not going to give you those deductions." That's going to be a work in process because this law that allowed both just came out. States are going to be scurrying a bit.
New Jersey, this is New Jersey only, the 2.5% surtax was extended for two years. Big shocker. It was only supposed to be around for two years. It's extended another two, if you have over one million of taxable income only in New Jersey, New Jersey sourced I should say.
The SALT Cap Workarounds quickly being considered, and we talked about that before. There's no current legislation. I said one of the COVID relief proposals is working on it. Popularity is really gaining steam because based on this next slide, you see here, these are the current estates that have an enacted and proposal on a workaround to the SALT cap. It's mostly entity level based.
You pay the tax at the pass-through entity level. Through your K1, your federal K1, you're going to get a deduction on that tax. You're circumvent to 10,000. Then, when you do your personal state return, you're going to get a credit on behalf of the taxes paid at the partnership. You can see the seven states currently have it. Connecticut's mandatory. Elective, New Jersey's elective. You can see several states are considering.
The New Jersey BAIT tax which has come out recently commences the beginning of last year, but the election is due March 15th, if you want to do this. Basically, you're paying a tax 5.67% up to 10.9% of the flow-through entities income. This does not mirror the individual rates perfectly. It's a business decision if you want to elect this to get that federal deduction.
New Jersey residents and trusts would receive the credit tax credit equal to the amount of their share of the BAIT tax paid at the entity level. Non-residents can still opt for the composite return and related credit, but they wouldn't be eligible for the BAIT.
The New York proposal, now they're joining the train. 5% UBT on partnerships/LLCs is doing business in New York. This does not include S-corps and sole proprietorships. And the partners get a tax credit, 93% of their allocated portion. Again, just a proposal, letting you know there's work around all over the place, but what's funny is within the next few months, we may have this whole thing repealed, the 10,000 cap. And none of this applies anyway, but letting what's out there especially for your business in your state planning of what is out there in the market.
Okay. I got 70 questions. We're not going to get to them. We have run out of time, but we will respond to as many questions as possible. If you register, we should have your email, and we will get back to you on your questions.
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