ARP Tax Changes Include Credit Extensions/Expansions, Tax Relief for EIDL and Grant Recipients, and Changes to Worldwide Interest Allocation Rules
Among many other provisions, the American Rescue Plan (ARP), the $1.9 trillion COVID-19 relief package, makes changes to the Internal Revenue Code, including extension and expansion of COVID-19-related employment tax credits, clarification of the treatment of forgiven emergency loans and grants, and removal of a provision related to the allocation of worldwide interest expenses.
Extension and Expansion of Employee Retention Credit (ERC)
The ARP provides another expansion of the successful ERC, a fully refundable payroll tax credit for employers equal to 50 percent of “qualified wages” paid by employers beginning on March 13, 2020. See our detailed discussion of the ERC as originally enacted here. To be eligible for the ERC, a business must (i) be fully or partially suspended due to an order from a governmental authority limiting travel, commerce, or meetings during the applicable calendar quarter or (ii) suffer a significant decline in gross receipts—i.e., a reduction in gross receipts of 50 percent or more during a calendar quarter when compared to the same quarter during the previous year. Special rules apply to the first and second quarter of 2020 and 2021, allowing employers to elect to measure the decline in gross receipts using the immediately preceding calendar quarter (i.e., the fourth calendar quarter of 2020 and first calendar quarter of 2021, respectively) compared to the same calendar quarter in 2019 instead of using the quarter in which wages were paid (which was required in 2020).
For wages paid in 2021, if a business that is an eligible employer averaged more than 500 full-time employees in 2019, the wages that qualify for the ERC are only the wages paid to an employee for time that the employee is not providing services due to one of the two circumstances described above. If a business that is an eligible employer averaged 500 or fewer full-time employees in 2019, all wages paid to any employee during a period of economic hardship that satisfies one of the two tests can qualify for the ERC in 2021. For these purposes, all entities that are treated as a single employer under Code Sections 52(a) or (b) or Sections 414(m) or (o) are considered one employer. For wages paid before January 1, 2021, the applicable employee threshold was 100 employees; this was raised to 500 employees by the December 2020 stimulus legislation effective for wages paid on or after January 1, 2021.
The original ERC was 50 percent of the qualified wages up to a cap of $10,000 (the maximum credit for qualified wages paid to any employee is $5,000) that was allowable against the employer’s share of Social Security tax. The December 2020 stimulus legislation extended the ERC through June 30, 2021 and increased the ERC for the first and second quarters of 2021 to 70 percent of qualified wages (including amounts paid towards health insurance) per full-time employee up to a cap of $10,000 of wages per employee (i.e., an employer can get a credit of up to $7,000 per employee per calendar quarter).
The ARP extends the increased ERC through the end of 2021, thereby allowing the credit for two additional calendar quarters. Additionally, the ERC now can be used to offset an employer’s Medicare tax liability in addition to the Social Security tax.
The ARP also makes the ERC available to “recovery start-up businesses,” businesses that began carrying on a trade or business after February 15, 2020 and that have annual gross receipts of $1 million or less. The rules generally applicable to other employers apply, except the aggregate amount of the ERC that can be claimed by such a recovery start-up business may not exceed $50,000 during any calendar quarter.
Extension and Expansion of Families First Coronavirus Response Act (FFCRA) Tax Credits
The ARP also extends and expands the FFCRA tax credits. Under the FFCRA, employers who are required by the FFCRA to provide medical leave and family leave to employees were eligible for credits against Social Security tax equal to (i) $511 per day for paid sick leave for employees to care for themselves, with a maximum of 10 days – i.e., a maximum of $5,100 per employee, or (ii) $200 per day if the paid sick leave is to care for a family member, subject to a maximum of $10,000 per employee.
The December 2020 stimulus legislation extended the FFCRA tax credits until March 31, 2021 for employers who were required to provide the FFCRA leave through December 2020, if such employers voluntarily agreed to continue such coverage through March 31, 2021.
The ARP extends the FFCRA tax credit for voluntary leave provided by employers through the third quarter of 2021 and increased the maximum allowable credit to $12,000 per employee. The ARP also re-starts the 10-day clock, allowing employers who claimed the credit with respect to an employee in 2020 to claim the credit with respect to qualifying wages paid to the same employee in 2021. As is true of the ERC, the FFCRA tax credits now can be applied against an employers’ Medicare tax liability in addition to Social Security tax.
The ARP extends the situations under which qualifying sick leave may be taken to include situations where an employee is awaiting a COVID-19 test or is self-quarantining due to a potential exposure and makes the FFCRA tax credits available for paid sick leave and paid family leave provided because an employee is (i) getting vaccinated for COVID-19 or (ii) recovering from any injury, disability, illness, or condition related to COVID-19 vaccination.
Finally, the ARP also (i) allows governmental entities that are corporations with separate tax-exempt status (i.e., non-profit corporations that are controlled by a state or local government but that separately applied for a determination letter) and state colleges, universities, or hospitals to claim the FFCRA tax credits and (ii) adds non-discrimination rules to provide that no FFCRA tax credit is available if the employer discriminates against employees based on compensation, full-time status, or tenure with the employer. Interestingly, the changes to the FFCRA tax credits are effective for wages paid after March 31, 2021 and on or before September 30, 2021, but self-employed individuals can take advantage of the increased FFCRA tax credits retroactively to January 1, 2021.
Treatment of Forgiven Economic Injury Disaster Loans (EIDLs) and Restaurant Revitalization Grants
The ARP provides that forgiven EIDLs and Restaurant Revitalization Grants – like forgiven PPP loans - are not included in gross income but that such exclusion from gross income does not result in a denial of a deduction, reduction of tax attributes, or denial of basis increase.
Repeal of Election to Allocate Interest on a Worldwide Basis
Although U.S. corporations can claim foreign tax credits against U.S. taxable income, the Code limits those credits. These credit limits are based on a calculation of a company’s foreign taxable income compared to its U.S. domestic income. Deductions for interest expense are generally apportioned between foreign or domestic income depending on whether the expense was incurred by domestic entities or controlled foreign corporations.
Section 864(f) of the Code provides an election pursuant to which corporations can allocate interest among foreign and domestic members of an affiliated group on a worldwide basis. Once this election is made, the taxable income of each domestic corporation that is a member of the affiliated group is determined by allocating and apportioning the interest expense of each member as if all group members were a single corporation. This worldwide allocation allows an affiliated group to apportion excess interest expenses of its foreign subsidiaries to its domestic income, effectively raising the limit on the use of foreign tax credits.
Although Section 864(f) was added to the Code in 2004, its availability was deferred numerous times and it would have been available starting in 2021.
Effective for taxable years beginning in 2021, ARP repeals the election available under Section 864(f) and, as a result, maintains the policy on limiting the allocation of foreign interest expenses that was in place prior to 2021. Repealing Section 864(f) is expected to result in fewer foreign tax credits being claimed and therefore increased tax revenue. In fact, the Joint Committee on Taxation estimates repeal of the interest allocation rules will raise approximately $22 billion over 10 years.