On December 27, 2020, the Consolidated Appropriations Act, 2021 ("CAA" or the "Act") was signed into law. The 2,100+page CAA is made up of 32 Divisions. The significant business and individual taxpayer related provisions are in Division EE, known as the Taxpayer Certainty and Disaster Tax Relief Act of 2020, and Division N, which includes the COVID-related Tax Relief Act of 2020 and the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (the "Economic Aid Act"). This alert represents our high level summary of the items that most directly affect businesses, individuals and benefit plans.
Paycheck Protection Program: Tweaks and a Second Draw
The Economic Aid Act allows for a "second draw" for certain businesses under the Paycheck Protection Program ("PPP"). Like the original program, loan proceeds are available to help fund payroll and group health benefit costs, as well as certain mortgage interest, rent and utilities. In addition, "authorized"costs now also include COVID-19 related worker protection costs, uninsured property damage costs due to looting or vandalism during 2020 and certain supplier costs and expenses for operations. The Economic Aid Act also expands benefit costs to include group dental, vision, life and disability benefits. All of these changes are generally retroactive to the original Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"), meaning that the changes may be taken into account in processing loan forgiveness with respect to an original PPP loan.
A business is eligible for a second draw if it (i) already received a PPP loan and used (or will use) the full amount of that loan by the time the second draw is disbursed, (ii) has no more than 300 employees and (iii) has had a reduction in gross receipts of at least 25% between comparable quarters in 2019 and 2020. The maximum size of a second draw is generally the lesser of 2.5 times (3.5 times for businesses in the accommodation and food services sector (NAICS 72)) the average 2019 or 2020 payroll costs or $2,000,000. The Economic Aid Act also expanded slightly the scope of eligible borrowers.
The SBA has already posted some guidance about the second draw program, including a borrower priority approach for small businesses in low- or moderate-income neighborhoods.
Taxation of PPP Loan Forgiveness
The CAA also provides welcome relief to all businesses with PPP loans. Clients will recall that the CARES Act provided that amounts forgiven under the PPP are not treated as taxable income for federal income tax purposes. However, the CARES Act did not address whether the payroll and nonpayroll costs that supported the PPP loan are also deductible.
In the Spring, the Internal Revenue Service published Notice 2020-32, which provided that no deduction is allowed for an otherwise deductible expense to the extent the payment of the expense results in forgiveness of a PPP loan. The IRS went a step further in November when it published Rev. Rul. 2020-27, which provided that no deduction could be claimed if the taxpayer "reasonably expects to receive forgiveness" with respect to the expense, even if the taxpayer had not yet submitted a forgiveness application.
After months of discussion in Congress, the CAA firmly overrides the IRS’s position by providing that in addition to the forgiveness itself being excluded from income, no deduction is denied nor shall any basis or tax attribution adjustment be required with respect to the underlying expense. (A special rule was added to ensure similar results for pass-through entities – Subchapter S corporations and partnerships.) Shortly following the CAA’s enactment, the IRS formally rescinded its earlier guidance. Note that these provisions apply with respect to preexisting PPP loans and any new second draw PPP loans.
While the federal position is now clear, businesses may face a different result under state law. Businesses may wish to consult with a member of our State and Local Tax group for further information on this nuance.
No Tax on Other Forms of COVID-19 Related Federal Assistance
In addition to resolving tax issues relating to PPP loan forgiveness, the CAA also provides that gross income does not include amounts arising from the forgiveness of various other forms of federal financial support under the CARES Act. This includes, for example, emergency Economic Injury Disaster Loans ("EIDL") and emergency financial aid grants. Similarly, the Act also provides, as applicable, that deductions are allowed with respect to expenses that support such amounts, and neither tax basis nor other tax attributes are required to be reduced.
As noted in the preceding section, the same results will not necessarily apply for state income tax purposes.
Employee Retention Credit
The Act extended and made a number of modifications to the employee retention credit, originally adopted as part of the CARES Act. Our earlier alert provided an overview of this provision, which was set to expire as of December 31, 2020 and was available to businesses that did not take a PPP loan.
- The credit is now available with respect to “qualified wages” paid from January 1, 2021 through June 30, 2021.
- The credit is increased from 50% of qualified wages to 70% of qualified wages and the cap of $10,000 in qualified wages per employee is increased significantly – to $10,000 of qualified wages per employee per quarter. Thus, for the first two quarters of 2021, the maximum credit available to an employer with respect to any individual employee is the lesser of $14,000 ($7,000 per quarter) or 70% of the employee’s qualified wages in each quarter.
- Availability of the credit is broadened in several respects, including creating a lower hurdle for the quarterly year-over-year reduction in gross receipts test (from more than 50% to more than 20%), allowing newer employers to claim the credit by providing that if a comparable quarter did not exist for 2019 the comparable quarter for 2020 may be used and significantly expanding the number of employees whose wages can be taken into account for calculating the credit.
Importantly and retroactive to the original CARES Act effective date, the credit is now available to businesses that received or will receive PPP loans so long as the "qualified wages" used for determining the amount of the employee retention credit are not also being used as authorized costs for PPP loan forgiveness. Other retroactive changes involved clarification of the meaning of gross receipts for nonprofits and providing that the credit is available with respect to health benefits even in the absence of other compensation.
Deferral of Collection and Withholding of Employee FICA Tax
Following an Executive Order by the President, the IRS published Notice 2020-65, which allowed employers to electively forgo withholding and remitting the employee share (only; not the employer share) of FICA tax for the September 1 through December 31, 2020 period, up to a cap (bi-weekly wages of less than $4,000 per employee or the equivalent amount for other payroll cycles).
While much maligned (the provision permits only a deferral of the collection and payment of the tax, not a waiver of the tax itself), Congress has implicitly endorsed this provision by providing as part of the Act that employers now have all of 2021 (rather than only the period January 1 through April 30, 2021) within which to collect from employees (and remit) the deferred payroll tax. This should help employees in managing cash flow during 2021 by providing additional time to make up the deferred liability.
Assistance Checks for Certain Eligible Individuals
Eligible individuals are generally entitled to an additional "recovery rebate" of $600 ($1,200 in the case of eligible individuals filing a joint return) plus $600 per qualifying child. The recovery rebate is an advance on a tax credit that will be available when the individual’s 2020 federal income tax return is filed. Similar to the earlier rebate under the CARES Act, this new rebate is phased out beginning at adjusted gross income ("AGI") levels, as generally reported on a 2019 return, of $150,000 (for joint filers), $112,500 (for head of household filers) and $75,000 (for all others). The rebate is completely phased out for AGI above certain levels.
Retirement Plan Provisions
Coronavirus-Related Distributions. The CAA provides, retroactive to the adoption of the CARES Act, that an in-service distribution from a money purchase pension plan on or after January 1, 2020 and through December 30, 2020 could qualify as a coronavirus-related distribution ("CRD"), assuming that all other requirements were satisfied. (Our earlier alert provides additional information on CRDs.)
In June, the IRS published Notice 2020-50 in which it took the position that because the CRD was not a new form of in-service distribution, it was not possible to take a CRD from a money purchase pension plan unless the plan permitted an in-service distribution (generally not before age 59½). The CAA change modifies the IRS position and provides clarification that a money purchase pension plan that permitted an in-service CRD does not have a tax qualification problem. The clarification also ensures that distributees are entitled to the benefits of a CRD, including the ability to make a repayment.
Partial Plan Termination Relief. As we have previously observed, temporary and permanent layoffs raise the specter of a so-called partial termination. If a plan experiences a partial termination, which is generally the result of employer action (such as a reduction in force) that affects a large enough group of participants (an ill-defined rule of thumb is 20% of participants), affected participants become fully vested in their retirement plan benefits. The contours of a partial termination are by no means certain, and to make matters more difficult, a series of terminations can result in a retroactive partial termination when aggregated.
The CAA includes a relief provision that allows a plan to avoid a partial termination with respect to any plan year that includes the period beginning March 13, 2020 and ending on March 31, 2021 if the number of active participants at the end of the period is at least 80% of the number of active participants at the beginning of the period. In other words, provided enough participants are hired or rehired by March 31, 2021, a plan may avoid the accelerated vesting required by a partial termination.
Use of this relief under the Act works best with respect to a plan that has not yet determined that vesting must be accelerated as a result of a partial termination. If a partial termination has already been implemented with respect to a retirement plan, plan sponsors and plan administrators are advised to tread very carefully. The statute provides little guidance on a host of thorny issues (such as whether the accelerated vesting can be "undone" on a prospective basis).
Qualified Disaster Distribution. The Act provides additional retirement plan relief for those affected by a non-COVID-19 related "qualified disaster." The incident must be declared to be a disaster by the President on or after January 1, 2020 and through February 25, 2021, and the relevant “incident period” must have begun on or after December 28, 2019 and on or before December 27, 2020.
Similar to CRDs and other disaster relief, a participant may receive a "qualified disaster distribution" (a “QDD”) from various forms of tax-favored retirement arrangements including 401(k), profit sharing and money purchase pension plans, individual retirement accounts (IRAs), 403(a) and 403(b) arrangements and certain 457 arrangements. The QDD must be made on or after the beginning of the incident period and no later than June 24, 2021. A recipient must have incurred an economic loss as a result of the disaster and have a principal place of abode in the qualified disaster area. The maximum aggregate amount of distributions that can qualify for QDD treatment is $100,000 (per disaster). A QDD is not subject to the 10% early withdrawal penalty, is taxable over a 3-year period (unless the taxpayer elects otherwise), and can be recontributed to a tax-favored retirement arrangement over the 3-year period beginning on the day after the distribution. A QDD is not available with respect to a disaster declared only by reason of COVID-19; that relief, in the form of a CRD, expired on December 30, 2020. Note also that certain retirement withdrawals (including a hardship withdrawal from a 401(k) or 403(b) arrangement) can be recontributed no later than June 25, 2021 if the funds were received in connection with the purchase or construction of a principal residence in a qualified disaster area but because of the disaster, the purchase or construction did not (or will not) occur.
Similar to the CARES Act (and other disaster relief legislation), participants affected by a qualified disaster may also take larger loans and benefit from repayment relief, if the plan so permits. The Act also provides for an employee retention credit for employers affected by qualified disasters, as well as some other disaster related relief. Plans adopting any of these provisions will need to be amended.
New Flexible Spending Account Relief
The Act makes several helpful changes with respect to health care and dependent care flexible spending accounts ("FSAs").
Because non-essential medical services were not provided for much of 2020 and with so many childcare centers and day camps shut down, many employees faced the prospect of forfeiting substantial amounts of FSA contributions if not used by the end of the 2020 plan year. In May, the IRS announced limited relief with respect to this issue, including the ability of an employer to amend its FSA arrangements to allow for a mid-year election change. The guidance did little, however, to address the issue of unused funds in an FSA as of the end of the 2020 plan year.
The Act significantly loosens the use-it or lose-it rules that normally apply to health care and dependent care FSAs by allowing employers to amend their FSAs to permit the entirety of any unused amounts from 2020 to be carried over to 2021, and to similarly allow the entirety of any unused amounts from 2021 to be carried over to 2022. In addition, the CAA allows employers to extend any FSA grace periods, which allow access to unused amounts from a prior year in a subsequent year, for up to the entire subsequent plan year (rather than only 2½ months after the plan year-end) for both the 2020 and 2021 plan years. These changes seem to allow employees to, in effect, "double up" on FSA dollars for 2021 or 2022 and (at least for plans that adopt a grace period) allow expenses incurred in 2021 or 2022 to be reimbursed from both prior year and current year contributions.
The Act also allows plans to be amended to permit eligible employees to make a change to their 2021 plan year FSA elections even if there is no change in status event. This relief, similar to that permitted for 2020 under prior IRS guidance, is particularly helpful for employees participating in calendar year FSA arrangements who did not have an opportunity to consider the effects of the Act’s changes before 2021 elections became final.
For health FSAs, the Act also allows plans to be amended to permit employees who terminated in 2020 or 2021 to continue to be reimbursed from any remaining unused balance for health expenses incurred after the date of termination and through the end of plan year (plus the expanded grace period, if applicable), even if they did not elect COBRA and do not continue to make contributions.
Finally, the CAA enacted special rules for dependent care FSAs, generally allowing reimbursements to continue for a dependent who is age 14 if the dependent aged out (attained age 13) during the 2020 plan year. Also, employees who qualify for this relief may tap outstanding dependent care FSA balances at the end of the 2020 plan year to utilize these amounts for children up to age 14 in the 2021 plan year.
All of these changes are elective and employers may adopt some and not others. If changes are adopted, plans will need to be amended but amendments can be made retroactively, and the Act provides an extended period of time within which to adopt amendments. But before implementing any of the changes, employers should consider the financial and administrative implications, including more limited forfeitures, increased costs, adverse selection risk and the potential effects of extended health FSA coverage on HSA contributions.
The changes also introduce a fair amount of administrative complexity and for this reason, employers are encouraged to promptly reach out to their FSA vendors.
Other Important Changes
Educational Assistance. The CARES Act included a temporary change that allowed employees to avoid tax on student loan repayments made by their employer between March 27, 2020 and December 31, 2020 with respect to "qualified education loans." The amount that could be excluded is capped at the Internal Revenue Code Section 127 limit of $5,250 (this is an annual limit, which is not indexed for inflation, and so would take into account other amounts that might be excluded under this provision). The CAA has extended the availability of this provision to loan repayments by employers through December 31, 2025.
Paid FMLA and Sick Leave Extension. The Families First Coronavirus Response Act ("FFCRA") introduced a new emergency Family and Medical Leave Act benefit ("EFLMA") and a new emergency Paid Sick Leave Act benefit ("PSLA"). As discussed in an earlier alert, each was paid for through federal tax credits and each was scheduled to expire at the end of 2020. The CAA extended each of these federally funded benefits through March 31, 2021.
Employer Paid FMLA Subsidy. In addition to the new EFLMA and PSLA benefits, the Internal Revenue Code has made available since 2018 an employer credit to assist with the cost of providing paid FMLA leave. Eligible employers are able to claim a credit equal to 12.5% of eligible wages (if the paid leave benefit is at least 50% of wages) and increasing to up to 25% of wages (if the paid leave benefit is equal to 100% of wages). The maximum FMLA leave supported by the credit is 12 weeks per year and is available only for employees paid less than a certain amount in the preceding year (for 2021, $78,000 paid in 2020). Moreover, the credit is not available until the employer has adopted a written leave policy that includes at least two weeks of paid FMLA leave for all qualifying employees, and the amount of paid leave is at least 50% of the wages that would normally be paid.
This provision, which is available whether or not the employer is subject to FMLA, was originally due to expire at the end of 2019 but was extended through the end of 2020. The CAA extends this credit through the end of 2025. Additional information about this credit is available on the IRS website.
Charitable Contributions. The more generous charitable contribution limits available under the CARES Act in 2020 have been extended into 2021. This includes the special $300 ($600 in the case of a joint return) charitable deduction that will be available in arriving at taxable income for those taxpayers who no longer itemize their deductions. The allowance applies to cash contributions to most public charities. (The rule does not apply to contributions made to certain public charities, including supporting organizations and donor advised funds.) The CAA also extends into 2021 the elective suspension of percentage limits on cash contributions to most public charities that was originally enacted as part of the CARES Act.