Tax and financial advice from the Silicon Valley expert.

Tax tips and developments relating to individuals

Had a PPP loan in 2020? Your tax returns will probably be delayed

The Consolidated Appropriations Act (CAA), 2021 enacted on December 27, 2020 included some great tax breaks. Some of them are retroactive and will result in delays when preparing 2020 income tax returns, especially when a business had a Paycheck Protection Program (PPP) loan during 2020.

For example, the Employee Retention Credit (ERC) applies to employees retained by employers impacted by the COVID-19 pandemic.

In order to qualify to claim the credit, an employer must have carried on a trade or business during calendar year 2020 and EITHER

  1. the operation of the employer’s trade or business was fully or partially suspended during a calendar quarter in 2020 under orders from an appropriate governmental authority limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19 (note: reducing inside dining of a restaurant to 25% of capacity qualifies as a partial suspension), OR
  2. The employer’s calendar quarter is within a period during which the employer is experiencing a significant decline in gross receipts. The period of significant decline in gross receipts (a) begins with the first calendar quarter beginning after December 31, 2019 for which the employer’s gross receipts are less than 50% of gross receipts for the same calendar quarter in the prior year; and (b) ends with the first subsequent calendar quarter for which the employers gross receipts are greater than 80% of gross receipts for the same calendar quarter in the prior year.

In the CARES Act, enacted on March 27, 2020, any business that had a PPP loan was ineligible for the Employee Retention Credit (ERC).

The CAA changed that rule and allows PPP loan borrowers to claim the ERC, retroactively effective March 13, 2020. Instead, any wages that qualified for PPP loan forgiveness aren’t eligible as payroll costs for computing the ERC.

The IRS is directed to issue regulations for how a taxpayer elects to exclude wages when computing the ERC, so the wages may be used to qualify for a PPP loan exclusion. That guidance hasn’t been issued as a I write this alert.

The CAA also modifies how health plan expenses are added to employee wages for computing the ERC, making more employers eligible to include them.

For 2020, the ERC is 50% of up to $10,000 wages for each employee, or a maximum of $5,000 per employee.

The credit is refundable and is claimed on Form 941, the quarterly Federal payroll tax return. The first payroll tax return on which it could be claimed was for the second quarter, 2020.

The ERC is subtracted from the tax deduction for wages on the federal income tax return. For example, if the employer only had one employee with $10,000 of wages, the deduction for wages would be $10,000 – $5,000 = $5,000.

Some banks haven’t issued procedures for applying for cancelling a PPP loan yet.

In order to have the information to prepare an employer’s or owner’s income tax return the following things will be required.

  1. The bank that processed the PPP loan will have to issue the procedures to apply for loan cancellation.
  2. The employer will have to determine which wages will be used to qualify for PPP loan cancellation.
  3. The IRS will have to issue guidance on how to elect to exclude wages when computing the ERC and possibly issue guidance allowing the entire credit for 2020 to be claimed on the fourth quarter federal payroll tax return.
  4. The employer will have to submit amended 2020 Federal payroll tax returns (Form 941X) to claim the credit, and elect for wages used to qualify for PPP loan exclusion to not be used for computing the ERC.
  5. The employer will have to apply for PPP loan cancellation.
  6. The employer and/or the employer’s owners should then have this part of the information needed to prepare 2020 federal income tax returns.

For employers that file California income tax returns, there is also an issue about which expenses to reduce for cancellation of a PPP loan. Legislation has been introduced to conform to the federal rule allowing the deduction of those expenses, but whether it will pass is uncertain.

Many businesses have been suffering during the pandemic and are anxious to file net operating loss carryback claims. Tax return preparers might decide to file preliminary income tax returns and net operating loss carryback claims and correct them later. This will probably result in additional expense and inconvenience for their clients, and potential fee collection problems. There might not be much choice under the circumstances.

I’ve intentionally left many details out of this explanation for brevity, including which payroll expenses qualify for the credit for employers with more than 100 full-time employees. Employers will probably need professional help preparing amended payroll tax returns to claim additional Employee Retention Credits.

If your business received a Paycheck Protection Plan loan during 2020 that you expect to be cancelled, discuss this issue with your tax consultant.

Not much time to protect assessed value of California real estate

Effective for transfers after February 15, 2021, the exemption from reassessment only applies to the excess of the fair market value of a primary residence (qualifying for the homeowner's real estate tax exemption) over the transferor's assessed value up to $1 million.

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Tax highlights of the Consolidated Appropriations Act, 2021

President Trump changed his mind and signed The Consolidated Appropriations Act, 2021 on December 27, 2020.  The Act is more than 5,000 pages.  There were not very many tax law changes in the Consolidated Appropriations Act compared to the CARES Act enacted during March 2020. Here are a few highlights

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Does waiting to apply for PPP loan forgiveness change the time for the expense offset?

the IRS clarifies that when a taxpayer satisfies all of the requirements (having qualified expenses during 2020) and expects to apply for forgiveness of the related PPP loan, those expenses aren't tax-deductible for 2020, even when the application for forgiveness isn't made until 2021.

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Consider filing a protective claim for Obamacare taxes

The U.S. Supreme Court has agreed to hear California v. Texas (U.S. Supreme Court Docket 19-840.)  This case challenges the constitutionality of the Affordable Care Act, nicknamed Obamacare.

If the Supreme Court rules the Affordable Care Act to be unconstitutional, taxes and penalties enacted as part of the Act could be eliminated and taxpayers could apply for refunds of those taxes.  These include an extra 0.9% Medicare tax and the 3.8% net investment income tax.

Consider sending a protective claim to the IRS by July 15, 2020 for the tax year 2016.  Spidell Publishing has posted a suggested simple form for a claim.  Here is a URL for the form.  http://www.mmsend63.com/link.cfm?r=4MGaSk-8do9OSq5rWJozRA~~&pe=MLxUYHWRMJTah2hlVsRhufQV3c6p4SCiez5_l6NGi1-_VLwkya4_xaxcLOOmNGM5Qkg_z_cN4pc5N38k-Y3xTA~~&t=QIJYj7V5qtg-xGkCJ-dZlw~~

You might remember the Supreme Court previously upheld the Affordable Care Act as constitutional during 2012 in National Federation of Independent Businesses v. Sebelius, because the penalties enacted in that Act to enforce the Mandate that everyone have medical insurance were considered to be taxes and Congress has the power to levy taxes under the U.S. Constitution.

One of the provisions of the Tax Cuts and Jobs Act of 2017 was to change the penalty rate to zero.

The Fifth Circuit Court of Appeals ruled on December 18, 2019 that since the “tax” for the Mandate no longer applies, the Mandate is unconstitutional, and so is the Affordable Care Act.

California and other states are contesting the decision of the Fifth Circuit Circuit Court of Appeals.

This is a last-minute development.  Personally, I question whether the U.S. Supreme Court would retroactively strike down the Affordable Care Act when they previously upheld it and the penalty “tax” applied before 2019.  But I could be wrong.  If you don’t file a protective claim and the U.S. Supreme Court rules Obamacare was unconstitutional during 2016, you won’t be able to recover the taxes for that year.

Tax return preparers are probably already occupied with finishing 2019 income tax returns and extensions for the July 15, 2020 deadline.

If you paid these taxes and can get through to your tax advisor, discuss this matter with her or him.

For Seniors Only – IRS allows “undoing” an unneeded 2020 “required” retirement plan distribution

The CARES Act eliminated required minimum distributions for 2020.  (Distributions are still required for a defined benefit account, which is basically an employer-provided retirement annuity.)

As a general rule, you have to start taking distributions from a retirement account, like an IRA or a 401(k), when you reach age 72 (as amended by the SECURE Act.)  The required minimum distribution is computed based on your life expectancy each year.  This rule has been waived by the CARES Act for 2020.

If you don’t need the money for living expenses, it’s best not to  take money out of a retirement account, so that it can continue to enjoy tax-deferred growth.  (If you do need the money for living expenses, this discussion doesn’t apply to you.  There’s no requirement to roll over what would otherwise be a required minimum distribution.)

Without this exception for 2020, distributions that are required minimum distributions wouldn’t be eligible for a rollover to an IRA or other qualified retirement account.

The elimination of required minimum distributions created a problem for some taxpayers.  Taxpayers usually can only roll over one distribution in a 12-month period.  Many retired persons take their distributions in monthly installments to make it easier for them to budget funding their expenditures.

In addition, rollovers usually must be completed within 60 days.  The IRS previously extended the due date to complete a rollover for a distribution made during the period from February 1, 2020 to May 16, 2020 to July 15, 2020 with Notice 2020-23.

Now the IRS has announced more relief for retirement account distributions received during 2020 that would otherwise be required minimum distributions in Notice 2020-51.  Here is a URL for the Notice. https://www.irs.gov/pub/irs-drop/n-20-51.pdf

  1. The due date to complete a rollover of any distribution that would otherwise be a required minimum distribution during 2020 is extended to be not before August 31, 2020.
  2. Any distribution that would otherwise be a required minimum distribution paid during 2020 is not subject to the one rollover per 12-month period limitation.  In other words, if multiple payments have been received that would otherwise be required minimum distributions, the total of all of the payments can be rolled over.
  3. The IRS clarified that a plan participant with a required beginning date of April 1, 2021 (became age 72 during 2020), is not required to take an initial distribution on that date.  Unless there is a later tax law change, the plan participant will still have to receive a required minimum distribution for 2021 during 2021.  Any distributions made during 2021 will first be applied as required minimum distributions and will ineligible for a rollover.
  4. Even though no distribution is required when the required beginning date is April 1, 2020 or April 1, 2021, those dates will still be the required beginning date for every other purpose, such as determining how distributions must be paid after the death of the participant.

IRAs don’t have to be amended in order to receive a rollover contribution of required minimum distributions.  Employer-provided defined contribution retirement plans (like 401(k)s) do have to be amended to accept these rollover contributions.  Notice 2020-51 includes a sample amendment for a defined contributions plan to accept these contributions.

Notice 2020-51 clarifies that payments that are part of a series of substantially equal periodic payments under the “RMD method” (commenced before age 59 1/2) aren’t considered “required minimum distributions” for the 2020 waiver.  If the payments are stopped in 2020 (other than because of death or disability) prior to age 59 1/2 (or prior to 5 years from the date of the first payment), the cessation of the payments is a modification so that ALL of the payments made under the series are subject to an early distribution recapture penalty tax.

If you already received what would normally be required minimum distributions during 2020, consider rolling them over by August 31, 2020.

If you haven’t received what would normally be a required minimum distribution but have one scheduled for later this year, consider notifying the plan administrator to cancel the distribution.

Also consider that Roth conversions aren’t limited to one per year.  Considering the stock market has been soft, 2020 may be a good year to make one or more Roth conversions.

If you have questions about these matters or need help with your tax and financial planning, consult with your tax advisor and financial advisor.  You can also write to me at mgray@taxtrimmers.com.

 

 

 

Tax and financial advice from the Silicon Valley expert.