The tax consequences of fraud on the victims are complex and usually aren’t good news.
Tax tips and developments relating to individuals
California expands the passthrough entity tax
The passthrough entity tax is a workaround for the $10,000 individual income tax limit on the deduction for state taxes adopted in the Tax Cuts and Jobs Act of 2017. On February 9, 2022, Governor Newsom signed SB 113, which fixes some of the issues with California's passthrough entity tax.
Oopsie! California wages aren’t reduced for Employee Retention Credit
According to 2020 FTB Publication 1001 (Revised November, 2021), page 13, the federal reduction of wages doesn't apply on the California income tax return.
IRS employee retention credit guidance confounds tax professionals
According to the Notice, whether wages of controlling owners of a business and their spouses qualify for the employee retention credit depends on whether they have certain relatives.
No federal tax increase, for now
Many high income and high net worth taxpayers will be relieved to learn that Biden's major revenue proposals are NOT included in the agreement.
Tax deadline extended, but not really
Most significantly for individuals who are small business owners and investors, the extension doesn't apply to the first estimated tax payment for 2021
IRS issues guidance for unemployment compensation exclusion
The IRS has posted guidance about the procedure for reporting unemployment compensation for taxpayers who qualify for the new exclusion of up to $10,200 per taxpayer.
Got unemployment compensation during 2020? Wait to file your federal income tax return
If a taxpayer (same threshold for a single or joint return) has adjusted gross income of less than $150,000, up to $10,200 of unemployment compensation received is excluded from federal taxable income.
File Schedule C and haven’t applied for a PPP loan? Now you can apply for a bigger loan
The Small Business Administration has issued new rules enabling small business owners who file Schedule C to apply for a bigger Paycheck Protection Program (PPP) loan, but only if they haven't had a PPP loan approved before.
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
- 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
- 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.
- The bank that processed the PPP loan will have to issue the procedures to apply for loan cancellation.
- The employer will have to determine which wages will be used to qualify for PPP loan cancellation.
- 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.
- 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.
- The employer will have to apply for PPP loan cancellation.
- 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.