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.
Tax tips and developments relating to partnerships
Most significantly for individuals who are small business owners and investors, the extension doesn't apply to the first estimated tax payment for 2021
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.
Section 278 of Subtitle B, COVID-related Tax Relief Act of 2020, clarifies that otherwise deductible expenses paid with proceeds of a PPP loan that is forgiven remain tax deductible.
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.
The SBA has issued new forms and updated its Paycheck Protection Program loan “final rules” for the Paycheck Protection Program Flexibility Act of 2020, enacted on June 5, 2020.
One of the forms is a new one, simplified Form 3805EZ.
Here are URLs for the final rules and forms.
Under the Act, the “covered period” was extended from the eight-week period beginning on the date of the origination of a covered loan to 24 weeks. Borrowers that received PPP loans before June 5, 2020 may elect to use the original eight-week period.
The forgiveness requirement to use at least 75% of loan proceeds for payroll costs was reduced to 60%.
The forms reflect that a pro-rated forgiveness can apply if there is a reduction of the employee count by the end of the covered period.
The maximum payroll costs, including salary, wages and tips, eligible for the forgiveness for an employee is $46,154 with the 24-week covered period and $15,385 with the eight-week covered period.
The owner compensation replacement is calculated based on 2019 net profit. The amounts are 2.5/12 of 2019 net profit, up to $20,833, for a 24-week covered period and 8/52 of 2019 net profit, up to $15,385, for an eight-week covered period. Amounts for which a credit is claimed for qualified sick leave equivalent amount and qualified family leave equivalent amount aren’t eligible for forgiveness.
Remember up to 25% of loan proceeds used to pay otherwise tax deductible interest on mortgage obligations or personal property incurred before February 15, 2020, otherwise tax deductible rent payments on lease agreements in force before February 15, 2020 and otherwise tax deductible utility payments under service agreements dated before February 15, 2020 is eligible for forgiveness under the eight-week covered period scenario. Up to 40% of loan proceeds used to pay the same expenses is eligible for forgiveness under the 24-week covered period scenario.
Many more borrowers should be able to qualify for exclusion of their PPP loans under the new rules.
The California legislature has passed budget legislation, AB 85, and sent it to Governor Newsom, who is expected to approve it.
Notably, there were no provisions conforming California tax law to the CARES Act relief measures adopted by the federal government earlier this year.
Net operating loss deductions won’t be allowed on California income (including corporate franchise) tax returns for 2020-2022 tax years for businesses with business income, or modified adjusted gross income of $1 million or more. The term for which net operating losses that could have been deducted in those years is extended by one year for losses incurred in taxable years years beginning on or after January 1, 2021 and before January 1, 2022, by two years for losses incurred in taxable years beginning on or after January 1, 2020 and before January 1, 2021, and by three years for losses incurred in taxable years beginning before January 1, 2020.
The $800 “privilege tax” for corporations, limited partnerships and limited liability companies “doing business” in California is waived for new companies organized (registered with the California Secretary of State) on or after January 1, 20121 and before January 1, 2024.
Business credits will be limited to $5 million for the 2020 – 2022 tax years. The carryover period for the credits is extended to compensate for the years the limitation applies.
The exemption for sales tax for baby diapers and for menstrual hygiene products, which was scheduled to expire on January 1, 2022 is extended to June 30, 2023.
New sales tax collection and reporting rules will apply for auto dealers, other than new car dealers, effective January 1, 2021. The details are beyond the scope of this summary. See your tax advisor for details.
The maximum monthly penalty for not having mandated health insurance for a responsible person with an applicable household size of five or more individuals is capped at the penalty for five individuals.
The IRS has issued guidance relating to the tax deductibility of expenses paid with a Paycheck Protection Loan that is forgiven. (Notice 2020-32. https://www.irs.gov/pub/irs-drop/n-20-32.pdf)
According to the CARES Act, the forgiveness of indebtedness is not taxable income. (CARES Act Section 1106(i).)
The CARES Act doesn’t specify whether the expenses are tax deductible.
A Paycheck Protection Loan is eligible for forgiveness when the proceeds are used for the following expenses during the 8-week “covered period” beginning on the the loan’s origination date (CARES Act Section 1106(b)):
- Payroll costs
- A payment of interest on a covered mortgage obligation
- A payment on a covered rent obligation
- A covered utility payment
The IRS reminds taxpayers that, according to Internal Revenue Code Section 265(a)(1), no deduction is allowed for any item that is allocable to tax-exempt income.
To receive tax-exempt income from the federal government and to be allowed a tax deduction paid using the income would be a double benefit.
Taxpayers and their tax return preparers should note that these items won’t be tax-deductible on their 2020 income tax returns.
The Joint Committee on Taxation has issued a description of the tax provisions in the CARES Act.
Here is a URL to download the report. https://www.jct.gov/publications.html?func=startdown&id=5256
Congress enacted and President Trump signed legislation requiring employers to make employee leave payments as a coronavirus relief measure on March 18, 2020. The title of the legislation is the Families First Coronavirus Reponse Act (P.L. 116-127) (the Family First Act, FFA or the Act.) Employers are reimbursed for these payments through tax credits that they can apply against their payroll tax liabilities.
Here is a URL to the text of the Act. https://www.congress.gov/116/plaws/publ127/PLAW-116publ127.pdf
The Department of Labor recently published questions and answers that provide important information about which employees are covered and the amounts that employers are required to pay those employees. Here is a URL to the questions and answers. https://www.dol.gov/agencies/whd/pandemic/ffcra-questions
The Department of Labor has also issued a poster that employers are required to use to notify employees of their rights. Here is a URL to the poster. https://www.dol.gov/sites/dolgov/files/WHD/posters/FFCRA_Poster_WH1422_Federal.pdf
According to the Department of Labor Questions and Answers, the FFA’s paid leave provisions are effective on April 1, 2020 and apply to leave taken between April 1, 2020 and December 31, 2020.
The IRS has published FAQs about the payroll tax credits for required employee leave under the FFA. Here is a URL to the FAQs. https://www.irs.gov/newsroom/covid-19-related-tax-credits-for-required-paid-leave-provided-by-small-and-midsize-businesses-faqs
The employee leave requirements of the FFA do not apply to private sector employers that have 500 or more employees.
Employers with fewer than 50 employees and compliance with the requirements would threaten the viability of the business as a going concern may qualify for a small business exemption. These businesses should document the reason the business viability is threatened. There currently isn’t a form or application procedure for the exemption.
According to guidance issued by the Department of Labor, employees who take paid leave under the Act are required to provide the employer with documentation supporting the reason for leave. The employer should keep copies of federal and local quarantine orders. The employee should give a statement with the employee’s name, qualifying reason for requesting leave, a statement that the employee is unable to work, including telework, for that reason, and the date(s) for which leave is requested. If leave is requested under a doctor’s orders, a letter from the doctor should be kept by the employer.
If expanded family leave is requested because a child’s school is closed, documentation should be kept for that event.
According to guidance issued by the Department of Labor, you are unable to work if your employer has work for you and one of the reasons listed below for the Emergency Paid Sick Leave Act prevents you from being able to perform that work, either under normal circumstances at your normal worksite or by teleworking.
According the Department of Labor guidance, if an employer closed its worksite before April 1, 2020, the employee isn’t entitled to paid sick leave because there isn’t any work for the employee to do. This is true whether the employer closes the worksite for lack of business or because it’s required to close because of a Federal, state or local directive. In this case, the employee should apply for state unemployment insurance benefits.
If an employer closes its worksite after April 1, 2020 but before the employee goes on leave, the employee isn’t entitled to paid leave under the Act and should apply for unemployment insurance benefits.
If an employer closes its worksite after April 1, 2020 when an employee is on paid sick leave under the Act, the employee is no longer eligible for paid leave under the Act and should apply for unemployment insurance benefits.
If an employer remains open and furloughs an employee after April 1, 2020 because there isn’t work for the employee, the employee isn’t eligible for paid leave under the Act and should apply for unemployment insurance benefits.
If an employer remains open and reduces an employee’s scheduled work hours because of a reduced workload, the employee isn’t entitled to paid leave under the Act, even if the reduced hours are a result of the coronavirus shutdown. The reason is the employee isn’t prevented from working those hours because of a coronavirus-related reason.
An employee may take paid sick leave or expanded family and medical leave intermittently while teleworking.
Unless you are teleworking, paid sick leave for qualifying reasons related to coronavirus must be taken in full-day increments.
Unless you are teleworking, once you begin taking paid sick leave for one or more of the qualifying reasons, you must continue to take paid sick leave each day until you either (1) use the full amount of paid sick leave or (2) no longer have a qualifying reason for taking paid sick leave. This requirement is imposed to avoid having other employees be exposed to the coronavirus.
The rules are different when a parent is taking sick leave to care for a child whose school or place of care is closed. In that case, the employer and employee can agree for the employee to take paid sick leave intermittently, such as taking leave on Mondays, Wednesdays and Fridays and working on Tuesdays and Thursdays.
Employees may not receive unemployment benefits when they are receiving paid sick leave.
According to Department of Labor guidance, employers aren’t allowed to require employees to supplement or adjust the pay mandated under the Act with paid leave under the employer’s paid leave policy. The employee must choose one or the other.
Wages paid for employee leave under the FFA are taxable wages for employees, but aren’t subject to the employer shares of Social Security tax (6.2%).
There are two sections of the FFA relating to employee leave: The Emergency Family And Medical Leave Act and The Emergency Paid Sick Leave Act.
The Emergency Family And Medical Leave Expansion Act
The Emergency Family And Medical Leave Act relates to employees who are unable to work or telework due to a need to take leave to care for a son or daughter under 18 years of age of such employee if the school or place of care has been closed, or the child care provider of the son or daughter is unavailable due to a public health emergency (the coronavirus shutdown declared by a Federal, state or local authority.)
In order to be eligible, the employee must have been employed for at least 30 calendar days by the employer from whom leave is being requested.
The first 10 days for which an employee takes leave may be unpaid leave. An employee may elect to substitute accrued vacation leave, personal leave, or medical or sick leave for unpaid leave. According to guidance issued by the Department of Labor, the employee may be entitled to paid leave under the Emergency Paid Sick Leave Act for the initial 10 days, which is a higher rate of pay. (See below.)
After the first 10 days, the employer is required to pay the employee not less than two-thirds of the employee’s regular rate of pay, based on the number of hours the employee would normally be scheduled to work. The maximum required paid leave is $200 per day, or $10,000 total for the ten-week period.
According to guidance issued by the Department of Labor, the employee initially uses up to 10 days under the Emergency Medical Leave Act, and then may use up to ten weeks expanded leave after that under the Emergency Family And Medical Leave Expansion Act.
If the employee has an irregular schedule, the employer should determine an average of hours worked per week and average rate of pay per hour over a six-month period ending on the date the employee starts taking leave. If the employee worked less the six months, the employer may estimate the hours expected the employee to be scheduled to work. According to guidance issued by the Department of Labor, if the employee hasn’t been employed for at least six months, use the number of hours that the employer and the employee agreed the employee would work when the employee was hired. If there wasn’t such an agreement, calculate the appropriate number of hours of leave based on the average hours per day the employee was scheduled to work over the entire term of his or her employment.
According to Department of Labor guidance, overtime hours are included when computing the hours the employee would normally work in a week when computing expanded leave. Pay does not include a premium for overtime hours.
Employers with less than 25 employees are not required to pay leave provided:
- The employee takes leave to care for the employee’s child.
- The position held by the employee does not exist due to economic conditions or other operating conditions of the employer (a) that affect employment; and (b) are caused by a public health emergency during the period of leave.
- The employer makes reasonable efforts to restore the employee to a similar position, with equivalent pay and benefits.
- If the employer is unable to restore the employee to a similar position, the employer makes a reasonable effort to contact the employee during the 1-year period beginning on the earlier of (a) the date on which the qualifying need from a public health emergency concludes, or (b) the date 12 weeks after the date on which the employee’s leave commences.
The Emergency Paid Sick Leave Act
An employer is required to provide to each employee employed by the employer paid sick time to the extent that the employee is unable to work (or telework) and takes leave because:
- The employee is subject to a Federal, State or local quarantine order relating to the coronavirus.
- The employee has been advised by a health care provider to self-quarantine due to concerns relating to the coronavirus.
- The employee is experiencing symptoms of the coronavirus and seeking a medical diagnosis.
- The employee is caring for an individual who is subject to an order described at item 1 or has been advised as described at item 2.
- The employee is caring for a son or daughter of the employee if the school or place of care of the son or daughter has been closed, or the child care provider of the son or daughter is unavailable due to coronavirus precautions.
- The employee is experiencing any other substantially similar condition specified by the Secretary of Health and Human Services in consultation with the Secretary of the Treasury and the Secretary of Labor.
An employer of an employee who is a health care provider or an emergency responder may elect to exclude the employee from eligibility from paid sick leave under this Act.
An employee that meets requirements 1, 2, or 3 above is entitled to paid sick time at the employee’s regular rate of pay for up to 80 hours for a full time employee or, for a part-time employee, the average number of hours the employee works during a two-week period. According to guidance issued by the Department of Labor, the amount received will be based on the greater of (a) the employee’s regular rate of pay, (2) the federal minimum wage, or (3) the applicable state or local minimum wage, up to a maximum of $511 per day, or $5,110 for the entire sick leave period.
(According to guidance issued by the Department of Labor, once the employee takes 80 hours, the employee won’t qualify for additional sick leave under the Act for 2020. Only sick leave received for the period on or after April 1, 2020 counts.)
According to guidance issued by the Department of Labor, commissions, tips, and piece rates must be included in the employee’s regular rate of pay.
An employee that meets requirements 4, 5, or 6 above is entitled to compensation based on 2/3 of the amounts for requirements 1, 2, or 3 to a maximum of $200 per day, or $2,000 for the two-week period.
The sick time under the Act isn’t eligible for carryover to a subsequent year.
Paid sick time under the Act ceases beginning with employee’s next workshift following the termination of the need described at items 1 – 6 above.
An employer may not require that an employee search for or find a replacement employee as a condition to receive sick pay under the Act.
If the employee is eligible for accrued sick pay from the employer, the employee uses sick pay under the Act first.
Employers are prohibited from discharging, disciplining, or in any other way discriminating against an employee who takes leave in accordance with the Act and files a complaint relating to the Act.
Tax Credits For Paid Sick and Paid Family and Medical Leave
Certain employers are eligible for a tax credit against the employer share of social security tax (6.2%.) The credit is 100% of qualified sick leave wages paid by the employer for the calendar quarter.
The maximum sick leave wages for an individual is $200 per day, or $511 per day in the case of sick leave wages paid under the Emergency Paid Sick Leave Act.
In addition to the sick leave wages, the credit is increased for the employer’s qualified health plan expenses that are properly allocable to the qualified sick leave wages for which the credit is allowed. The IRS is to define a procedure to prorate the qualified health plan expenses on the basis of period of coverage to to time periods of leave that the wages relate to.
The maximum days for an individual for a calendar quarter is 10 minus the total days taken in preceding calendar quarters during 2020.
The credit is limited to the total employer portion of social security taxes and medicare taxes for the quarter, but any excess credit over that limit is treated as a refundable overpayment.
Qualified sick leave wages for the credit means compensation required to be paid under the Emergency Paid Sick Leave Act.
Any credit allowed increases taxable income and no credit is allowed for wages when another tax credit is based on them.
An employer may elect out of claiming the credit.
The credit is not available for employees of Federal, state, or local governments.
Tax credit for sick leave of self-employed individuals
Self-employed individuals may claim a credit for the qualified sick leave equivalent amount for the individual against the individual’s self-employment tax.
An eligible self-employed individual is covered if he or she would be entitled to receive benefits under the Emergency Paid Sick Leave Act if the individual was an employee of an employer (other than himself or herself.)
The “qualified sick leave equivalent amount” is an amount equal to the number of days during the taxable year (up to the applicable number of days) that the individual is unable to perform services in any trade or business referred to in IRC Section 1402 for a reason that individual would be entitled to receive sick leave under the Emergency Paid Sick Leave Act multiplied by the lesser of (a) $200 ($511 for any day of sick time for reasons 1, 2, or 3 above) or (b) 67% (100% for any day of paid sick time for reasons 1, 2, or 3 above) of the average daily self-employment income of the individual for the taxable year.
The average daily self-employment income is the net earnings from self-employment of the individual for the taxable year divided by 260.
The applicable number of days is the excess of 10 days over the number of days taken into account in all preceding taxable years.
Any credit in excess of the self-employment tax is treated as a refundable payment.
The taxpayer is required to document the reason why he or she is entitled to the credit.
If the individual also receives wages from an employer that are required to be paid under the Emergency Paid Sick Leave Act, the qualified sick leave equivalent amount is reduced by any paid leave amount received.
Payroll credit for Required Paid Family Leave
An employer may claim a tax credit to apply against the employer portion of social security taxes (6.2%) for each calendar quarter an amount equal to 100% of the qualified family leave wages paid by the employer with respect to the calendar quarter.
The qualified family leave wages for an individual are up to $200 per day, to a maximum of $10,000 for a calendar year.
Any credit in excess of the employment taxes is treated as a refundable overpayment.
In addition, qualified health plan expenses attributable to the wages are added to the credit, under rules similar to those described for Paid Sick and Paid Family Leave, above.
This credit also increases taxable income and any expenses for which another tax credit is allowed are disallowed for computing this credit.
Credit for Family Leave for Self-Employed Individuals
Self-employed individuals who would have been eligible for leave under the Emergency Family and Medical Leave Expansion Act if they were employees may claim a tax credit against their self-employment tax for amounts equivalent to Family Leave.
The individual may claim up to 50 days times the lesser of (a) 67% of the average daily self-employment income, or (2) $200.
The self-employed person is required to be able to document being entitled to the credit.
If the self-employed person receives leave compensation as an employee for another employer, the eligible self-employment income is reduced for any leave payments received.
The credit is refundable.
If any benefit is allowed for the income under another Code section, the credit is disallowed for that amount.
Expediting getting payroll tax credits
The employer can expedite getting the cash benefit of payroll tax credits under the FFA or the CARES Act by either
- Retaining these employment taxes instead of depositing them: (a) Federal income tax withheld for all employees; (b) The employee’s share of social security and medicare taxes (for employees who received paid leave benefits); and (c) the employer’s share of social security and medicare taxes for all employees or
- Employers may file Form 7200, Advance Payment of Employer Credits Due To COVID-19. The IRS says it will try to issue refunds within two weeks for this form. It can be filed several times during a quarter.
Here is a URL for Form 7200 with instructions. https://www.irs.gov/forms-pubs/about-form-7200