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Credits

  • 8552. What is a refundable tax credit and what are some examples?

    • Editor’s Note: The Families First Coronavirus Response Act, signed into law in March 2020, creates a new refundable tax credit for employers who provide required paid and FMLA leave to employees impacted by the virus.  See Q 8502 for information about extension of the 2020 tax filing and payment deadlines. See Q 8554 for more information on the CARES Act employee retention tax credit.

      On Form 1040, after the amount of tax owed is computed, the taxpayer is entitled to subtract certain payments and credits from the tax to arrive at the amount of tax that is actually payable.

      A refundable credit is a tax credit that can result in a refund or credit even if the taxpayer owes no tax or the credit exceeds the amount of tax owing. The refundable credits include:

      …Taxes withheld from salaries and wages.1

      …Overpayments of tax.2

      …The excess of Social Security withheld (which could occur, for example, if an individual has two or more employers).3

      …The earned income credit.4

      …The 72.5 percent health care tax credit for uninsured workers displaced by trade competition.5

      …The unused long-term minimum tax credit.

      Example: In 2018, Ashley, a single mother, is entitled to an earned income tax credit of $3,500. Her income tax liability before the application of the credit is $1,000. Other than the earned income tax credit, Ashley has no other credits. Because the earned income credit is a refundable credit, Ashley is entitled to a refund of $2,500 ($3,500 credit minus $1,000 tax liability).

       


      1 .IRC Sec. 31(a).

      2 .IRC Sec. 37.

      3 .Treas. Reg. §1.31-2.

      4 .IRC Sec. 32.

      5 .IRC Sec. 35.

  • 8553. What refundable tax credit is available to employers who provide paid sick leave and FMLA leave under the Families First Coronavirus Response Act?

    • The Families First Coronavirus Response Act (FFCRA) created a tax credit to help small business owners subject to the FFCRA paid leave requirements (see Q 767).

      The tax credit is computed each quarter, and allows as a credit (1) the amount of qualified paid sick leave wages paid in weeks 1-2, and (2) qualified FMLA wages paid (in the remaining ten weeks) during the quarter.  The credit is taken against the employer portion of the relevant employment taxes.  IRS guidance provides that employers are entitled to withhold payment of employment tax deposits to cover the amount of the credit.  If the amount of the credit will exceed the amount withheld, the employer can file for an advance payment of the refundable credit (see Q 8555 and Q 8556 for information).

      Amounts that exceed the taxes due will be refunded as a credit (in the same manner as though the employer had overpaid taxes during the quarter).  While it initially appeared that only Social Security tax deposits could be withheld, guidance now clarifies that employers may retain deposits for Social Security taxes, Medicare taxes and federal income tax withholding of the employer portion of the employment tax as an immediate advance against the available tax credit.

      The employer is also entitled to the credit with respect to amounts of employer-paid qualified health plan expenses that are allocated to periods when the paid sick leave or family leave wages are paid.  See Q 8554 for information on the employee retention tax credit allowed under the CARES Act.

  • 8554. What is the CARES Act employee retention tax credit?

    • Editor’s Note: The Infrastructure Investment and Jobs Act of 2021 retroactively ended the employee retention tax credit, so that wages paid after September 30, 2021, will not be eligible for the credit.  The law did exempt recovery startup businesses from the early termination.  Originally, the credit was set to expire after 2021.  While guidance and penalty relief are possible, employers who failed to make sufficient payroll tax deposits in reliance on the fourth-quarter tax credit may be required to send additional amounts to the IRS.

      IRS regulations allow the IRS to recapture any of the tax credits credited to an employer in excess of the amount that the employer was actually entitled to receive.  That includes the employee retention tax credit, credits for qualified leave wages and credits for qualified health plan expenses under Sections 3131(d) and 3132(d).  Those incorrect tax credits will be treated as underpayments of taxes and may be administratively assessed and collected in the same manner as the taxes. The temporary regulations also provide that the calculation of any credits erroneously claimed must account for any amounts that were advanced to the employer under the processes established in 2020.

      The Consolidated Appropriations Act of 2021 expanded the employee retention tax credit (ERTC), discussed below. Under the CAA, the applicable credit percentage is increased from 50 percent to 70 percent of qualified wages. The limit on qualified wages per-employee is increased from $10,000 per year to $10,000 per quarter. The “decline in gross receipts” threshold is decreased from 50 percent to 20 percent, and a new safe harbor rule allows business owners to use the calendar quarter immediately preceding the current quarter to determine eligibility.


      Planning Point: IRS Revenue Procedure 2021-33 provides a safe harbor allowing employers to exclude certain amounts from gross receipts for the sole purpose of determining eligibility for the ERTC. Amounts that may be excluded include: (1) the amount of the forgiveness of a PPP loan, (2) Shuttered Venue Operators Grants under the Economic Aid to Hard-Hit Small Businesses, Non-Profits, and Venues Act, and (3) Restaurant Revitalization Grants under the ARPA. Employees elect to apply this safe harbor by simply excluding these amounts for purposes of determining whether it is an ERTC-eligible employer on an employment tax return. Employers are required to apply the safe harbor consistently in determining ERTC eligibility (meaning the employer must exclude the amounts from gross receipts for each calendar quarter when gross receipts are relevant to determining ERTC eligibility). If the employer applies the safe harbor, it also must apply the safe harbor to all employers treated as a single employer under aggregation rules.


      The rules discussed below that applied to “large employers” now only apply to those with more than 500 employees (as opposed to 100 under the CARES Act). Further, employers that were not in existence for all or part of 2019 are now eligible to claim the credit. Businesses with 500 or fewer employees have the option of advancing the credit at any point during the quarter, and the amount of the credit is estimated based on 70 percent of the average quarterly wages the employer paid in 2019.

      As long as the wages are not paid for with forgiven PPP loan proceeds, PPP loan recipients are entitled to claim the tax credit retroactive to the date of the CARES Act.

      Editor’s Note: The ARPA made further changes the ERTC, which remains fixed at 70 percent of qualified wages (up to a $10,000 per-quarter cap) for employers who have experienced a 20 percent year-over-year decline in per-quarter gross receipts (or a qualifying suspension of business). Starting June 30, 2021, certain small businesses that began operations after February 15, 2020 will be eligible for a maximum $50,000 per-quarter credit. Qualifying “recovery startup businesses” must have average annual gross receipts for the three-taxable-year period ending with the taxable year that precedes the quarter that do not exceed $1 million. These businesses can qualify to claim the expanded ERTC even if they do not otherwise meet the eligibility requirements for claiming the credit. Beginning in the third quarter of 2021, employers who have suffered a decline of 90 percent or more in gross receipts compared to the same quarter in 2019 can treat all wages paid as qualified wages (up to the $10,000 cap) regardless of the number of employees the business has and regardless of whether the employees provide services (in other words, even employers with more than 500 employees qualify if they are under severe financial distress). Employers can continue to claim the credit even if they’ve received a PPP loan, but cannot claim the credit with respect to wages paid with forgiven PPP funds.

      The new ERTC will be allowed against the Medicare tax only in the third and fourth quarters of 2021. While this procedural shift does not impact the available value of the ERTC, it could be important for business owners who had relied upon taking the credit in advance. Because the Medicare tax is only 1.45 percent, more clients might be required to file a Form 7200 to receive advance payment of the credit. The law also extends the statute of limitations on assessments under the law to five years from the date the return claiming the credit is filed.

      CARES Act ERTC

      The CARES Act created a refundable tax credit designed to help employers who retained employees during the COVID-19 health crisis. The credit is taken against employment taxes and is equal to 70 percent (originally 50 percent) of the first $10,000 of qualified wages paid to the employee. Originally, wages paid between March 12, 2020 and January 1, 2021 counted in calculating the credit (the credit has since been extended).[1] Wages include both cash payments and employer health care payments (see below for allocation rules). Because the credit is refundable, employers are eligible for a refund if the credit amount exceeds the employment taxes due.

      Employers are eligible regardless of size if they were in business during 2020.

      The credit is available for calendar quarters where either:

      (1) operations were either fully or partially suspended because of a government-issued order relating to COVID-19 (see below), or

      (2) the business remained open, but gross receipts declined by more than 20 percent (originally 50 percent) when compared to the same calendar quarter in the previous year. Once gross receipts rebound and exceed 80 percent when compared to the same quarter in 2019, the employer no longer qualifies in the subsequent quarter.

      Eligible government issued orders include restrictions on travel, group gatherings or limitations on commerce (such as the orders requiring certain businesses to close or limit operations).

      Qualification is calculated every quarter.[2] If the employer has no more than 500 (originally 100) employees, the amount of qualified wages includes wages paid during a quarter where COVID-19 impacts the business, including when the employees continue to provide services for payment during the relevant period and when employees are paid, but not working.

      If the employer has more than 500 full-time employees, the wages counted toward the credit include only those paid while the employee was not working for the employer because of a government order or decline in gross receipts. In counting the number of employees, the employer uses average employees during 2019.


      Planning Point: For purposes of determining whether a credit-eligible employer is a large eligible employer or a small eligible employer, employers are not required to include full-time equivalents when determining the average number of full-time employees. However, for purposes of identifying qualified wages, an employee’s status as a full-time employee is irrelevant because wages paid to a part-time employee may be treated as qualified wages if all other requirements are satisfied.[3]


      Employers who pay wages with PPP loans that are forgiven cannot claim the tax credit for the same wages. Further, the credit does not apply with respect to wages paid under the FFCRA paid sick leave laws (in other words, the employer cannot “double dip”).


      Planning Point: Any cash tips treated as wages within the definition of IRC Section 3121(a) or compensation within the definition of IRC Section 3231(e)(3) are treated as qualified wages if all other requirements are satisfied. According to IRS reasoning, eligible employers are not prevented from receiving both the employee retention credit and the Section 45B credit (the FICA tip credit) for the same wages because the CARES Act and subsequent legislation do not reference Section 45B in areas where a “no double dipping” rule applies.[4]


      The amount of wages considered for purposes of the credit cannot exceed the wages the employee would have received for working an equal amount of time in the 30-days preceding the applicable period when the credit is available.

      Qualified wages also include the employer’s health plan expenses allocated to the wages taken into account for the credit. The health plan expenses must be amounts paid or incurred by the employer to provide and maintain a group health plan, but only if the amounts are excluded from employees’ income under IRC Section 106(a).[5]


      Planning Point:  IRS Notice 2021-49 addresses the issue of whether wages paid to majority owners and spouses of majority owners may be treated as “qualified wages”.  “Majority ownership”, for these purposes, means more than 50 percent of the value in a corporation.  According to the IRS, if the majority owner of a corporation has no brother or sister (whether by whole or half-blood), ancestor, or lineal descendant as defined in IRC Section 267(c)(4), then neither the majority owner nor the spouse is a related individual within the meaning of Section 51(i)(1) and the wages paid to the majority owner and the spouse are qualified wages for ERTC purposes, assuming the other requirements for qualified wages are satisfied.  The notice contains multiple examples that provide guidance on various scenarios and various types of relationships.


      Unless otherwise provided, allocating health expenses pro rata among employees and pro rata based on the periods of coverage (i.e., lining the payments up with the periods to which the wages relate) is sufficient.

      [1].     IR-2020-62, Notice 2020-22.

      [2].     IR-2020-62.

      [3].     Notice 2021-49.

      [4].     Notice 2021-49.

      [5].     See generally Pub. Law No. 116-136, Sec. 2301.

  • 8555. What do employers need to know about claiming the CARES Act employee retention tax credit? Are there any reporting requirements?

    • Employers are entitled to reduce their quarterly payroll tax deposits (i.e., amounts that have been withheld from employee pay) by the amount of the credit. In other words, the credit is available in advance, rather than during tax filing season.  Employers must report total qualified wages (and health insurance costs) quarterly on their employment tax returns, or Form 941, beginning with the second quarter. If payroll tax deposits are not sufficient to cover the amount of the credit via withholding from the usual deposits, the employer can file Form 7200, Advance Payment of Employer Credits Due to COVID-19.[1]

      Generally, employers are required to deposit employment taxes quarterly. Practically, many employers must make deposits monthly, weekly or even daily (employers that accumulate $100,000 or more in employment taxes on any day within a deposit period are required to deposit those amounts on the next banking day).[2] Most employers report employment tax liability quarterly on Form 941, which is where the refundable credits will be reported.

      [1] Available at https://www.irs.gov/forms-pubs/about-form-7200.

      [2].     Treas. Reg. § 31.6302-1(c).

  • 8556. What penalty relief is provided for employers who withhold payroll tax deposits in light of the employee retention tax credit and the paid leave credit?

    • The IRS has provided relief from penalties under IRC Section 6656 for an employer’s failure to timely deposit employment taxes to the extent that amounts not deposited are equal to or less than the amount of refundable tax credits to which the employer is entitled under the CARES Act and the FFCRA.  The relief applies to reductions in deposit amounts based on wages paid for qualified leave between April 1, 2020 and December 31, 2020.  With respect to the employee retention credit, amounts withheld between March 13, 2020 and December 31, 2020 are covered.

      For purposes of the FFCRA credits for paid leave, employment taxes include Social Security taxes, Medicare taxes and federal income tax withholding under Section 3402.  See Q 766.01 on the FFCRA paid leave requirements.

      For purposes of the CARES Act employee retention credit, the offset can only be taken against the employer portion of the Social Security tax (i.e., the employer’s 6.2 percent), not the employee portion or the 1.45 percent Medicare tax.  See Q 8550.01 for more information on the employee retention tax credit.[1]

      Employers eligible for the credit will not be subject to a penalty under IRC Section 6656 for failing to deposit employment taxes on qualified retention wages in a calendar quarter if:

      • The employer paid qualified retention wages to its employees in the quarter prior to the time of the required deposit,
      • The amount of withheld employment taxes, reduced by the amount of employment taxes not deposited in anticipation of the credits claimed for qualified leave wages, qualified health plan cxpenses, and the employer’s share of Medicare tax on the wages, is less than or equal to the amount of the employer’s anticipated credits under the CARES Act for the quarter as of the time of the required deposit, and
      • The employer did not seek payment of an advance credit by filing Form 7200, Advance Payment of Employer Credits Due to COVID-19, with respect to the anticipated credits it relied upon to reduce its deposits.

      In other words, after a reduction of a deposit by the amount of credits anticipated for qualified leave wages, an employer may further reduce, without penalty, the employment tax deposit by the amount of qualified retention wages the employer paid in the calendar quarter prior to the required deposit, as long as the employer does not also seek an advance credit with regard to the same amount.

      The total amount of any reduction in any required deposit may not exceed the total amount of qualified retention wages in the quarter, minus any amount of qualified retention wages that had been previously used to either: (1) to reduce a prior required deposit in the quarter and obtain the penalty relief or (2) to seek payment of an advance credit.[2]


      Planning Point: Proposed and temporary IRS regulations makes clear that employers are required to reconcile any advance payments claimed on Form 7200 with total credits claimed and total taxes due on their employment tax returns.  Any refund of credits paid to an employer that exceeds the amount the employer is allowed is an erroneous refund for which the IRS will seek repayment.[3]


      [1]      Notice 2020-22.

      [2]      Notice 2020-22.

      [3]      See Prop. Treas. Reg. §§31.3111-6, 31.3221-5.

  • 8557. Did the CARES Act provide any relief from depositing payroll taxes in 2020?

    • Yes. The CARES Act allows both employers and independent contractors to defer payment of employer payroll taxes without penalty.

      Under the CARES Act payroll tax deferral, employers are permitted to defer the employer portion of the Social Security tax on wages paid through December 31, 2020 for up to two years.  Note that, at this time, the deferral only appears to apply to Social Security taxes (the employer 6.2 percent portion of the payroll tax).

      Payroll taxes are generally due in two installments under CARES: 50 percent by December 31, 2021 and the remaining 50 percent by December 31, 2022.[1] Economic hardship is presumed, meaning the employer does not have to produce documentation establishing that COVID-19 impacted the business.

      If the taxes are paid by the end of the applicable deferral period, the employer is treated as having paid them on time. Payroll tax deferral options apparently apply to all employers, regardless of size. However, employers who have loans forgiven under the CARES Act Payroll Protection Loan program are not eligible for the deferral.[2]

      Importantly, employers with fewer than 500 employees are also entitled to withhold payroll taxes as an advance repayment of the tax credit for paid sick leave and expanded FMLA leave under the FFCRA.


      Planning Point: Note that this deferral opportunity is distinct from the opportunity to defer the employee portion of the payroll tax.  Employers who elected to defer employee payroll taxes will have until January 3, 2022 to repay those taxes under Notice 2021-11.  Originally, those taxes would have been due by April 30, 2021.


      Employee Payroll Tax Holiday

      Beginning September 1, 2020 employers have the option of deferring the employee portion of the payroll tax through December 31, 2020.  Employers can choose to stop withholding the 6.2% employee portion of the Social Security tax for employees who earn less than $4,000 bi-weekly (pre-tax).  The amount is determined on a pay period-by-pay period basis.  In other words, if the employee makes less than $4,000 for the current pay period, the employee qualifies for deferral regardless of amounts earned in other pay periods.

      Employers are required to continue contributing the employer half under preexisting rules.

      However, employees should note that under current IRS guidance, deferred employee payroll taxes must be repaid during the period beginning January 1, 2021 and ending April 30, 2021.[3]  Taxes that are not repaid during that period will accrue interest and penalties, and employers can pass those amounts on to employees who have not repaid their deferral amounts. While it remains possible that Congress could pass legislation to forgive any payroll taxes that are deferred during 2020, it is far from certain.


      Planning Point: It’s important for employers to note that current IRS guidance does not release employers from their obligation to pay over the payroll tax if they are unable to collect deferred amounts from employees.


      [1].     Pub. Law No. 116-136, Sec.2302(d)(3).

      [2].     Pub. Law No. 116-136, Sec. 2302(a)(3).

      [3]      See Notice 2020-65.

  • 8558. What are the paycheck protection loans and economic injury disaster loans for small business owners?

    • Editor’s Note: As of the date of this publication, Congress has approved another round of funding for the PPP loan program.  Businesses who have already spent their initial loan proceeds may be eligible for a second loan.  See heading below for details.

      The CARES Act provides opportunities for small business owners to get direct cash loans to keep their businesses afloat—even without a formal, documented showing of financial loss at the outset, which is being presumed under the new law. Small businesses taking out loan assistance should be prepared to provide documentation in order to obtain loan forgiveness under the payroll protection program. Two primary types of loans are available under the law: (1) expanded Economic Injury Disaster Loans (EIDLs) and (2) Paycheck Protection Loans.

      EIDLs[1] are available through the Small Business Administration (SBA), and, even pre-COVID-19, contained favorable terms such as thirty-year repayment periods, 3.75 percent interest rates and deferral of the first month’s payments. The expanded relief makes it easier to qualify as long as the business existed as of January 31, 2020. The SBA can grant the loan based on the business’ credit score without a tax return and regardless of past bankruptcies—and the average annual receipts tests will not apply. For loans of less than $200,000, no personal guarantee or real estate collateral is required.

      Paycheck protection loans[2] are available to employers with fewer than 500 employees that were in operation before February 15, 2020. These loans max out at (a) $10 million or (b) 2.5 times the employer’s average monthly payroll costs during the one-year period ending the date the loan is made. Loan terms for amounts not forgiven include: interest rates of up to 4 percent, ten-year repayment terms, payment deferrals for six to twelve months and waiver of personal guarantee and collateral requirements.

      Under the CARES Act, part of the paycheck protection loan could be forgiven when used during the eight weeks following the loan origination date for operating costs like payroll costs, rent, mortgage interest, interest on outstanding debt, utilities, employee retirement benefits and health insurance costs. The Paycheck Protection Program Flexibility Act (PPPFA) extended the eight-week period to twenty-four weeks from the date the lender made the first loan payment to the small business owner.


      Planning Point: Under the Consolidated Appropriations Act of 2021, all borrowers can choose the length of their own covered period.  Borrowers are entitled to choose a covered period that is as short as eight weeks or as long as twenty-four weeks.  The clock starts to run on the date the second draw loan proceeds are disbursed.

      Compensation that exceeds $100,000 per employee, as pro-rated for the period, is excluded from the definition of payroll costs. See Q 8550.07.

      Loan forgiveness does require the employer to maintain the same average number of employees during the first eight-weeks of the loan, based on the eight-week period spanning from February 15, 2019 to June 30, 2019 or January 1, 2020 to February 15, 2020 (loan forgiveness will be pro-rated, not entirely eliminated, for employers who reduce staffing). Reducing compensation for employees earning under $100,000 by more than 25 percent can also reduce the amount forgiven. The PPPFA gives employers until December 31, 2020 to bring workers back to work/restore wage levels to continue to qualify for loan forgiveness (extended from prior law, which set the deadline at June 30)).

      PPPFA also creates a new exemption for employers who are legitimately unable to restore employment numbers to pre-COVID levels. The exemption is designed to reflect the reality that some employees may not be available or willing to return to work. Employers will not be subject to a proportionate reduction in loan forgiveness based on reductions that occur under either (or both) of two scenarios during February 15, 2020 and December 31, 2020.

      First, reductions in the number of full-time equivalent employees will not jeopardize loan forgiveness if the employer can document an (1) inability to rehire employees who were employees as of February 15, 2020 and (2) is similarly unable to hire similarly qualified replacement employees before December 31, 2020. To preserve their right to loan forgiveness, employers should maintain written documents that show (1) the offer was made to an employee, (2) at the same salary, wage and hour levels as the last pay period prior to the separation or reduction in hours and (3) the offer was rejected. The employer must also inform the state unemployment agency of the offer and rejection within thirty days after the rejection is received.

      Reductions in loan forgiveness will also be disregarded if the employer cannot return to the same level of business activity as before February 1, 2020 because of a need to comply with HHS, CDS or OSHA rules established between March 1, 2020 and December 31, 2020 (related to customer or employee safety initiatives). Second Draw PPP Loan Eligibility.

      Second Draw PPP Loans

      Congress authorized a round of “second draw” PPP loans for certain businesses who had already spent their loan proceeds as of December 31, 2021.


      Planning Point: Note that business owners can apply for a second draw loan even if they haven’t fully spent their initial loan proceeds—but that second round loans will not be disbursed until all first draw funds are exhausted.


      Second draw PPP loans will be available through March 31, 2021.  To qualify, the business must:

      • have 300 or fewer employees,
      • not be permanently closed (temporarily closed businesses may apply),
      • demonstrate at least a 25% reduction in gross receipts when comparing the same quarter in 2019 to 2020 (see below),
      • have used (or will use) all of their initial PPP loan proceeds.

      Second draw PPP loans may be for up to 2.5 times average monthly payroll costs for the year prior to the loan.  Restaurants and other hospitality businesses may qualify to borrow up to 3.5 times their average monthly payroll costs.  However, PPP loans are now capped at $2 million regardless of the business’ payroll costs.  The $2 million cap applies to both new loans and second draw loans.

      The SBA rules define “gross receipts” broadly, to include all revenue from any sources, including sales, interest, dividends, rent, royalties, etc.  The SBA has also clarified that amounts that were forgiven for the business’ initial PPP loan are not included in gross receipts for 2020.

      Recognizing that very small businesses might not have quarterly information readily available, if the business existed for all of 2019, the SBA will allow the business to determine whether it experienced a 25 percent reduction by comparing annual receipts in 2020 to 2019.  Business owners who elect to use this method will be required to submit annual tax forms to verify the required decline.

      The list of “qualifying” uses for PPP loan proceeds was also expanded under CAA 2021.  Proceeds can continue to be used to cover payroll costs and operating expenses.  They can also be used to pay for personal protective equipment and modifications to the business that are necessary to adapt the business to meet new health and safety standards.  These types of capital expenditures might include physical barriers, ventilation systems, expansion of outdoor spaces, health screening facilities and more.

      PPP funds can also be forgiven if used to repair damage caused by protests and other disturbances in 2020, as long as the damage was not covered by insurance.  Proceeds can now be used to cover supplier costs, which include expenses related to contracts and other purchase orders for supplies that were in effect before the business took out the second draw loan.

      Payments for operations expenses like cloud computing services, business software, accounting or HR needs also qualify.


      Planning Point: Some business owners may be eligible for larger loan amounts under the rules released in 2021.  The SBA will allow those businesses to request an increase in their loans if eligible, either by returning all or a portion of the loan or requesting an increase if the business hasn’t yet accepted the loan proceeds.  Those requests must be made electronically to the SBA no later than March 31, 2021 under current rules.


      Planning Point: From the inception of the program, there was controversy over whether certain businesses were entitled to the loans. In FAQ, Treasury has stated that most companies with adequate sources of alternative liquidity were likely not eligible for PPP loans. In order to qualify for initial loans, PPP borrowers were required to provide a good faith certification stating that current economic conditions and uncertainty made the loan necessary to support ongoing operations (second draw borrowers are generally required to prove they experienced a revenue decline). While Treasury guidance specifically pointed to public companies with substantial market value and access to the capital markets, the guidance could also impact businesses who had adequate alternative liquidity to support operations. PPP borrowers who found they cannot make the certification in good faith were permitted to return the funds.


      If the initial loan amount did not exceed $2 million, the SBA announced that it would assume the loan was taken in good faith.

      [1].     Pub. Law No. 116-136 (CARES Act) Sec. 1110.

      [2].     Pub. Law No. 116-136 (CARES Act) Sec. 1102.

  • 8559. How are “payroll costs” defined for purposes of the payroll protection loan program?

    • Taxpayers with fewer than 500 employees are eligible for new “paycheck protection loans” administered via the Small Business Administration (see Q 8558). In general, the loans may be forgiven (and amounts excluded from income for tax purposes) if used to cover payroll costs.  PPP loan forgiveness is determined based on how the small business client spent the loan proceeds.  Under the PPPFA, at least 60 percent of the loan must be used for payroll costs (this 60 percent threshold was reduced from 75 percent under the CARES Act).

      Under the CARES Act and subsequent administrative guidance, payroll costs have been defined to INCLUDE the sum of:

      1. payments of any compensation with respect to employees that is:

      a. salary, wage, commission, or similar compensation;

      b. payment of cash tip or equivalent;

      c. payment for vacation, parental, family, medical, or sick leave;

      d. allowances for dismissal or separation;

      e. payment required for the provisions of group health care benefits, including insurance premiums;

      f. payment of any retirement benefit; or

      g. payment of state or local tax assessed on the compensation of employees;

      AND

      1. the sum of payments of any compensation to or income of a sole proprietor or independent contractor that is a wage, commission, income, net earnings from self-employment, or similar compensation that is not more than $100,000 in one year, as prorated for the covered period.

      Payroll costs EXCLUDE:

      1. compensation of an individual employee over $100,000 per year, as prorated for the covered period;
      2. taxes imposed or withheld under chapters 21, 22, or 24 of the IRC during the loan forgiveness period;
      3. any compensation of an employee whose principal place of residence is outside of the U.S.;
      4. qualified sick leave wages for which a credit is allowed under the FFCRA; and
      5. qualified family leave wages for which a credit is allowed under the FFCRA.

      Wages credited under the employee retention credit program are also excluded from loan forgiveness.

  • 8560. What are the tax consequences of loan forgiveness under the paycheck protection loan program?

    • Editor’s Note: The IRS released a safe harbor for taxpayers who did not deduct otherwise deductible expenses paid or incurred during the tax year ending after March 26, 2020, and on or before December 31, 2020 (the 2020 tax year) that resulted in, or were expected to result in, loan forgiveness. Under the safe harbor, these taxpayers may deduct the expenses on the taxpayer’s original federal income tax return or information return for the first tax year following the 2020 tax year rather than filing an amended return or administrative adjustment request for the taxpayer’s 2020 tax year.[1]

      Under normal circumstances, when a loan or debt is forgiven, the income is included in the debtor’s income under cancellation of debt principles. Paycheck protection loans, however, are excluded from these generally applicable rules—meaning that amounts forgiven are not included in the recipient’s income when forgiven.

      Late in 2020, Congress clarified that business owners will be entitled to their typical business deductions even if the expenses are paid out of loan proceeds that are forgiven.[2] This contrasts earlier IRS guidance contained in Notice 2020-32, which provided that otherwise allowable deductions were to be disallowed if the payment of the expense (1) resulted in loan forgiveness under the PPP loan program and (2) the income associated with the loan forgiveness was excluded from income under CARES Act Section 1106(i).

      Expenses like salary, rent, mortgage interest and utilities are generally deductible as ordinary and necessary business expenses under IRC Section 162. These are also exactly the types of expenses can be incurred in order for a business to receive loan forgiveness under the CARES Act.


      Planning Point: The 2020 year-end stimulus package clarified that federal tax deductions will be available even if the business used PPP loan proceeds that were forgiven to cover the expenses.  However, the issue is far from settled at the state level.  While some states, like New York and Illinois, generally conform to federal laws on these issues, others do not.  For example, Kentucky and North Carolina have both announced that for state income tax purposes, business expense deductions will not be allowed if the expenses were paid for with forgiven PPP loan funds.  Small business clients should make sure to pay close attention to changing local laws on this subject when determining whether to seek loan forgiveness.


      Original IRS Safe Harbor Rules

      The IRS safe harbor rules for certain taxpayers whose application for forgiveness was denied or who opted to forgo applying for forgiveness are now less relevant, as business owners can take their typical business deductions regardless of whether the loan is forgiven.

      The safe harbors allow a taxpayer to claim a deduction in the 2020 tax year for certain otherwise deductible eligible expenses.  The deduction may be allowed if (1) the eligible expenses are paid or incurred during the taxpayer’s 2020 tax year, (2) the taxpayer receives a PPP loan, which at the end of the 2020 tax year the taxpayer expects to be forgiven in a subsequent tax year, and (3) in a subsequent tax year, the taxpayer’s request for forgiveness of the covered loan is denied, in whole or in part, or the taxpayer decides never to request forgiveness of the covered loan.   Taxpayers may elect to use one of two safe harbors, depending upon their situation.

      Safe Harbor 1: Eligible taxpayers may deduct non-deducted eligible expenses on the taxpayer’s timely filed, including extensions, original income tax return or information return for 2020, or amended return or AAR for 2020, as applicable.

      Safe Harbor 2: Eligible taxpayers may deduct non-deducted eligible expenses on the taxpayer’s timely filed, including extensions, original income tax return or information return, as applicable, for a subsequent tax year.  Taxpayers whose loan forgiveness was denied may, but do not need to, use this safe harbor to deduct non-deducted eligible expenses in a subsequent tax year because those taxpayers may deduct the non-deducted eligible expenses in the year that the loan forgiveness is denied under general tax principles, assuming that the taxpayer does not elect to deduct the expenses in 2020.

      Taxpayers relying on either safe harbor may not deduct an amount of non-deducted eligible expenses in excess of the principal amount of the taxpayer’s covered loan for which forgiveness was denied or will no longer be sought.

      The taxpayer must also attach a statement to the return on which the expenses are deducted.  The statement must be titled “Revenue Procedure 2020-51 Statement,” and must include: (1) The taxpayer’s name, address, and Social Security number or employer identification number; (2) A statement specifying whether the taxpayer is an eligible taxpayer under either safe harbor in Revenue Procedure 2020-51; (3) A statement that the taxpayer is applying section 4.01 or section 4.02 of Revenue Procedure 2020-51; (4) The amount and date of disbursement of the taxpayer’s covered loan; (5) The total amount of covered loan forgiveness that the taxpayer was denied or decided not to seek; (6) The date the taxpayer was denied or decided not to seek loan forgiveness; and (7) The total amount of eligible expenses and non-deducted eligible expenses that are reported on the return.[3]

      Note also that, under the CARES Act rules, taxpayers were entitled to take advantage of payroll tax deferral options under the CARES Act until the borrower received notice from the lender that the loan has been forgiven. After that notice has been received, employers can no longer defer payment of payroll tax deposits without penalty. The amounts already deferred will continue to be deferred and due by the otherwise applicable payment dates (i.e., 50 percent by December 31, 2021 and the remaining half by December 31, 2022).[4]

      [1]      Rev. Proc. 2021-20.

      [2]      Consolidated Appropriations Act of 2021.

      [3]      Rev. Proc. 2020-51.

      [4].     See https://www.irs.gov/newsroom/deferral-of-employment-tax-deposits-and-payments-through-december-31-2020.

  • 8561. What do small business clients need to know about obtaining loan forgiveness under the paycheck protection program?

    • PPP loan forgiveness is determined based on how the small business client spent the loan proceeds. Importantly, at least 60 percent of the loan must be used for payroll costs (note that this 60 percent threshold was reduced from 75 percent under the CARES Act by the Paycheck Protection Program Flexibility Act (PPPFA), passed in early June 2020).

      The small business administration (SBA) has also released a form version of the loan forgiveness application, but that form was released before enactment of the PPPFA. Every PPP lender can use its own version of the SBA form application. At the most basic level, after the small business owner completes the application for loan forgiveness, the lender has 60 days to decide whether the borrower qualifies. The SBA then has an additional 90 days to providing funding for the lender.

      Importantly, the original SBA loan forgiveness application mentions the original eight-week period, which has now been extended. Presumably, the application will be updated to reflect this change.


      Planning Point: There is a potentially important divergence between the SBA loan forgiveness application and the actual terms of the PPPFA. While the SBA loan forgiveness application indicates that 75 percent of the “forgiveness amount” had to be used for payroll costs, the terms of the new law, which was released after the application, says that 60 percent of the “loan amount” must be used for payroll costs. This difference can be significant for small business clients who only anticipated requesting forgiveness for part of the loan. (However, there are rumors that the IRS will release business-favorable guidance to clear up the divergence.)


      The loan application also now requires employers to certify whether they received loans in excess of $2 million (also considering loans by affiliates). (Generally, if the loan amount was $2 million or less, the government will presume that it was made in good faith—i.e., that the borrower did not have a viable alternate liquidity source). The provisions in the Consolidated Appropriations Act of 2021 imposed a firm $2 million cap on the amount of any PPP loan.


      Planning Point: In a surprise move, the SBA has begun asking PPP lenders to issue loan necessity questionnaires to recipients of loans of at least $2 million.  The questionnaires are detailed and request significant information, and were issued without warning.  It’s expected that these information requests might be used in enforcement of PPP loan requirements or in determining eligibility for forgiveness.  According to the SBA, the forms will be used to evaluate whether a recipient’s loan was made necessary by economic uncertainty.  Information provided in the forms must be certified under threat of criminal action for false statements.  The questions essentially ask borrowers to certify actual detrimental economic impact.  Borrowers will also have to provide information about local Covid-19 shutdown orders, other CARES Act aid, financial information and compensation to highly compensated owners and employees.  Upon receipt, the borrower has only 10 days to complete the questionnaire and submit supporting documents.


      Employers must certify that loan amounts were used to cover eligible expenses and that the borrower has accurately confirmed payments made for both payroll costs and non-payroll costs.

      The application itself contains a worksheet to help small business clients calculate their loan forgiveness amount, as well as any reductions that may be necessary because the employer reduced its workforce or employee salaries. The document also provides a cure provision for employers who impermissibly reduced workforce (and may wish to bring employees back to work) or salary levels. The employer must provide documentation to show the payroll costs it paid out during the relevant period—whether in the form of bank records or reports from a third-party payroll service. IRS payroll tax filing forms (i.e., Form 941) and state quarterly wage reporting forms, as well as payment receipts, cancelled checks or other account statements showing contributions to employee retirement accounts or healthcare are also necessary.

      Importantly, employers will be required to document the number of full-time employees employed between February 15, 2019 and June 30, 2019, when compared to the same period in 2020. Two methods are available for counting FTEs: employers can elect to (1) assign “1” for every employee working at least 40 hours per week and “0.5” for all other employees, or (2) divide the average number of hours worked weekly by each employee by 40, rounding up to the nearest tenth (up to a maximum of “1” per employee).


      Planning Point: Determining eligibility for loan forgiveness is much more complex than expected.  In response, the SBA released a streamlined application (Form 3508S) that can be used by business owners who borrowed $50,000 or less.  Borrowers of small loans will no longer be required to reduce their loan forgiveness value if they reduced the salary or wages of an employee earning less than $100,000 during the covered period.  Similarly, these borrowers will not be required to reduce the amount forgiven if they reduced their number of full-time equivalent employees during the covered period.

      Small loan recipients are still required to calculate the amount of their forgiveness and retain applicable documentation–remembering that the SBA may ask to see supporting documents even if they are not required to be submitted with the application.


      For employers that used funds to pay costs such as rent or mortgage interest, copies of lender amortization schedules, account statements and/or lease agreements must be submitted with the application.


      Planning Point: All documentation that would support the small business owner’s loan forgiveness should be maintained for at least six years after the date the loan was forgiven (or repaid).


       

       

       

  • 8562. How does a nonrefundable tax credit work and what are some examples?

    • Editor’s Note: Many of the credits listed below contain sunset provisions so that they apply only so long as Congress chooses to renew them from year to year. Recently, Congress has extended various credits through the Protecting Americans from Tax Hikes Act of 2015 (PATH) the Bipartisan Budget Act of 2018 (BBA 2018) and the Tax Certainty and Disaster Relief Act of 2020.  See below for more details. As of the date of this revision and with respect to provisions that were not made permanent, Congress has not indicated whether it will extend this treatment for future years.

      A nonrefundable credit is a credit that is limited by the amount of the taxpayer’s tax liability for the year. A taxpayer is only entitled to claim nonrefundable tax credits to the extent that the combined amount of the credits does not exceed total income tax liability for the tax year. So unlike refundable credits (Q 8552), a nonrefundable credit can never result in a refund or credit.

      However, because certain nonrefundable credits in excess of a taxpayer’s tax liability for a tax year may be carried forward into future tax years (and others cannot be carried over), it is important to consider the order in which a taxpayer claims the nonrefundable credits.1

      The following tax credits are classified as nonrefundable credits:

      …Personal credits which consist of the child and dependent care credit;2 the credit for the elderly and the permanently and totally disabled,3 the qualified adoption credit,4 the nonrefundable portion of the child tax credit,5 the American Opportunity (the increased limits were made permanent by PATH), Hope Scholarship, and Lifetime Learning credits,6 the credit for elective deferrals and IRA contributions (the “saver’s credit,” which became permanent under PPA 2006);7

      …The nonbusiness energy property credit (extended through 2021)8; and the residential energy efficient property credit;9

      …Other nonbusiness credits;10

      …The general business credit is the sum of the following credits determined for the taxable year:

      (1) the investment credit determined under IRC Section 46 (including the rehabilitation credit);

      (2) the work opportunity credit determined under IRC Section 51(a) (extended through 2025);


      Planning Point: The work opportunity tax credit (WOTC) can provide a valuable tax benefit for business owners who hire certain workers through the end of 2025.  Businesses can claim the WOTC for hiring workers classified into one of ten groups.  One of those groups includes individuals who have been unemployed for at least 27 consecutive weeks and have received state or federal unemployment benefits for at least a portion of that period. The employer must submit Form 8850 to their state workforce agency (not to the IRS) within 28 days after the employee begins work.  The employer claims the credit on their federal income tax return, based on wages paid during the first year of employment.  The credit is calculated on Form 5884 and claimed on Form 3800, General Business Credit.  Because of the pandemic and widespread unemployment relief, many additional small business clients may qualify for this credit in 2021 and 2022.


      (3) the alcohol fuels credit determined under IRC Section 40(a);

      (4) the research credit determined under IRC Section 41(a) (made permanent by PATH);

      (5) the low-income housing credit determined under IRC Section 42(a);

      (6) the enhanced oil recovery credit under IRC Section 43(a);

      (7) in the case of an eligible small business, the disabled access credit determined under IRC Section 44(a);

      (8) the renewable electricity production credit under IRC Section 45(a) (extended only through 2009 under EIEA 2008);

      (9) the empowerment zone employment credit determined under IRC Section 1396(a) (extended through 2025);

      (10) the Native American employment credit as determined under IRC Section 45A(a) (extended through 2021);

      (11) the employer Social Security credit determined under IRC Section 45B(a);

      (12) the orphan drug credit determined under IRC Section 45C(a);

      (13) the new markets tax credit determined under IRC Section 45D(a) (extended through 2025);

      (14) in the case of an eligible employer (as defined in IRC Section 45E(c)); the small employer pension plan startup cost credit determined under IRC Section 45E(a);

      (15) the employer-provided child care credit determined under IRC Section 45F(a);

      (16) the railroad track maintenance credit determined under IRC Section 45G(a) (made permanent by the 2021 CAA, although the credit was reduced from 50 percent to 40 percent);

      (17) the biodiesel fuels credit determined under IRC Section 40A(a) (extended through 2022);

      (18) the low sulfur diesel fuel production credit determined under IRC Section 45H(a);

      (19) the marginal oil and gas well production credit determined under IRC Section 45I(a);

      (20) for tax years beginning after September 20, 2005, the distilled spirits credit determined under IRC Section 5011(a);

      (21) for tax year beginning after August 8, 2005, the advanced nuclear power facility production credit determined under IRC Section 45J(a);

      (22) for property placed in service after December 31, 2005, the nonconventional source production credit determined under IRC Section 45K(a);

      (23) the energy efficient home credit determined under IRC Section 45L(a) (extended through 2021);

      (24) the energy efficient appliance credit determined under IRC Section 45M(a) (extended through 2014);

      (25) the portion of the alternative motor vehicle credit to which IRC Section 30B(g)(1) applies; and

      (26) the portion of the alternative fuel vehicle refueling property credit to which IRC Section 30C(d)(1) applies (extended through 2021).11

      (27) for eligible employers, the paid family and medical leave credit determined under IRC Section 45S (created by the 2017 tax reform legislation and extended through 2025).

      A credit was also available for new qualified plug-in electric drive motor vehicles acquired and placed in service after 2009. The amount of the credit can vary from $2,500 to $7,500 depending on battery capacity (and subject to phase-out based on number of vehicles sold by the manufacturer). The portion of the credit attributable to property of a character subject to an allowance for depreciation is treated as part of the general business credit. The balance of the credit is generally treated as a nonrefundable personal credit.12 An alternative credit is available for certain plug-in electric cars placed in service after February 17, 2009 and before 2022. This credit is equal to 10 percent of cost, up to $2,500.13


      1 .See, for example, IRC Secs. 23 (adoption expense credit), 25 (mortgage interest credit) and 25D (residential energy efficient property credit) for examples of nonrefundable credits that may be carried over to succeeding tax years.

      2 .IRC Sec. 21.

      3 .IRC Sec. 22.

      4 .IRC Sec. 23.

      5 .See IRC Sec. 24.

      6 .IRC Sec. 25A, as amended by ATRA, Sec. 103 and PATH, Sec. 102.

      7 .IRC Sec. 25B.

      8 .IRC Sec. 25C, as amended by ATRA, Sec. 401 and PATH, Sec. 181.

      9 .IRC Sec. 25D.

      10 .See e.g., IRC Secs. 53, 901.

      11 .IRC Sec. 38(b).

      12 .IRC Sec. 30D, as amended by ARRA 2009.

      13 .IRC Sec. 30, as amended by ARRA 2009 ATRA and the Tax Certainty and Disaster Relief Act of 2020.

  • 8563. What tax credit is available for small business retirement plan start-up costs?

    • Editor’s Note: The SECURE Act expanded the retirement plan start-up credit for small businesses who are eligible. The credit available under IRC Section 45E, is available for up to three tax years and, was increased to the greater of (a) $500 or (b) the lesser of (i) $250 per employee of the eligible employer who is not a highly-compensated employee and who is eligible to participate in the eligible employer plan maintained by the employer or (ii) $5,000.

      Eligible small employers (under IRC Section 408(p)(2)(C)(1)) who provide an auto-enrollment feature are eligible for an additional $500 per year credit (for the first three years the auto-enrollment feature is offered).


      Planning Point: The credit for auto-enrollment can be claimed even if a new auto-enrollment feature is added to an existing plan.


      A tax credit for qualified retirement plan start-up costs is available to small business owners. A small business employer is eligible if, during the preceding tax year, it employed 100 or fewer employees who received at least $5,000 in annual compensation from the employer (the same definition that generally applies for SIMPLE retirement plans).1 The plan must be available to at least one employee who is a non-highly compensated employee (a highly compensated employee is one who owns 5 percent of the business or who has earned more than $130,000 in 2020 and 2021).2

      Importantly, the small business employer is only eligible for the credit if its employees were not able to participate in another retirement plan sponsored by the employer, a member of a controlled group or a predecessor of either within three years of establishing the new plan (essentially, this requirement ensures that the plan truly is a newly-established retirement plan).3


      Planning Point: The credit is also available to small business employers who participate in a multiple-employer plan (MEP) and add an auto-enrollment feature.


      The credit is equal to 50 percent of the ordinary and necessary costs of starting up the retirement plan, including both the costs of setting up and administering the plan and costs related to educating employees about the plan, up to a maximum credit of $500 per year.4 The credit is available for three years, with the option of first claiming the credit in the year before the year in which the plan becomes effective.5

      If the entire value of the plan cannot be maximized in a single year, the small business employer has the option of carrying it back or forward to another tax year, so long as that tax year does not begin prior to January 1, 2002. To claim the credit, the taxpayer must file Form 8881 with the IRS.6


      1 .IRS Pub. 560 (2019).

      2 .IRC Sec. 45E(d)(1), IR-2014-99 (Oct. 23, 2014), Notice 2018-83, Notice 2020-45.

      3 .IRC Sec. 45E(c).

      4 .IRC Secs. 38, 45E (a), 45E(b).

      5 .IRC Sec. 45E(b).

      6 .IRS Pub. 560 (2019).

  • 8564. When does a taxpayer qualify for the tax credit for the elderly and the permanently and totally disabled and how is the credit computed?

    • The tax credit for the elderly and the permanently and totally disabled is a nonrefundable credit, meaning that it is available only to the extent that it does not exceed the taxpayer’s tax liability (see Q 8562). The credit is available to (1) taxpayers age sixty-five or older, or (2) those who are under age sixty-five, retired on disability, and were considered permanently and totally disabled when they retired.1

      “An individual is permanently and totally disabled if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than twelve months. An individual shall not be considered to be permanently and totally disabled unless he furnishes proof of the existence thereof in such form and manner, and at such times, as the Secretary may require.”2

      The credit equals 15 percent of an individual’s IRC Section 22 amount for the taxable year, but may not exceed the amount of tax. This IRC Section 22 base amount is $5,000 for a single taxpayer or married taxpayers filing jointly if only one spouse qualifies for the credit; $7,500 for married taxpayers filing jointly if both qualify; and $3,750 for a married taxpayer filing separately.3 Married taxpayers must file a joint return to claim the credit, unless they lived apart for the entire taxable year.4

      For individuals under age sixty-five, this base figure is limited to the amount of the disability income (taxable amount an individual receives under an employer plan as wages or payments in lieu of wages for the period the individual is absent from work on account of permanent and total disability) received during the taxable year.5 (The taxpayer may be required to provide proof of continuing permanent and total disability.)6 For married taxpayers who are both qualified and who file jointly, the base figure cannot exceed the total of both spouses’ disability income if both are under age sixty-five. If only one spouse is under age sixty-five, the base figure cannot exceed the sum of $5,000 plus the disability income of the spouse who is under sixty-five.7

      The base figure (or the amount of disability income in the case of individuals under age sixty-five, if lower) is reduced dollar-for-dollar by one-half of adjusted gross income in excess of $7,500 (single taxpayers), $10,000 (joint return), or $5,000 (married filing separately).8 A reduction is also made for Social Security and railroad retirement benefits that are excluded from gross income, and certain other tax-exempt income.9


      1 .IRC Sec. 22(b).

      2 .IRC Sec. 22(e)(3).

      3 .IRC Sec. 22(c).

      4 .IRC Sec. 22(e)(1).

      5 .IRC Sec. 22(c)(2)(B)(i).

      6 .GCM 39269 (8-2-84).

      7 .IRC Sec. 22(c)(2)(B)(ii).

      8 .IRC Sec. 22(d).

      9 .IRC Sec. 22(c)(3).

  • 8565. When is a taxpayer entitled to claim the child tax credit?

    • Editor’s Note: The ARPA expanded and enhanced the child tax credit for the 2021 tax year.  For tax years beginning after December 31, 2021 and before January 1, 2022, the child tax credit amount increased from $2,000 to $3,000 per qualifying child.  The credit amount is also fully refundable for the 2021 tax year only (under TCJA, $1,400 was refundable, see below).  The $3,000 amount is also further increased to $3,600 per qualifying child under the age of six years old as of December 31, 2021.  17-year-olds will be treated as qualifying children in 2021.

      The income phaseout ranges for the enhanced tax credit have also been reduced.  The phaseout will now begin at $150,000 for married taxpayers filing jointly and $75,000 for single filers (down from $400,000 and $200,000 for the standard child tax credit).  Additionally, the IRS will pay 50% of the 2021 child tax credit in the second half of 2021, using 2020 tax data (although the amounts may be subject to clawback in cases where the taxpayer does not qualify using 2021 tax information).

      Eligible taxpayers are not required to take any action to receive the advance payments on the 15th of every month.  Monthly payments will total up to $300 for each child under age six and up to $250 per month for each child aged six and older.  Depending upon the information the IRS has on file, payments will be made via direct deposit, paper checks or debit cards.  The advance payments will total up to 50% of the amount the taxpayer is eligible to receive based on 2020 filing information.  According to new IRS guidance, taxpayers who were not otherwise required to file tax returns for 2020 can file simplified 2020 returns to receive monthly advance payments of the expanded child tax credit.  Those taxpayers can file Form 1040, Form 1040-SR or Form 1040-NR to provide Social Security numbers, addresses and other information.  Those taxpayers must write “Rev. Proc. 2021-24” on the forms.  Taxpayers who had $0 in adjusted gross income (AGI) can report $1 in AGI in order to file electronically and qualify for advance payments.[1]

       The 2017 Tax Act eliminated the personal exemption (and the dependency exemption) and expanded the previously available child tax credit. Under the Act, the child tax credit is increased to $2,000 (from $1,000) per child under age seventeen; $1,400 of this per-child credit is refundable. The taxpayer must include the Social Security number for each child for which the refundable portion of the child tax credit is claimed.[2] The $1,400 refundable amount will be indexed for inflation and rounded to the next multiple of $100 (the amount for 2020 remained at $1,400, but see Editor’s Note, above).[3]

      A new family tax credit was created to allow for a $500 nonrefundable credit for dependent parents and other non-child dependents (the requirement for furnishing a Social Security number does not apply to this family tax credit).[4]

      The child tax credit is generally a tax credit that is available for each “qualifying child” (defined below) of eligible taxpayers who meet certain income requirements. The child tax credit may be refundable to the extent that the taxpayer has three or more qualifying children or for a certain portion of the taxpayer’s earned income (see below). The child tax credit is now $2,000 ($1,000 prior to 2018) per child.[5]

      The term qualifying child means a “qualifying child” of the taxpayer (as defined under IRC Section 152(c) – see below) who has not attained the age of seventeen;[6] and

      (1) who is the taxpayer’s “child” (see below) or a descendant of such a child, or the taxpayer’s brother, sister, stepbrother, or stepsister or a descendant of any such relative;

      (2) who has the same principal place of abode as the taxpayer for more than one-half of the taxable year; and

      (3) who has not provided over one-half of his or her own support for the calendar year in which the taxpayer’s taxable year begins.[7]

      Additionally, a qualifying child must be either a citizen or a resident of the United States.[8]

      The term “child” means an individual who is: (1) a son, daughter, stepson, or stepdaughter of the taxpayer; or (2) an “eligible foster child” of the taxpayer.[9] An “eligible foster child” means an individual who is placed with the taxpayer by an authorized placement agency or by judgment decree, or other order of any court of competent jurisdiction.[10] Any adopted children of the taxpayer are treated the same as natural born children.[11]

      The amount of the credit is reduced for taxpayers whose modified adjusted gross income (MAGI) exceeds certain levels. A taxpayer’s MAGI is adjusted gross income without regard to the exclusions for income derived from certain foreign sources or sources within United States possessions. The credit amount is reduced by $50 for every $1,000, or fraction thereof, by which the taxpayer’s MAGI exceeds the following threshold amounts pre-reform: $110,000 for married taxpayers filing jointly, $75,000 for unmarried individuals, and $55,000 for married taxpayers filing separately.[12] For 2018-2025, the threshold amounts increase to $400,000 (joint returns) or $200,000 (all other filers). The phase out amounts are not indexed for inflation.[13]

      The child tax credit is also refundable (only a portion of the expanded credit is refundable). Prior to the 2017 tax reform, if the child tax credit exceeded the taxpayer’s tax liability, a taxpayer with one or two children could receive a refund of the lesser of the unused amount of the credit or 15 percent of earned income in excess of $3,000.[14] For families with three or more qualifying children, the amount of the refundable credit is the greater of (1) 15 percent of earned income over $3,000 or (2) the sum of Social Security and Medicare taxes paid minus the earned income credit. For 2018-2025, $1,400 of the credit is refundable (only the refundable portion is indexed for inflation under the 2017 Tax Act).

      The nonrefundable child tax credit can be claimed against the individual’s regular income tax and alternative minimum tax (see Q 8561 and Q 8563). The tax credit cannot exceed the excess of (i) the sum of the taxpayer’s regular tax plus the alternative minimum tax over (ii) the sum of the taxpayer’s nonrefundable personal credits (other than the child tax credit, adoption credit, and saver’s credit) and the foreign tax credit for the taxable year.[15] Finally, the refundable child tax credit is not required to be reduced by the amount of the taxpayer’s alternative minimum tax.[16]

      Some additional restrictions applying to the child tax credit include: (1) an individual’s tax return must identify the name and taxpayer identification number (Social Security number) of the child for whom the credit is claimed; and (2) the credit may be claimed only for a full taxable year, unless the taxable year is cut short by the death of the taxpayer.[17]

      For purposes of applying a uniform method of determining when a child attains a specific age, the IRS has ruled that a child attains a given age on the anniversary of the date that the child was born (e.g., a child born on January 1, 1987, attains the age of seventeen on January 1, 2004).[18]

       

      [1]      Rev. Proc. 2021-24.

      [2].     IRC Sec. 24(h)(7).

      [3].     IRC Sec. 24(h), Rev. Proc. 2018-57.

      [4].     IRC Sec. 24(h)(4).

      [5].     IRC Sec. 24(a).

      [6].     IRC Sec. 24(c)(1).

      [7].     IRC Sec. 152(c).

      [8].     IRC Sec. 24(c)(2).

      [9].     IRC Sec. 152(f)(1).

      [10].  IRC Sec. 152(f)(1)(C).

      [11].  IRC Sec. 152(f)(1)(B).

      [12].  IRC Sec. 24(b)(2).

      [13].    IRC Sec. 24(h)(3).

      [14].    IRC Sec. 24(d). The $3,000 earned income threshold was made permanent by the Protecting Americans from Tax Hikes Act of 2015 (PATH).

      [15].    IRC Sec. 24(b)(3).

      [16].    IRC Sec. 24(d)(1).

      [17].    IRC Secs. 24(e), 24(f).

      [18].    Rev. Rul. 2003-72, 2003-2 CB 346.