A number of tax law changes were enacted in 2020 to enable
individuals and businesses to get through the pandemic. These included changes
made by the CARES Act and the Consolidated Appropriations Act, 2021. Many of
the changes were temporary, which means that individuals and businesses now
must use old tax rules or revised rules in figuring taxes for 2021. Here is a
rundown of some changes for 2021 income tax returns that result from
COVID-19-related laws. Because many of the rules triggered by the pandemic were
temporary, the IRS only provided informal guidance on these rules via notices
and FAQs.
Individual taxpayers
Individuals adjusting to life during the pandemic may have
received various benefits from the government or their employers, or relief
from other sources. Be sure to note changes in rules from 2020 to 2021 and the
actions that should be taken.
Figuring economic impact payments. Early in 2021,
EIP3, the third round of economic impact payments, were made to individuals
based on information the IRS had from 2020 returns, or 2019 returns if the 2020
returns were not yet filed. Individuals who received less than the amount to
which they were entitled (e.g., their income in 2020 was higher than in 2021;
they had a new dependent in early 2021), can figure a recovery rebate credit
using 2021 information (2021 adjusted gross income and number of dependents)
and obtain a tax refund. If, due to these changes, individuals received a
higher EIP3 than they would have been entitled to, there is no repayment
required.
Repaying qualified coronavirus distributions. In
2020, individuals were permitted to take qualified coronavirus distributions up
to $100,000 in 2020 from qualified retirement plans and IRAs. There is a
three-year window to recontribute the funds to the account. The income
resulting from the distribution was spread over three years until the person
opted to report it all in 2020. If there is a repayment in 2021 of some or all
of the distribution that was taken last year, an amended return needs to be
filed for 2020 to claim a refund of taxes paid on the distribution last year.
Taking required minimum distributions. Required
minimum distributions (RMDs) were suspended for 2020. The suspension does not
apply to 2021, so RMDs for 2021 must be taken in accordance with the usual
rules. Individuals born after June 30, 1949, have a new starting age of 72
(instead of 70½); those born after this date and before Jan. 1, 2022, have
their first RMD in 2021. Employees who are not more than 5% owners may defer
RMDs until they retire (this rule does not apply to IRAs). Beneficiaries who
inherited accounts from decedents dying after 2019 are subject to a new 10-year
rule that prevents them from spreading out distributions over their life
expectancy. However, the 10-year rule does not apply to eligible designated
beneficiaries (e.g., spouses, minor children, beneficiaries more than 10 years
younger than the account owner) from spreading distributions over their life
expectancy based on an IRS table. Note: New life expectancy tables, which were
announced at the end of 2020, are used to figure RMDs staring in 2022; they do
not apply to 2021 RMDs.
Excluding cancellation of home mortgage debt. The
exclusion from income for cancellation of home mortgage debt, which had been
set to expire at the end of 2020, was extended through 2025. However, the limit
on the exclusion is reduced to $750,000 for 2021 through 2025 (down from $2
million); one half the limit applies to married persons filing separately.
Reporting unemployment benefits. For 2020, up to
$10,200 in unemployment benefits were excludable from gross income. For 2021,
there is no exclusion; all unemployment benefits are included in income. Those
who received an automatic refund from the IRS because they didn’t claim the
exclusion on a 2020 return should review that return to determine whether an
amended return should be filed. Lowering adjusted gross income due to the
exclusion may entitle an individual to claim other tax brackets not factored
into the automatic refund.
COVID-19-related payments. Some payments were new for
2021, while others were a continuation 2020 payments.
Paid sick leave and paid family leave. Payments made from
Jan. 1, 2021, through Sept. 30, 2021, to eligible employees—those with certain
COVID-19-related issues—are treated as taxable compensation. Eligible
self-employed individuals may claim a tax credit that essentially equates to
these payments (see the instructions to IRS Form 7202).
COBRA premium assistance. If employers were subject to
COBRA, then involuntarily terminated employees as well as those with reduced
hours received COBRA premium assistance from employers from April 1, 2021,
through Sept. 30, 2021. These payments are not includible in gross income.
Personal tax credits. A number of a tax credits have
been dramatically changed for 2021. These include the child tax credit (one
half of which was payable in advance via monthly amounts in July through
December 2021), the child and dependent care credit (fully refundable in 2021),
the earned income tax credit, and the premium tax credit.
Business taxpayers
During the pandemic, some businesses shut down, some
struggled to survive, and some prospered. A number of tax rules in 2021 for
businesses are different from those in 2020.
Government grants and other payments. Generally,
cancellation of debt and grants are includible in gross income. However, the
law says forgiveness of Paycheck Protection Program (PPP) loans, as well as grants
under the Shuttered Venue Operators Program and grants under the Restaurant
Revitalization program, are not taxable. However, they are still treated as
gross receipts, even though tax free (Rev. Procs. 2021-48, 2021-49, and
2021-50). This means they count toward the gross receipts test used for various
purposes (e.g., the gross receipts test for determining whether a business is
“small”, as explained later, and eligible to use the cash method of
accounting).
Net operating losses. Net operating losses incurred
in 2020 were subject to a five-year carryback and an unlimited carryover; they
could be used to offset up to 100% of taxable income. In 2021, the NOL rules
created by the Tax Cuts and Jobs Act take effect. This means no carrybacks
(other than a two-year carryback for farming businesses). There is an unlimited
carryforward, but it can only be used to offset up to 80% of taxable income.
Excess business loss limitation. This rule bars
noncorporate taxpayers (i.e., owners of pass-through entities) from taking a
write-off of business losses. These are net business losses plus a threshold
amount depending on the owner’s filing status (Code §461(l)). This limitation
was suspended for 2018, 2019, and 2020. It applies for 2021 and the threshold
amounts have been adjusted for inflation. Note: The limitation had been set to
run only through 2025, but has been extended by the American Recovery Plan Act
of 2021 through 2026.
Interest expense limitation. A deduction for business
interest is limited to the sum of its business income, a percentage of adjusted
taxable income (ATI), and floor plan financing interest (Code §163(j)). For
2019 and 2020, the percentage of ATI was 50%, but for 2021, it is 30%. Small
businesses (for 2021 these are businesses meeting a gross receipts test of
having average annual gross receipts in the three prior years not exceeding $26
million), as well as electing farming businesses and real property businesses,
are exempt from this limitation.
Business meals. In 2020, a deduction for business
meals was limited to 50% of cost. For 2021 and 2022, the deduction is 100% for
business meals provided at restaurants. The term “restaurants” is defined in
Notice 2021-25. The 100% limit may also be used to substantiate the cost of
business meals under a per diem allowance (Notice 2021-63).
Qualified business income (QBI) deduction. The basic
rules for the QBI deduction for owners of pass-through entities have not changed
from 2020 to 2021 (Code §199A). However, there are two important points to
note: First, the taxable income thresholds at which the deduction may be
reduced or eliminated have been adjusted for inflation in 2021. Second, if 2020
was a loss year, that loss adversely impacts the amount of the QBI deduction
for 2021.
Conclusion
The Build Back Better Act would make some changes in a few
of the rules discussed above, such as extension of the child tax credit advance
payments. These changes likely would apply to 2022 and would not impact 2021
returns. But you never know
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