Individual And Small Business Credits

March 13, 2024

8563 / How does a nonrefundable tax credit work and what are some examples?

<div class="Section1">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.<div class="Section1"> 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 <a href="javascript:void(0)" class="accordion-cross-reference" id="8553">8553</a>), 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.<a href="#_ftn1" name="_ftnref1">1</a> The following tax credits are classified as nonrefundable credits: …Personal credits which consist of the child and dependent care credit;<a href="#_ftn2" name="_ftnref2">2</a> the credit for the elderly and the permanently and totally disabled,<a href="#_ftn3" name="_ftnref3">3</a> the qualified adoption credit,<a href="#_ftn4" name="_ftnref4">4</a> the nonrefundable portion of the child tax credit,<a href="#_ftn5" name="_ftnref5">5</a> the American Opportunity (the increased limits were made permanent by PATH), Hope Scholarship, and Lifetime Learning credits,<a href="#_ftn6" name="_ftnref6">6</a> the credit for elective deferrals and IRA contributions (the “saver’s credit,” which became permanent under PPA 2006);<a href="#_ftn7" name="_ftnref7">7</a> …The nonbusiness energy property credit (renamed the Energy Efficient Home Improvement Credit and extended through 2032)<a href="#_ftn8" name="_ftnref8">8</a>; and the residential energy efficient property credit (renamed the Residential Clean Energy Credit and extended through 2034);<a href="#_ftn9" name="_ftnref9">9</a> …Other nonbusiness credits;<a href="#_ftn10" name="_ftnref10">10</a> …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); <hr> Planning Point: The work opportunity tax credit 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. Employers are required to satisfy a pre-screening requirement to claim the credit. The pre-screening requirement is satisfied when the employer and the job applicant complete Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit, on or before the day a job offer is made.<a href="#_ftn11" name="_ftnref11">11</a> The employer also 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. <hr> (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 Indian 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 2024 under the Inflation Reduction Act of 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 2032); (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; (26)  the portion of the alternative fuel vehicle refueling property credit to which IRC Section 30C(d)(1) applies (extended through 2032);<a href="#_ftn12" name="_ftnref12">12</a> (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.<a href="#_ftn13" name="_ftnref13">13</a> 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.<a href="#_ftn14" name="_ftnref14">14</a> This tax credit has been extended through 2032 and expanded by the Inflation Reduction Act (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="767">767</a> for details). </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  See, e.g., IRC §§ 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. <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 21. <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 22. <a href="#_ftnref4" name="_ftn4">4</a>.  IRC § 23. <a href="#_ftnref5" name="_ftn5">5</a>.  IRC § 24. <a href="#_ftnref6" name="_ftn6">6</a>.  IRC § 25A, as amended by ATRA, § 103 and PATH, § 102. <a href="#_ftnref7" name="_ftn7">7</a>.  IRC § 25B. <a href="#_ftnref8" name="_ftn8">8</a>.  IRC § 25C. <a href="#_ftnref9" name="_ftn9">9</a>.  IRC § 25D. <a href="#_ftnref10" name="_ftn10">10</a>.  See, e.g., IRC §§ 53, 901. <a href="#_ftnref11" name="_ftn11">11</a>.    See IR-2022-159 for updated guidance on claiming the WOTC. <a href="#_ftnref12" name="_ftn12">12</a>.  IRC § 38(b). <a href="#_ftnref13" name="_ftn13">13</a>.  IRC § 30D, as amended by ARRA 2009. <a href="#_ftnref14" name="_ftn14">14</a>.  IRC § 30, as amended by ARRA 2009, ATRA and the Tax Certainty and Disaster Relief Act of 2020. </div></div>

March 13, 2024

8565 / When does a taxpayer qualify for the tax credit for the elderly and the permanently and totally disabled and how is the credit computed?

<div class="Section1">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 <a href="javascript:void(0)" class="accordion-cross-reference" id="8563">8563</a>). The credit is available to (1) taxpayers age 65 or older, or (2) those who are under age 65, retired on disability, and were considered permanently and totally disabled when they retired.<a href="#_ftn1" name="_ftnref1">1</a><div class="Section1"> <blockquote>“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 12 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.”<a href="#_ftn2" name="_ftnref2">2</a></blockquote> 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.<a href="#_ftn3" name="_ftnref3">3</a> Married taxpayers must file a joint return to claim the credit, unless they lived apart for the entire taxable year.<a href="#_ftn4" name="_ftnref4">4</a> For individuals under age 65, 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.<a href="#_ftn5" name="_ftnref5">5</a> (The taxpayer may be required to provide proof of continuing permanent and total disability.)<a href="#_ftn6" name="_ftnref6">6</a> 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 65. If only one spouse is under age 65, the base figure cannot exceed the sum of $5,000 plus the disability income of the spouse who is under 65.<a href="#_ftn7" name="_ftnref7">7</a> The base figure (or the amount of disability income in the case of individuals under age 65, 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).<a href="#_ftn8" name="_ftnref8">8</a> A reduction is also made for Social Security and railroad retirement benefits that are excluded from gross income, and certain other tax-exempt income.<a href="#_ftn9" name="_ftnref9">9</a> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 22(b). <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 22(e)(3). <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 22(c). <a href="#_ftnref4" name="_ftn4">4</a>.  IRC § 22(e)(1). <a href="#_ftnref5" name="_ftn5">5</a>.  IRC § 22(c)(2)(B)(i). <a href="#_ftnref6" name="_ftn6">6</a>.  GCM 39269 (8-2-84). <a href="#_ftnref7" name="_ftn7">7</a>.  IRC § 22(c)(2)(B)(ii). <a href="#_ftnref8" name="_ftn8">8</a>.  IRC § 22(d). <a href="#_ftnref9" name="_ftn9">9</a>.  IRC § 22(c)(3). </div></div>

March 13, 2024

8564 / What tax credit is available for small business retirement plan start-up costs?

<div class="Section1">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, available for three tax years, is 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.</div> <div class="Section1"> Eligible small employers (under IRC Section 408(p)(2)(C)(1)) who provide an eligible auto-enrollment feature are eligible for an additional $500 per year credit (for the first three years the auto-enrollment feature is offered). <hr /> Planning Point: The credit for auto-enrollment can be claimed even if a new auto-enrollment feature is added to an existing plan. <hr /> 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).<a href="#_ftn1" name="_ftnref1">1</a> 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 $160,000 in 2025).<a href="#_ftn2" name="_ftnref2">2</a> 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).<a href="#_ftn3" name="_ftnref3">3</a> 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.<a href="#_ftn4" name="_ftnref4">4</a> 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.<a href="#_ftn5" name="_ftnref5">5</a> Beginning in 2023, the 50 percent limit was increased to 100 percent under the SECURE Act 2.0 for small employers with 50 or fewer employees. The law also creates an additional tax credit for a percentage of the employer’s contributions made to employees with compensation that does not exceed $100,000 for the year. The additional credit cannot exceed $1,000 per employee and will phase out over a five-year period. The additional credit also phases out for employers with between 51 and 100 employees, and the credit is reduced by 2 percent for each employee that exceeds the 50-employee limit in the prior year. Employers who join an existing multiple employer plan (MEP) will also now be eligible to receive the tax credit for small employers even if the MEP has been in existence for several years (this provision is effective retroactively, for 2020 and all later tax years). 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.<a href="#_ftn6" name="_ftnref6">6</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRS Pub. 560 (2019). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 45E(d)(1), IR-2014-99 (Oct. 23, 2014), Notice 2024-80. <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 45E(c). <a href="#_ftnref4" name="_ftn4">4</a>. IRC §§ 38, 45E (a), 45E(b). <a href="#_ftnref5" name="_ftn5">5</a>. IRC § 45E(b). <a href="#_ftnref6" name="_ftn6">6</a>. IRS Pub. 560 (2019). </div>

March 13, 2024

8567 / When is a taxpayer entitled to claim the child and dependent care tax credit?

<div class="Section1">The child and dependent care tax credit provides a tax credit to offset the cost of qualifying work-related dependent care expenses (a dependent who is a child must be under age 13 to qualify). Those expenses can include the cost of physically caring for the dependent—and also include household expenses, such as hiring someone to help with cooking and cleaning for a dependent, as long as the expenses are primarily for the benefit of the dependent. The IRS noted that summer day camp expenses can also qualify, but expenses related to overnight camp cannot be used to figure the credit.</div> <div class="Section1"> For 2024, the maximum eligible work-related childcare expense used to figure the credit is $3,000 for one qualifying child and $6,000 for two or more children. The taxpayer multiplies the amount of childcare expenses incurred by a percentage. The percentage varies depending on the taxpayer’s income. Depending on their income levels, taxpayers can receive a credit worth up to 35% of their qualifying childcare expenses. Once the taxpayer’s income equals or exceeds $43,000, 20% of the expenses qualify. The maximum amount of the credit cannot be more than the taxpayer's earned income for the year, or the smaller of the taxpayer or their spouse's earned income if the taxpayer is married. To claim the credit, the taxpayer must complete and attach Form 2441 to Form 1040, 1040-SR, or 1040-NR. The credit is entered on Schedule 3 (Form 1040), line 2. The credit is typically nonrefundable. The taxpayer claiming the credit must subtract employer-provided dependent care benefits, including those provided through a flexible spending account, from total work-related expenses when calculating the credit. The more a taxpayer earns, the lower the percentage of work-related expenses that are taken into account in determining the credit. Taxpayers must provide a valid taxpayer identification number (TIN) for each qualifying person. Usually, this is the qualifying person’s Social Security number. Taxpayers without a Social Security number must obtain an individual taxpayer identification number. Editor’s Note: For 2021 only, the dependent care tax credit was fully refundable under the American Rescue Plan Act (ARPA). The maximum credit percentage was increased from 35 percent to 50 percent of qualifying dependent care expenses (the credit phases down to 20 percent for taxpayers with income between $125,000 and $183,000). The level of qualifying dependent care expenses also increased for 2021—from $3,000 to $8,000 for a single qualifying dependent and from $6,000 to $16,000 for two or more qualifying dependents. The IRS released FAQ to help taxpayers understand the expanded child and dependent care tax credit in 2021. As always, to claim the credit, taxpayers were required to have earnings. The FAQ was clear that the amount of qualifying work-related expenses claimed could not exceed the taxpayer’s earnings. However, the credit was fully refundable for the first time in 2021 (the refundable nature of the credit was not extended beyond 2021). That allowed an eligible taxpayer to receive the credit even if they owed no federal income tax. To be eligible for the refundable credit In 2021, a taxpayer (or the taxpayer’s spouse on a joint return) had to reside in the United States for more than half of the year. </div>

June 16, 2020

8562 / What do small business clients need to know about obtaining loan forgiveness under the paycheck protection program?

<div class="Section1">PPP loan forgiveness was 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 (reduced from 75 percent under the CARES Act by the Paycheck Protection Program Flexibility Act (PPPFA), passed in early June 2020).</div> <div class="Section1"> Early on, the small business administration (SBA) released a form version of the loan forgiveness application. Every PPP lender could use its own version of the SBA form application. Generally, after the business owner completed the application for loan forgiveness, the lender had 60 days to decide whether the borrower qualified. The SBA then had an additional 90 days to provide funding for the lender. The loan application also required 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 presumed 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. <hr /> Planning Point: In a surprise move, the SBA began asking PPP lenders to issue loan necessity questionnaires to recipients of loans of at least $2 million. The questionnaires were detailed and request significant information. They were also issued without warning. It is expected that these information requests may 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 asked borrowers to certify actual detrimental economic impact. Borrowers also had 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 had only 10 days to complete the questionnaire and submit supporting documents. <hr /> Employers were required to 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 contained a worksheet to help small business clients calculate their loan forgiveness amount, as well as any reductions necessary because the employer reduced its workforce or employee salaries. The document provided a cure provision for employers who impermissibly reduced workforce (and may have brought employees back to work) or salary levels. The employer provided 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 were also necessary. Importantly, employers were 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 were 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 10th (up to a maximum of “1” per employee). <hr /> Planning Point: Determining eligibility for loan forgiveness was much more complex than expected. In response, the SBA released a streamlined application (Form 3508S) for business owners who borrowed $150,000 or less (previously, the threshold was set at $50,000). Borrowers of small loans were no longer 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 were not required to reduce the amount forgiven if they reduced their number of full-time equivalent employees during the covered period. Small loan recipients were 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. <hr /> 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. Borrowers that qualified to use Form 3508S were required to complete a one-page certification that contains basic information about the loan and use of the proceeds, including: <blockquote>the number of employees retained because of the loan, the amount of the loan, an estimate of how much of the loan was used for payroll costs, documentation to prove the business experienced the required revenue loss, if not already provided to the lender.</blockquote> Borrowers who were not eligible for the short form application were required to carefully document how the funds were spent. This documentation could include tax forms, bank statements, receipts, purchase orders, cancelled checks and other written documentation. <hr /> Planning Point: All documentation to support the small business owner’s loan forgiveness eligibility should be maintained for at least six years after the date the loan was forgiven (or repaid). <hr /> </div>

May 12, 2020

8561 / What are the tax consequences of loan forgiveness under the paycheck protection loan program?

<div class="Section1">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 could 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 AAR for the 2020 tax year.<a href="#_ftn1" name="_ftnref1">1</a></div> <div class="Section1"> 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, were excluded from these generally applicable rules—meaning that amounts forgiven were not included in the recipient’s income when forgiven. Late in 2020, Congress clarified that business owners were entitled to their typical business deductions even if the expenses were paid out of loan proceeds that were forgiven.<a href="#_ftn2" name="_ftnref2">2</a> This overrides 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 were also exactly the types of expenses could be incurred in order for a business to receive loan forgiveness under the CARES Act. <hr /> Planning Point: The 2020 year-end stimulus package clarified that federal tax deductions were be available even if the business used PPP loan proceeds that were forgiven to cover the expenses. However, state tax issues may still arise. 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 both announced that for state income tax purposes, business expense deductions were not 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. <hr /> 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 could take their typical business deductions regardless of whether the loan is forgiven. The safe harbors allowed a taxpayer to claim a deduction in the 2020 tax year for certain otherwise deductible eligible expenses. The deduction was allowed if (1) the eligible expenses were paid or incurred during the taxpayer’s 2020 tax year, (2) the taxpayer received a PPP loan, which at the end of the 2020 tax year the taxpayer expected 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 was denied, in whole or in part, or the taxpayer decided not to request forgiveness of the covered loan. Taxpayers could elect to use one of two safe harbors, depending upon their situation. Safe Harbor 1: Eligible taxpayers could 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 could 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 could, but were not required, to use this safe harbor to deduct non-deducted eligible expenses in a subsequent tax year because those taxpayers could deduct the non-deducted eligible expenses in the year that the loan forgiveness was denied under general tax principles, assuming that the taxpayer did not elect to deduct the expenses in 2020. Taxpayers relying on either safe harbor could 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 was not sought. The taxpayer was required to attach a statement to the return on which the expenses are deducted. The statement was titled “Revenue Procedure 2020-51 Statement,” and included: (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 were reported on the return.<a href="#_ftn3" name="_ftnref3">3</a> 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 was received, employers could no longer defer payment of payroll tax deposits without penalty. The amounts already deferred continued to be deferred and due by the otherwise applicable payment dates (i.e., 50 percent by December 31, 2021 and the 50 percent by December 31, 2022).<a href="#_ftn4" name="_ftnref4">4</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. Rev. Proc. 2021-20. <a href="#_ftnref2" name="_ftn2">2</a>. Consolidated Appropriations Act of 2021. <a href="#_ftnref3" name="_ftn3">3</a>. Rev. Proc. 2020-51. <a href="#_ftnref4" name="_ftn4">4</a>. See https://www.irs.gov/newsroom/deferral-of-employment-tax-deposits-and-payments-through-december-31-2020. </div>

April 20, 2020

8559 / What are the paycheck protection loans and economic injury disaster loans for small business owners?

<div class="Section1">The CARES Act provided 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 presumed under the law. Small businesses taking out loan assistance were required to provide documentation in order to obtain loan forgiveness under the payroll protection program. Two primary types of loans were available under the law: (1) expanded Economic Injury Disaster Loans (EIDLs) and (2) Paycheck Protection Loans.<div class="Section1"> EIDLs<a href="#_ftn1" name="_ftnref1">1</a> were available through the Small Business Administration (SBA), and, even pre-COVID-19, contained favorable terms such as 30-year repayment periods, 3.75 percent interest rates and deferral of the first month’s payments. The relief made it easier to qualify if the business existed as of January 31, 2020. The SBA could grant the loan based on the business’ credit score without a tax return and regardless of past bankruptcies—and the average annual receipts tests did not apply. For loans of less than $200,000, no personal guarantee or real estate collateral was required. Paycheck protection loans (PPP loans)<a href="#_ftn2" name="_ftnref2">2</a> were available to employers with fewer than 500 employees that were in operation before February 15, 2020. These loans maxed 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 was made. Loan terms for amounts not forgiven included: interest rates of up to 4 percent, 10-year repayment terms, payment deferrals for six to 12 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 24 weeks from the date the lender made the first loan payment to the small business owner. <hr> Planning Point: Under the Consolidated Appropriations Act of 2021, all borrowers can choose the length of their own covered period. Borrowers were entitled to choose a covered period that is as short as eight weeks or as long as 24 weeks. The clock started to run on the date the second draw loan proceeds were disbursed. <hr> Compensation that exceeded $100,000 per employee, as pro-rated for the period, was excluded from the definition of payroll costs. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>. Loan forgiveness did 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 was pro-rated, not entirely eliminated, for employers who reduced staffing). Reducing compensation for employees earning under $100,000 by more than 25 percent could also reduce the amount forgiven. The PPPFA gave employers until December 31, 2020 to bring workers back to work/restore wage levels to continue to qualify for loan forgiveness (extended from an earlier June 30, 2020 deadline). PPPFA also created a new exemption for employers who were legitimately unable to restore employment numbers to pre-COVID levels. The exemption was designed to reflect the reality that some employees may not be available or willing to return to work. Employers were not subject to a proportionate reduction in loan forgiveness based on reductions that occurred 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 did not jeopardize loan forgiveness if the employer could document (1) an inability to rehire employees who were employees as of February 15, 2020 and (2) was unable to hire similarly qualified replacement employees. To preserve their right to loan forgiveness, employers should maintain written documents that show (1) an 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 was also required to inform the state unemployment agency of the offer and rejection within 30 days after the rejection is received. Reductions in loan forgiveness were also disregarded if the employer could not 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 Loans Congress authorized a round of “second draw” PPP loans for certain businesses who had already spent their loan proceeds by December 31, 2021. <hr> Planning Point: Business owners could apply for a second draw loan even if they had not fully spent their initial loan proceeds. However, second round loans were not disbursed until all first draw funds were exhausted. <hr> Second draw PPP loans were available through March 31, 2021. To qualify, the business must: <blockquote>have 300 or fewer employees, not be permanently closed (temporarily closed businesses could apply), demonstrate at least a 25 percent reduction in gross receipts when comparing the same quarter in 2019 to 2020 (see below), have used all of their initial PPP loan proceeds.</blockquote> Second draw PPP loans were available for up to 2.5 times average monthly payroll costs for the year prior to the loan. Restaurants and other hospitality businesses could qualify to borrow up to 3.5 times their average monthly payroll costs. However, PPP loans were capped at $2 million regardless of the business’ payroll costs. The $2 million cap applied to both initial loans and second draw loans. The SBA rules defined “gross receipts” broadly, to include all revenue from any sources, including sales, interest, dividends, rent, royalties, etc. The SBA also clarified that amounts that were forgiven for the business’ initial PPP loan were 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 allowed the business to determine whether it experienced a 25 percent reduction by comparing annual receipts in 2020 to 2019. Business owners who elected to use this method were 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 could be used to cover payroll costs and operating expenses. They could also be used to pay for personal protective equipment and modifications to the business 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 could 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 could be used to cover supplier costs, which included 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 qualified. <hr> Planning Point: Some business owners were eligible for larger loan amounts under the rules released in 2021. The SBA allowed 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 had not yet accepted the loan proceeds. Those requests were made electronically to the SBA no later than March 31, 2021. <hr> Planning Point: From the inception of the program, there was controversy over whether certain businesses were entitled to the loans. In FAQ, Treasury 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 economic conditions and uncertainty made the loan necessary to support ongoing operations (second draw borrowers were 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 could 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. <hr> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  Pub. Law No. 116-136 (CARES Act) § 1110. <a href="#_ftnref2" name="_ftn2">2</a>.  Pub. Law No. 116-136 (CARES Act) § 1102. </div></div>

April 07, 2020

8556 / What do employers need to know about claiming the CARES Act employee retention tax credit? Are there any reporting requirements?

<div class="Section1">Editor’s Note: The ERTC expired after the third quarter of 2021.</div> <div class="Section1"> Employers were entitled to reduce their quarterly payroll tax deposits (i.e., amounts withheld from employee pay) by the amount of the credit. In other words, the credit was available in advance, rather than during tax filing season. Employers reported 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 were not sufficient to cover the amount of the credit via withholding from the usual deposits, the employer could file Form 7200, Advance Payment of Employer Credits Due to COVID-19.<a href="#_ftn1" name="_ftnref1">1</a> 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).<a href="#_ftn2" name="_ftnref2">2</a> Most employers report employment tax liability quarterly on Form 941, which is where the refundable credits were reported. </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. Available at https://www.irs.gov/forms-pubs/about-form-7200. <a href="#_ftnref2" name="_ftn2">2</a>. Treas. Reg. § 31.6302-1(c). </div>

April 07, 2020

8557 / 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?

<div class="Section1">The IRS 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 were equal to or less than the amount of refundable tax credits to which the employer was entitled under the CARES Act and the FFCRA.<div class="Section1"> For purposes of the credits, employment taxes include Social Security taxes, Medicare taxes and federal income tax withholding under Section 3402. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> on the FFCRA paid leave requirements. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> for more information on the employee retention tax credit.<a href="#_ftn1" name="_ftnref1">1</a> Employers eligible for the credit were not subject to a penalty under IRC Section 6656 for failing to deposit employment taxes on qualified retention wages in a calendar quarter if: <blockquote>(1)  The employer paid qualified retention wages to its employees in the quarter prior to the time of the required deposit, (2)  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 expenses, and the employer’s share of Medicare tax on the wages, was less than or equal to the amount of the employer’s anticipated credits under the CARES Act for the quarter at the time of the required deposit, and (3)  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.</blockquote> In other words, after a reduction of a deposit by the amount of credits anticipated for qualified leave wages, an employer could 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 did not also seek an advance credit with regard to the same amount. The total amount of any reduction in any required deposit could 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.<a href="#_ftn2" name="_ftnref2">2</a> <hr> Planning Point: Proposed and temporary IRS regulations make it clear that employers were 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 exceeded the amount the employer was allowed is an erroneous refund for which the IRS will seek repayment.<a href="#_ftn3" name="_ftnref3">3</a> <hr> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  Notice 2020-22. <a href="#_ftnref2" name="_ftn2">2</a>.  Notice 2020-22. <a href="#_ftnref3" name="_ftn3">3</a>.  Prop. Treas. Reg. §§ 31.3111-6, 31.3221-5. </div></div>

April 07, 2020

8554 / What refundable tax credit is available to employers who provide paid sick leave and FMLA leave under the Families First Coronavirus Response Act?

<div class="Section1">Editor’s Note: The FFCRA paid leave credits discussed below expired on December 31, 2020. The rules discussed below applied for the 2020 tax year only.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 <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>). 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 10 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 <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> 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 <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> for information on the employee retention tax credit allowed under the CARES Act. </div>