American Rescue Plan Act of 2021: Impact on Taxpayers and Key Issues to Understand

BROOKS NELSON: Welcome to the Tax Beat by Cherry Bekaert podcast. Today's discussion centers on the tax provisions of the American Rescue Plan Act (ARPA).

BROOKS NELSON: First, let's introduce my colleagues who will be joining me today. Sarah?

SARAH MCGREGOR: Hi. I'm Sarah McGregor. I'm a tax director in Federal Tax Services. I sit in Greenville, South Carolina, where it is a beautiful, sunny day and 70 degrees.

MARTY KMAN: This is Marty Kman. I'm a principal in our Strategic Tax Advisory practice and I am based out of our Tysons office. I'm actually working out of Brooklyn, New York today, and the weather is excellent.

KATHY STANTON: Hi. I'm Kathy Stanton. I lead the State and Local Tax practice for the firm and I am sitting in the Washington, D.C., area. It's about 64 degrees and sunny, which is a welcome change.

BROOKS NELSON: I'm Brooks Nelson. I am sitting in downtown Richmond, Virginia. It's been a beautiful, sunny spring day and it's about 65 degrees here as well.

BROOKS NELSON: Before we dive into ARPA, I thought we'd talk about the other big related news item that came out last Thursday. The IRS extended the individual income tax return filing and payment due date from April 15 to May 17. This is directly, or at least indirectly, related to ARPA.

BROOKS NELSON: Sarah, why is this related to ARPA and why do you think the IRS took this action?

SARAH MCGREGOR: The IRS was getting a lot of pressure from trade associations like the AICPA, from small businesses, and from Congressional representatives asking them to move the due date and give taxpayers more time. It's related to ARPA in one respect because ARPA included a provision affecting 2020 returns that allows a portion of unemployment benefits received in 2020 to be exempt from taxation. A number of returns have already been filed that need correction.

SARAH MCGREGOR: This extension also allows individuals to take advantage of that exemption and exclude that income from their returns. There were many CPAs, particularly smaller firms that may not have the same technology as larger firms, who were asking for relief as well.

BROOKS NELSON: What did this extension specifically cover and not cover?

SARAH MCGREGOR: It did not cover the broad spectrum of tax returns due on April 15. It was a narrow postponement for individual 2020 tax returns. Individuals who had returns due on April 15 can now file and pay those returns by May 17 and postpone their final 2020 tax payments until May 17.

SARAH MCGREGOR: It did not extend first-quarter estimated tax payments for 2021, which remain due on April 15. That creates a conundrum for tax professionals who must prepare 2020 returns to determine first-quarter estimated payments for 2021. It also did not extend business returns, trust returns, or estimated tax payments for those taxpayers. It was a very narrow extension.

MARTY KMAN: I would expect the IRS may provide additional expansion of the postponement to other areas, including possibly individual estimated tax payments, but we'll have to see. It's certainly added confusion to an already chaotic situation.

BROOKS NELSON: How will extensions work for our 1040 clients?

SARAH MCGREGOR: Taxpayers can file extensions electronically or by paper, though the IRS has limited ability to process paper returns timely. Electronic filing is important.

KATHY STANTON: From a state perspective, many states are issuing guidance to extend state return filing as well, because you often need your federal return to complete your state return. As of this morning, about 27 states had issued guidance allowing an extension to May 17.

BROOKS NELSON: What are you telling your clients about the April 15 to May 17 filing? Should they wait?

BROOKS NELSON: There's a lot of concern that if you wait until May 17 to file and you have a first-quarter estimated payment due on April 15, you could be late and subject to penalties. If you expect a refund, you should file now to get your cash. The best advice is to prepare and file as soon as possible. If you don't owe money until May 17, you can file now and pay on May 17.

BROOKS NELSON: Now let's flip to the main topic: the American Rescue Plan Act (ARPA). President Biden signed it into law on March 11. ARPA is the latest in a series of legislation related to COVID economic relief and stimulus packages. Today we'll focus on the tax provisions.

BROOKS NELSON: Sarah, let's start with the main tax provisions of ARPA affecting individuals.

SARAH MCGREGOR: We can't talk about ARPA without discussing the next round of stimulus payments—recovery rebate payments, also called Economic Impact Payments. This round provides $1,400 per taxpayer. For a couple filing jointly, it could be up to $2,800, plus $1,400 for each dependent.

SARAH MCGREGOR: This round differs from the first two 2020 payments in how it defines a dependent. Pretty much anyone you can claim as a dependent on your return is eligible, including non-child dependents such as elderly parents or adult children in college.

SARAH MCGREGOR: The phase-out range has narrowed. The payments are based on either your most recently filed tax return, which could be 2019 or 2020. For some taxpayers, if their 2020 income is above the phase-out threshold but 2019 is not, they may prefer to rely on 2019 until they receive the stimulus payment.

BROOKS NELSON: If you receive more than you were entitled to, do you have to pay it back?

SARAH MCGREGOR: No. There is no repayment or clawback provision for amounts paid that you are not ultimately entitled to when you file your 2021 return.

SARAH MCGREGOR: ARPA also extended an additional $300 per week in unemployment benefits through September 1, and it excludes up to $10,200 of unemployment compensation received in 2020 from taxable income for most taxpayers with adjusted gross income below $150,000. The IRS said it will recalculate returns already filed where taxpayers did not take this exemption and will send refund checks, so filing an amended return is not immediately necessary.

SARAH MCGREGOR: ARPA expanded the child tax credit for 2021 only, increasing it from $2,000 per child to $3,000 per child and up to $3,600 for children under age six. It also expanded eligibility to include 17-year-olds.

SARAH MCGREGOR: The legislation directs the IRS to pay out half of the anticipated 2021 child tax credit beginning July 1, with the remainder paid by December 31. For example, a family with three children eligible for $9,000 of child tax credit would be eligible to receive half—$4,500—distributed from July 1 to December 31.

SARAH MCGREGOR: The IRS is directed to create an online portal to allow taxpayers to add a child or update eligibility information for advance payments of the child tax credit.

SARAH MCGREGOR: ARPA also expanded and made fully refundable the child and dependent care tax credit, and it created a premium assistance period for COBRA coverage. From April 1 through September 30, eligible individuals do not have to pay COBRA premiums, and employers can recover the cost through a payroll tax refund mechanism administered by the IRS.

BROOKS NELSON: Is that all for individuals?

SARAH MCGREGOR: That's the primary individual tax relief applicable now. There are a few future items we can discuss later. It's fortunate we have tax software given the complex rules and calculations involved.

BROOKS NELSON: Now let's switch to business implications under ARPA.

MARTY KMAN: For COBRA coverage, employers who previously collected premiums from former employees will see those premiums cease for the subsidy period. The IRS has provided a mechanism using payroll taxes to refund employers for the cost of that coverage. This is a six-month event to provide health coverage to former employees and funding to employers via an employment tax refund.

MARTY KMAN: ARPA provided additional funding for the Restaurant Revitalization Fund and other industry-specific relief. For tax purposes, these grants are treated like PPP loan forgiveness: the income is tax-exempt, and expenses paid with those grants remain deductible if they would otherwise be deductible.

MARTY KMAN: ARPA also included a few other provisions affecting defined benefit pension plans, interest calculations, and timing of certain liabilities, and it included other targeted relief measures. We'll cover those as needed.

BROOKS NELSON: Marty, you mentioned employment taxes as a mechanism to put money back into companies’ pockets. Tell us about the Employee Retention Credit (ERC) and ARPA.

MARTY KMAN: The ERC is a refundable payroll tax credit for companies harmed by COVID. Originally created under the CARES Act in 2020, it provided a 50% credit on qualified wages for eligible employers. Smaller employers—100 or fewer full-time employees—could claim the credit on wages paid to all employees, while larger employers were limited to wages paid to employees not providing services.

MARTY KMAN: Changes allowed employers that took PPP to evaluate whether they could claim ERC as well. ARPA extended the ERC into 2021 with increased benefits—70% of qualified wages up to $10,000 per employee for the applicable quarters. ARPA extended the statute of limitations for ERC assessments from three to five years and created separate regimes for recovery startup businesses and for severely financially distressed employers.

MARTY KMAN: ARPA extended the ERC into quarters three and four of 2021 under similar rules, and many companies are seriously evaluating eligibility.

BROOKS NELSON: How does ERC stack with PPP and other relief programs?

MARTY KMAN: Technically, wages are allocated to ERC first unless you elect otherwise by claiming PPP. Practically, PPP often provides more benefit because it can cover 100% of certain expenses, whereas ERC is a percentage credit. Use PPP where it makes sense, particularly to cover non-wage expenses, which can then allow other wages to be ERC-eligible. You cannot double-dip on the same wages or expenses across programs.

MARTY KMAN: Other benefits such as the Families First Coronavirus Response Act paid leave credits and the Shuttered Venue Operators Grant can also be significant, but ERC is often the largest payroll tax refund available.

BROOKS NELSON: What are the implications of claiming ERC on income tax deductions and other credits?

MARTY KMAN: If a company claims ERC for 2020 or 2021, it must reduce its wage deduction for income tax purposes by the amount of the credit under Section 280C. That reduces the income tax benefit of the wages in the same taxable year. This interrelation between payroll tax returns and income tax returns is important for planning, especially when a company is in a loss position or is also claiming R&D credits.

MARTY KMAN: Also note that wages used to claim ERC generally cannot be used for the research credit or other credits that require the same wage base.

BROOKS NELSON: We have a lot of material on our website, cb.com, including a recent webinar with Marty that covers ERC in depth.

BROOKS NELSON: Kathy, talk about state implications. Federal legislation changing taxable income, credits, or deductions requires analysis at the state level.

KATHY STANTON: Each state can decouple from federal changes. Some states conform to the Internal Revenue Code on a rolling basis, others conform as of a fixed date. Many states start with federal adjusted gross income, so if an item is not included in AGI federally, it usually won't be taxable at the state level. For example, stimulus payments are exempt from federal tax and are likely exempt at the state level as well.

KATHY STANTON: With unemployment exclusion, most states will follow federal treatment, but you must check each state individually. For the ERC addback that Marty mentioned, states vary: about half will allow a deduction for expenses added back federally, and half will not. You must review state rules on a case-by-case basis.

KATHY STANTON: PPP forgiveness has been particularly troublesome for state conformity. Some states have adopted forgiveness, others have not, and guidance varies widely. For example, North Carolina requires an addback for expenses covered by PPP forgiveness, and Virginia limits deduction to $100,000 for certain taxes. Massachusetts treats PPP forgiveness income as taxable for individuals but not for businesses. There are many differences.

KATHY STANTON: Another significant ARPA provision is the $350 billion in relief funding to state and local governments. States can use the funds for COVID-related expenses and some infrastructure, but the funds cannot be used to offset tax reductions or to provide tax cuts. That "maintenance of effort" or non-supplanting condition has prompted legal challenges and requests for clarification. More guidance from Treasury is needed, and more than 20 states have sought clarification or relief from this limitation.

BROOKS NELSON: Final observation: be prepared for more change. ARPA is likely not the last round of COVID-related legislation. There is continued pressure on the IRS to expand filing deadline relief and to issue more guidance. Expect additional legislation and IRS guidance.

BROOKS NELSON: That concludes today's Tax Beat by Cherry Bekaert podcast. Check our firm's website at cb.com for more in-depth materials on these topics, especially the ERC.