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, also called ARPA.

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 our Federal Tax Services. I sit in Greenville, South Carolina, where it is a beautiful, sunshiny day and 70 degrees. You want to be here with me!

MARTY KARAMON: This is Marty Karamon. I am a Principal in our Strategic Tax Advisory practice, and I am based out of our Tysons office.

BROOKS NELSON: What's the weather, Marty?

MARTY KARAMON: The weather is excellent. I'm actually working out of Brooklyn, New York today, so it is beautiful up here in New York.

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

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

Before we dive into ARPA, I thought we would talk about the other big related news item that just 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 as well. Sarah, why is this related to ARPA, and why do you think the IRS took this action?

SARAH MCGREGOR: The IRS was certainly getting a lot of pressure from trade associations like the AICPA, small businesses, and Congressional representatives asking them to move this due date out to give folks more time.

It is related to ARPA in that there was a provision affecting 2020 returns allowing a portion of unemployment benefits that individuals received in 2020 to be exempt from taxation. A number of returns have already been filed that need correction, and this allows individuals to take advantage of this situation and exclude that income from their returns.

BROOKS NELSON: There were also a bunch of CPAs who were asking for some of this relief, particularly smaller CPAs who may not have some of the same technology that some of the larger firms have. Sarah, what did this extension specifically cover, and more importantly, what did it not cover?

SARAH MCGREGOR: It did not cover the broad spectrum of tax returns that are actually due on April 15. It really was limited to a very narrow postponement for individual tax returns for 2020.

Individuals who have tax returns due on April 15 will now be able to file those returns on May 17. They can also postpone their final 2020 tax payments that may be due until May 17.

One of the important areas for individuals that it did not address was their first quarter estimated tax payments that are due for 2021. Those payments are still due on April 15.

This sets up a real conundrum for a lot of us in the tax professional group. We have to go ahead and work on those 2020 returns for individuals so we can figure out how much the taxpayers should make for their first quarter estimated tax payment.

It also did not extend business returns, trust returns, or any estimated tax payments for those taxpayers. It was a very narrow extension. I would expect the IRS may wind up providing some additional expansion of that postponement to other areas, including individual estimated tax payments, but we will just have to see.

BROOKS NELSON: It certainly added a lot of confusion and chaos to a world that is already rather chaotic. Speaking of confusion, how are extensions going to work for our 1040 clients?

SARAH MCGREGOR: They will have an opportunity to file those extensions electronically or by paper. However, the IRS has not shown an ability to actually process a lot of paper returns in a timely manner, so filing by electronic means would be important.

Kathy, I know it is a big problem for state returns too with this last-minute change.

KATHY STANTON: You have to love it. I feel like it is déjà vu from last year when all the returns were extended.

From a state perspective, many states are coming out to extend the state return filing as well. If you don't have your federal return done, you can't do your state tax return. As of this morning, about 27 states had issued guidance that they will also allow an extension to May 17.

BROOKS NELSON: Sarah, what are you telling your clients about the April 15 or May 17 filing? Are you telling them they should wait?

SARAH MCGREGOR: No. As we already talked about, we have the first quarter estimate conundrum.

There is a lot of concern that if you wait until May 17 to make an extension and then you end up needing to pay in a first quarter, you are going to be late. As it stands now, those estimates would certainly be subject to penalties under the current guidance.

Beyond that, if you have a refund coming, you want to file now to take advantage of getting your cash back as soon as possible. You want that certainty and cash planning. There are all sorts of reasons that you want to go ahead and get it done now.

The best advice is to go ahead, prepare, and file as soon as possible. If you don't owe money until May 17, then take advantage and pay on May 17. That is perfectly acceptable under this guidance. File now and pay on May 17 when you have to.

BROOKS NELSON: Now let's flip over to the main topic of this podcast, the American Rescue Plan Act, or ARPA. President Biden signed that into law on March 11.

ARPA is the latest in a series of legislation related to COVID-19 economic relief and stimulus packages. Almost for sure, this will not be the last one and there will be more coming.

Today we're going to focus on ARPA and limit our discussion primarily to the tax provisions. ARPA contained all sorts of stimulus and other types of provisions which are not specific to tax, but this is a tax podcast, so we will try to center on that piece of it. Sarah, let's start and talk about some of the main tax provisions of ARPA affecting individual taxation.

SARAH MCGREGOR: We can't talk about ARPA without first talking about the next round of recovery rebate payments, economic impact payments, or stimulus payments.

This time around, it is $1,400 per taxpayer. For a couple filing together, it could be as much as $2,800, and then $1,400 for each dependent.

This round of payments is different than the first two that happened in 2020 regarding how it defines a dependent. Pretty much anyone you can claim as a dependent on your return is eligible for this $1,400 payment.

This includes both children and non-child dependents, such as parents, grown children in college, or those who wouldn't be in a traditional child role.

The other thing that is interesting on this set of recovery rebate payments is the phase-out range has narrowed. Originally, the first set of payments applied starting at $75,000 for individuals and $150,000 for joint filers, but it phases out very quickly.

When an individual reaches $80,000 of income, they are no longer eligible for the stimulus payment. For a married couple, when they reach $160,000, they have phased out.

The stimulus is based on either your most recently filed tax return, which could be 2019 or 2020. Brooks, another reason someone may not want to file their 2020 return right now is if that income for 2020 is well above this phase-out range but 2019 income isn't. They will want to stick with their 2019 return until they get their stimulus payment.

BROOKS NELSON: Is this one going to work the same way as the last rounds, where if you happen to get more than you otherwise would be entitled to, you still get to keep it?

SARAH MCGREGOR: That is correct. You will not have a payback or a clawback provision for anything that is paid to you that you are not entitled to when you file your 2021 return.

The final tallying happens when you file your actual 2021 return. If you don't collect it during this year, you may be eligible when you file.

Another important element we spoke to earlier has to do with unemployment compensation. ARPA did extend an additional $300 on top of the regular unemployment benefits that individuals receive until September 1.

A portion of those unemployment compensation benefits received in 2020 are going to be exempt from tax up to $10,200. This is going to apply to most taxpayers until they reach that $150,000 threshold. Beyond that, they will not be able to claim this exemption from their income.

The IRS said for those taxpayers who have already filed their 2020 returns and failed to take this exemption because it didn't exist at the time, the IRS will recalculate those returns. They are expected to send out refund checks to those individuals, so it is not necessary to file an amended return right away.

Two other areas that were pretty important are the increases to the Child Tax Credit and the Child and Dependent Care Credit.

The new change to the Child Tax Credit applies only to 2021. It expands the credit from $2,000 per child to $3,000 per child, and up to $3,600 for children under age six.

ARPA also expanded this credit to include 17-year-olds who have not been eligible for this credit in the past. This is going to follow along with some of President Biden's campaign proposals to help out families.

There is a two-step phase-out for that. There is one set of rules for the increase that is happening and then the original phase-out for the original portion.

The IRS is also directed to pay out half of the anticipated 2021 Child Tax Credit beginning July 1. For a family with three children who would be eligible for $9,000 of Child Tax Credit, they would be eligible to receive half of that, or $4,500, paid out to them over the period from July 1 to December 31 of this year.

This is another opportunity to put cash in the hands of individuals who need it to help with their families. The IRS is also directed to create an online portal to help figure out if you had a child in 2020 or 2021 so you could start getting payments now. If you had children leave home or pass age 18, this portal is supposed to help with that.

The last area that helps families with children is the Child and Dependent Care Expense credit. That also has been expanded, increased, and made fully refundable. We will see more of that as 2021 returns are filed.

The other element for individuals who are participating in their employer COBRA health coverage plan is for those who were terminated involuntarily or had a reduction in hours. ARPA puts in a premium holiday from April 1 until September 30. Individuals do not have to pay those premiums.

BROOKS NELSON: Is that about all for the individuals?

SARAH MCGREGOR: I think so. That's all that is applicable right now. There are a few things in the future which we can talk about later.

BROOKS NELSON: I think we're all fortunate to have tax software because there are a lot of tricky rules and calculations to be made with all that stuff. Let's switch over to the business side and talk about the implications from ARPA for business taxpayers.

SARAH MCGREGOR: Let's start with that COBRA coverage. For those businesses and employers that are having to still pay the insurance companies for those former employees, suddenly those premiums from the individuals are going to get cut off. They're not going to have that cash flow that they could then send on to their healthcare provider.

ARPA has provided a mechanism to use the payroll taxes as a way to refund to the employers the cost of that coverage that they are having to foot. This is just a special six-month event to provide health coverage to former employees and provide funding to employers using a refund mechanism through the employment tax system.

ARPA provided some additional funding for Restaurant Revitalization Grants and some other special industries. For our purposes, ARPA talked about how those are treated for tax purposes.

Basically, it's going to be like the PPP loan forgiveness program. The income is not going to be taxable and will be treated as tax-exempt income. All of the expenditures that have happened because of this, which would normally be a deduction if the income had been taxable, still get to be a deduction under ARPA.

BROOKS NELSON: We are very pleased they went ahead and clarified that up front this time around instead of waiting for all the confusion of coming back a couple of months later and finally telling us what to do.

SARAH MCGREGOR: They saved the confusion for other areas of this tax law, that's for sure.

There were a couple of other individual provisions that are sort of revenue raisers that dropped in, as well as some help to defined benefit pension plans by lowering some interest calculations and spreading out liabilities.

There were a few things that affect the future. When we get to a section to talk about future tax provisions, we will cover those.

Marty, we talked about employment taxes and how Congress keeps using that as a mechanism to put money back into companies' pockets through this payroll tax system. You're right in the middle of the Employee Retention Credit. What is going on there and what did ARPA do for your clients?

MARTY KARAMON: It did a lot. To answer that best, I'll just give a little historical context.

The Employee Retention Credit, or ERC, is a refundable payroll tax credit for companies that have been harmed by COVID-19 to the extent they had some significant decline in their gross receipts or some kind of partial shutdown as a result of government orders.

Originally, in the CARES Act, this was created as a 50% employment tax refund. It was 50% of every dollar you paid to your employees if you were an eligible employer.

To the extent you were a smaller company, meaning 100 or fewer full-time employees, you really did get that credit on every dollar you paid to your employees. If you were larger, you only got to include wages that you paid for actually retaining people who were not providing services.

The biggest issue for claimants of ERC was that if you took a PPP loan, you were not allowed to claim the ERC. Later in the year, the rule was changed such that if you claimed PPP, you were then allowed to take a look back and evaluate whether ERC was amenable for your business.

Additionally, the ERC was extended into 2021 at a 70% payroll tax refund for the first $10,000 you paid to any one of your employees if you're an eligible employer in Quarter 1 and Quarter 2. What ARPA did was extend this into Quarter 3 and Quarter 4 under the same rules that applied for Quarters 1 and 2.

To the extent you took advantage of the second round of PPP, you could still take this. But what it also did was extend the statute of limitations such that this could be open to IRS review for the next five years instead of three years.

It also set up two separate regimes. One is for recovery startup businesses that might not have the look-back history in order to qualify under the original rules. It also provided additional incentives for companies that were severely financially distressed. For the most part, the big benefit was the extension into Quarters 3 and 4 of 2021.

BROOKS NELSON: Marty, just one or two follow-up questions on this. Where does ERC fit in with these other CARES Act incentive programs like PPP? How does this integrate or stack up?

MARTY KARAMON: Technically speaking, if you could take advantage of PPP and ERC, the dollars that you pay to your employees default to being ERC eligible first, and you elect out of that by claiming PPP.

Practically speaking, take advantage of as much PPP as is possible for your business because PPP is 100% coverage as opposed to ERC, which is either 50 cents or 70 cents on the dollar per quarter.

To the extent you have the ability to have the PPP cover some non-wage expenses, that will allow additional expenses to be ERC eligible. If we think about the regime of incentives, PPP is probably the most beneficial.

This new Restaurant Revitalization Fund is also similarly very beneficial, and you can't double-dip on those with ERC. From just the payroll tax benefits that are out there, ERC is the most beneficial, followed second by what's known as the FFCRA.

BROOKS NELSON: That was the Families First Coronavirus Response Act. That was the very first of the bills that passed for paid medical leave and paid family leave, isn't it?

MARTY KARAMON: Yes. The other one would be the Shuttered Venue Operators Grant, which is very beneficial as well. But of the payroll tax refunds, ERC is definitely the larger of the two.

BROOKS NELSON: My other follow-up question concerns recent guidance. On the wages that we are using for ERC, what are the implications for your basic tax return deductions and income recognition?

MARTY KARAMON: What the ERC giveth, the income tax provisions take away a little bit, but not too extensively. To the extent a company claims ERC for 2020 or 2021, that company would similarly have to reduce its deduction for wages for income tax purposes in both of those years by the amount of the credit.

This is due to the operation of Section 280C. There are very similar rules if any of our listeners have ever claimed a research credit. Essentially, you're taking that ERC into income.

It's one of the few times I can remember where the payroll tax return and the income tax return have an offset against the other. That is very important for our clients to keep in mind as they think about what the net benefit is of taking advantage of ERC. They must keep in mind how much cash they need to have on hand for purposes of making their income tax payments. If you're in a loss position for income tax purposes, it's not going to affect you immediately.

BROOKS NELSON: I think the bottom line is there's a lot of planning to be done when you are in a scenario where you have PPP, ERC, and R&D, and you are also looking at the timing of the income tax deduction all at one time. There are lots of opportunities to take the ultimate advantage of the system.

MARTY KARAMON: You brought up one good last point. To the extent any of our clients are taking advantage of ERC, those dollars cannot also be claimed for the research credit.

BROOKS NELSON: Thank you. Good point. Before we move on, I want to mention that on our website, cbh.com, we have a tremendous amount of material on all this stuff. In particular, Marty has done a recent webinar for an in-depth deep dive on ERC.

Kathy, we have talked a lot about ARPA here. Talk to us about the states, because there are all sorts of implications for states coming in and out of ARPA.

KATHY STANTON: That's a great point, Brooks. Anytime you have any federal legislation that is changing taxable income, credits, or deductions, you really have to look at what the state impact of those changes is.

Each state has the ability to decouple from federal changes. Some states depend on where you start. If you're starting with Adjusted Gross Income (AGI) and they don't decouple from a change, then the state would adopt the change.

The states have conformity differences. Some states conform to the Internal Revenue Code on a rolling basis, so if there is a federal change, it automatically gets incorporated. Some are as of a fixed date. For example, Texas and California have dates that are very old fixed-date conformity, and then they adopt specific provisions of how they're going to follow that law.

Specifically with ARPA, you have the stimulus payments. The stimulus payments are exempt from federal tax and they are likely going to be exempt from state tax purposes as well. Most states start with AGI, so if that income is not in AGI, it is not going to be taxable for state purposes. It is similar for unemployment as well.

Generally, the states are not going to try to harm individuals for a benefit that has been given at the federal level. Specific to ARPA and the Employee Retention Credit, that add-back of deductions that Marty was talking about at the federal level is something many states will allow you to deduct.

It is probably about half and half whether you can deduct those for states where you had to add it back on the federal side. PPP forgiveness has also been troubling from the perspective of the states adopting forgiveness.

Conformity is very important to determine whether the PPP forgiveness income is going to be taxable or not in the state. I think most of the states are trying to provide forgiveness for that either through conformity or through a special provision.

Then on the expense side, the IRS has allowed us to take those expense deductions, but Virginia and North Carolina don't necessarily allow it. In North Carolina, you have to add back those expenses that were covered, and in Virginia, you are only allowed $100,000.

Massachusetts PPP forgiveness income is taxable to individuals but not taxable for businesses. You have all these differences with regard to the PPP forgiveness and expenses.

One other thing I wanted to mention with regard to ARPA that has really become the buzz in the state tax world is the additional funding to the states. There is up to $350 billion of relief to state and local governments.

The states are able to use that money for COVID-related expenses and some other infrastructure type expenses. However, it comes with a big catch. The catch is that the states may not use that money either directly or indirectly to offset a tax reduction or to provide a tax reduction for businesses and individuals.

What does that mean for states that already had legislation in effect where they were going to have a tax cut come into play? The federal government would view that as a way they are reducing taxes.

New York and California have been especially hit hard by COVID, so they are needing funding for sure. What about surrounding states that take all this funding and then provide huge incentives for businesses to locate in their state?

The federal government didn't want states to fund tax cuts; they really want it to be used for relief. It will be interesting to see what happens. We need Treasury regulations to provide more definition around that.

The state of Ohio has already sued and they want this provision removed. More than 20 states have signed on to a letter to Treasury Secretary Yellen saying that a lot more clarification is needed and this should not be used to limit them from providing tax relief.

BROOKS NELSON: Thank you, Kathy. A final wrap-up observation here is that all our listeners need to be prepared for more change.

Almost for sure, ARPA is not the last in the rounds of legislation related to COVID-19 relief. Regarding the deadline extension, there is continued pressure on the IRS to expand that to different types of entities and actions.

I think we can expect to see not only more legislation but more guidance from the IRS as well. That concludes today’s Tax Beat by Cherry Bekaert podcast. Thank you Sarah, Marty, and Kathy.

As a reminder, check out our firm's website at cbh.com for more in-depth materials on these topics and others, especially the ERC. Let's call it a day. Go forth and peace.