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.
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.
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.
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 …
Sidney Kess, CPA-attorney, is of counsel at Kostelanetz & Fink and senior consultant to Citrin Cooperman & Company.