In March of 2020, the U.S. federal government signed into law The Coronavirus Aid, Relief and Economic Security Act. We now refer to it as the CARES Act. This relief act provided $2 trillion (about $6,200 per person in the US) of stimulus to individuals, businesses, and government organizations. Many of these provisions will have some effect on how you prepare for your taxes next year. We will look at some of the frequently asked questions regarding the CARES Act and see how they might affect you.
EIP (Economic Impact Payment)
One of the most popular parts of the act was the Economic Impact Payment. This was an advanced refundable tax credit paid to eligible individuals based on their 2018 or 2019 tax return information. The total credit would be $1,200 ($2,400 in the case of a joint return) plus $500 for each qualifying child (under age 17) claimed on your tax return. Eligibility is based on your 2019 Adjusted Gross Income (AGI) and filing status. Those with higher AGI’s would see a phase-out or face ineligibility. The phase-out will reduce your payment by $5 for every $100 above the Phase-Out Threshold.
Single - $75,000 - $99,000
Head of Household - $112,500 - $146,500
Married Filing Joint - $150,000 - $198,000
If you did not receive a payment in 2020 and you are eligible to receive one, you will be able to take the credit when you file your 2020 individual tax return. This leaves an important responsibility for the taxpayer when filing their tax return, you will need to state how much of the credit you received. If you did not receive the full credit, that will be corrected on the 2020 tax return with a tax credit.
The advanced credit does not need to be included in income on your tax return, and if you received a credit that you were not eligible for there is no repayment. So be prepared when filing your return and have the amount of your payment ready.
Corona Virus Related Distributions
Section 2202 of the CARES Act addresses relief related to retirement plan distributions. An individual who meets one of the following requirements will be some special considerations to a distribution from their qualified retirement account (IRA, 401k, 403b and 457(b)):
The taxpayer is diagnosed with COVID-19 by a CDC approved test.
The spouse or dependent of the taxpayer is diagnosed with COVID-19 by a CDC approved test.
The Taxpayer or spouse who experiences adverse financial consequences because of:
Being quarantined, being furloughed, or laid off, or having work hours reduced due to COVID-19;
Being unable to work due to lack of childcare due to COVID-19; or
Closing or reducing hours of a business owned or operated by the individual due to COVID-19
The taxpayer experiences other factors announced by the IRS:
A reduction in pay (or self-employment income) due to COVID-19;
Having a job rescinded or start date delayed due to COVID-19.
The coronavirus related distribution is limited to $100,000 and receives three benefits:
10% Early Withdrawal Penalty for those under 59.5 is waived.
The taxpayer can elect to spread the distribution equally over tax years 2020, 2021, and 2022.
The taxpayer can repay the distribution back to a retirement account that accepts rollovers within 3 years.
The eligible taxpayer will be able to report this on their tax return regardless on how the financial institution reported the distribution. This may lead to major confusion for taxpayers that self-prepare their tax returns, as the codes and amounts listed on the tax form may default to applying penalties and a fully taxable event.
The distribution can be moved from a traditional IRA to a ROTH IRA through a ROTH conversion. The income will be spread over the 3 years as mentioned above.
Another key point of the coronavirus related distribution is that the distribution does not have to coincide with the qualifying event. The distribution timeframe is January 1, 2020, to December 31, 2020, you can apply the benefits to any distribution if you meet the qualifying test.
PPP (Paycheck Protection Program) Loans
The Paycheck Protection Program is a loan designed to give an incentive to small businesses to keep their workers on payroll during the government shutdowns. This was an extremely popular loan at the time and many businesses took advantage of it. One of the most attractive benefits of the program was that the loan would be forgivable if certain employee retention criteria were met and the funds were used for eligible expenses. The point of this article is not to discuss the criteria or what an eligible expense is but to prepare recipients for the tax consequences of a forgiven loan. PPP loan forgiveness is unique in that the amount can be also excluded from income.
The IRS has been issuing guidance as to the treatment of expenses paid with forgiven funds. Their position has been consistent, expenses paid with loan proceeds that are forgiven are not deductible. In early November, the IRS reinforced their stance by stating that if the taxpayer can expect the loan to be forgiven in a future year, expenses paid in the current year are not deductible.
Business owners that have received PPP loans and expect the loan to be forgiven should be looking heavily at their profit and loss statement. While having this loan forgiven is a huge benefit, this may increase your net profit and your income. Increased income can lead to higher tax brackets, loss of credits, and other limitations on your tax return. Make sure you have a planning session with your tax professional.