Tax Features of the American Rescue Plan Act of 2021
Today, the House of Representatives voted to accept the Senate’s revisions to the American Rescue Plan Act of 2021 (ARPA), thus sending the bill to President Biden for him to sign into law, which he has indicated that he will do on Friday, March 12. ARPA has a price tag of $1.9 trillion and was passed along party lines. In addition to its cornucopia of general relief and other spending provisions, including enhanced unemployment benefits, ARPA contains a number of tax provisions of potentially great significance to individuals and businesses. The purpose of this alert is to provide a high-level summary of some of these key tax-related changes. The 628-page text of the statute can be found here.
There are two important things to note before we proceed: First, one of the changes discussed below (added very late in the process by the Senate related to unemployment benefits) is retroactive to 2020, which could impact some previously-filed returns, requiring amended returns. Second, ARPA is federal legislation. Other than a few states whose own rules automatically incorporate federal law changes, we are once again tossed into a waiting game to see if, when, and how lawmakers in various states will adopt any of these changes.
Tax Changes Affecting Individuals
ARPA provides a third round of direct stimulus payments for taxpayers, following the payments under the CARES Act ($1,200 for taxpayers and $500 for qualifying children) and the Consolidated Appropriations Act, 2021 (CAA) ($600 for taxpayers and qualifying children).
Under ARPA, payments of $1,400 are made to taxpayers for themselves and for their qualifying children. The payments are subject to income limitations, phasing out from 100% to nothing between $150,000 and $160,000 of adjusted gross income (AGI) for joint filers, $75,000 and $80,000 of AGI for single filers, and $112,500 and $120,000 of AGI for heads of household. The narrow band of the phaseout ranges means that there is in effect an extremely high marginal tax rate for income within that range.
These payments will begin shortly, and are based upon 2020 AGI for taxpayers who have already filed their 2020 tax returns; if they have not yet filed, the payments are based on 2019 AGI. This means that, depending on the individual circumstances, taxpayers might benefit by accelerating or delaying the filing of their 2020 tax returns. Eligible recipients who do not receive payments can claim them when filing their 2021 tax returns, based on their 2021 incomes and fact patterns. Conversely, those who receive payments whose 2021 income levels suggest that they did not qualify will not be required to return those amounts.
Observation: When settling up on 2021 tax returns, adjustments related to income generally will work in the taxpayer’s favor. However, unlike earlier iterations of these rebates, Congress has asked Treasury to issue regulations to follow that are designed to prevent any individual from qualifying for more than one payment as the result of changes in filing status or dependents, potentially such as a child who was claimed as a dependent of a parent in one year but not the next. Presumably that could result in a reduction of credits (an increase in tax) at that time.
Child Tax Credit
ARPA includes a large expansion of the child tax credit for just 2021, but not later years. Currently, the credit is $2,000 per child, with $1,000 of it being refundable (meaning that it can be paid as a cash refund if the taxpayer doesn’t have any tax liability against which the credit can be offset.) ARPA expands the credit in three ways:
- Increases the amount of the credit to $3,000 per child ($3,600 for children under age 6);
- Makes the credit fully refundable; and
- Increases the maximum age to 17 for qualifying children.
The excess credit over the current (i.e. pre-ARPA) amount is phased out at a rate of $50 for each $1,000 (or fraction thereof) over the same AGI thresholds that apply in the case of the recovery rebates ($150,000 for joint filers, $75,000 for single filers, and $112,500 for heads of household).
ARPA sets up a complex process for claiming this credit in advance of the filing of the 2021 tax returns. The IRS is directed to make advance payments of half the credit amount, starting on July 1, 2021. Payments of this half of the credit are to be made monthly “if feasible.” The IRS is directed to set up a website where taxpayers can opt out of receiving advance payments and can provide information on status changes that could impact the amount of the credit.
Observation: The combination of the two features and phaseouts discussed above means that, for some taxpayers, it is quite possible for the marginal rate to be higher than 100% within the phaseout range, which leads to the almost surrealistic result that the taxpayer loses money by earning the income.
Earned Income Tax Credit (EITC)
For 2021 only, ARPA makes the EITC more generous by:
- Almost tripling the maximum amount of the credit for taxpayers without children;
- Increasing the amount of income at which the credit is maximized;
- Reducing the minimum age for claiming the credit by taxpayers without children from 25 to 19 (except for full time students); and
- Allowing taxpayers to elect to substitute 2019 earned income for 2021 earned income for purposes of calculating the credit.
For 2021 and future years, ARPA increases the maximum amount of allowable investment income from $3,650 to $10,000. This change will benefit, among others, certain low-income earners who are beneficiaries of family trust funds.
Child and Dependent Care Assistance
For 2021 only, ARPA makes the following very significant changes (most of which are enhancements) to the child and dependent care credit and exclusion:
- Currently, the amount of the credit starts at 35% of qualifying expenses, and lowers to 20% of qualifying expenses as the taxpayer’s AGI increases. For 2021, the amount of the credit starts at 50% of qualifying expenses, is reduced to 20% as the taxpayer’s AGI increases, and then is reduced to 0% at a rate of 1% for each $2,000 (or fraction thereof) by which the taxpayer’s AGI exceeds $400,000;
- The amount of the credit is increased from $3,000 to $8,000 for one qualifying dependent and from $6,000 to $16,000 for two or more qualifying dependents;
- The credit is made fully refundable; and
- The maximum exclusion for employer-provided dependent care assistance (typically but not always provided through a Section 125 cafeteria plan) is roughly doubled for 2021 to $10,500 ($5,250 for married taxpayers filing separate returns). This increase is not automatic; the dependent care assistance plan must be amended to allow for the increase.
COBRA Premium Assistance
For COBRA health insurance premiums payable from April 1, 2021 through September 30, 2021, the insured is not obligated to make any payment. The employer sponsoring the health insurance plan is reimbursed for the lost premium amount by receiving a credit against the employer portion of Medicare taxes.
Taxation of Unemployment Assistance
For taxpayers with AGI less than $150,000 (regardless of filing status), the first $10,200 of unemployment compensation received by each filer is tax-free. This change applies to payments received in 2020. For this purpose each spouse may receive up to $10,200 tax-free ($20,400 in total) even if filing a joint return, as long as income remains below $150,000. However, the $150,000 cap is measured by including all unemployment benefits received (before removing any tax-free portion). It also is a “cliff” threshold. In other words, taxpayers whose income, when including the entirety of the unemployment payments, reaches $150,000 will not receive any part of this benefit. Unfortunately, the retroactive nature of this benefit will mean that most returns with unemployment compensation will have to be amended if already filed. Additionally, it remains to be seen whether this unemployment compensation will be taxed by the states, and for residents of many states it probably makes sense to delay filing until the state treatment is resolved.
Premium Tax Credit
The premium tax credit is the mechanism for providing subsidies to low-income taxpayers in order to make “affordable” their purchases of health insurance through one of the Affordable Care Act exchanges. ARPA makes the following changes to the credit:
- The credit amounts are increased;
- For 2021 and 2022, the “affordability” threshold is increased, so that taxpayers with incomes above 400% of the federal poverty line can now qualify for credits;
- For 2021, advance premium tax credits are available for individuals receiving unemployment compensation; and
- Recapture provisions are eliminated for taxpayers receiving excess premium tax credits in 2020.
Student Loan Forgiveness
Post-secondary student loan forgiveness or cancellation is tax-free for debt forgiven between January 1, 2021 and December 31, 2025 if the loan falls into any of a broad set of categories, including loans made, insured, or guaranteed by a federal or state government, and private education loans as defined in the Truth in Lending Act.
The tax-free treatment does not appear to be available in the case of debt that is paid by a third party such as an employer.
Tax Changes Affecting Businesses
Paid Family and Sick Leave Credits
This credit, which was first implemented by the Families First Coronavirus Relief Act, required employers to provide up to 10 days of certain paid family and medical leave to employees, but enabled employers to recover the cost of this leave via a credit against the employer portion of FICA tax. The employer’s obligation to provide this leave ended on December 31, 2020, but the CAA extended the credit for wages paid through March 31, 2021 for employers who voluntarily continue to provide the leave.
ARPA modifies this credit in the following ways:
- The credit applies to leave paid through September 30, 2021;
- The credit applies to up to $12,000 (previously $10,000) of wages;
- The credit is limited to the employer portion of Medicare taxes imposed on the wages (however, the excess amount can be refunded);
- Creditable wages now include payments for time off both to receive and to recover from a COVID vaccine;
- The credit can be taken against the employer portion of Medicare tax, in addition to the employer portion of FICA tax; and
- The 10 day period starts anew for all employees as of April 1, 2021, so that a credit is available for leave paid to an employee who previously received 10 days of leave that was used in calculating the credit.
ARPA includes a provision that disallows the credit if the employer discriminates in favor of highly compensated employees when providing paid family and sick leave.
Employee Retention Credit (ERC)
The ERC was implemented by the CARES Act for 2020, and the CAA extended it on more favorable terms to wages paid between January 1, 2021 and June 30, 2021. ARPA extends the credit to wages paid through December 31, 2021, but for this new six month period ending December 31, 2021, the credit can now be taken only against the employer portion of Medicare tax (a 1.45% tax), instead of the employer portion of FICA tax (a 6.2% tax). However, the excess amount over the Medicare tax can be refunded.
In addition, the ERC is now available for the following types of businesses:
- “Recovery startup businesses” which are businesses that began operations after February 15, 2020 and have average annual gross receipts of $1 million or less; and
- Any “financially distressed employer,” which is an employer of any size with gross receipts less than 10% of the gross receipts of the same calendar quarter in 2019 (sustains a reduction in gross receipts of at least 90% from that quarter).
Other Business Provisions
The Act contains several other tax provisions, including but not limited to the following:
- Assistance to certain underfunded collectively bargained multiemployer defined benefit pension plans;
- Repeal of Code Section 864(f), which will result in the restriction on the ability of certain affiliated groups to elect to allocate interest on a worldwide basis; and
- Provisions providing favorable tax treatment to Small Business Association grants (for example, Economic Injury Disaster Loan (EIDL) grants and restaurant revitalization grants).
The above summary is not intended to be comprehensive. ARPA is a very long statute that was passed in haste, and many aspects of it are not completely clear. We will be providing more guidance in the coming months. In the meantime, we encourage you to reach out to your BNN advisor with any questions and to discuss how this might impact you and your business.
For more information, please contact your BNN tax service provider at 800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.