President Biden’s “Build Back Better” policy initiative, which targets economic recovery, includes a $1.8 trillion American Families Plan (AFP) and a $2.3 trillion American Jobs Plan. The administration plans to fund both initiatives through a Made in America Tax Plan. Below is an overview of what’s included in this far-reaching tax overhaul.
American Jobs Plan
Estimated to cost around $2.3 trillion over the next eight years, this part of Biden’s “Build Back Better” initiative would consist of clean energy projects; affordable housing; the reconstruction or repair of 20,000 miles of road and 10,000 bridges; as well as funding for those who provide care for the elderly and disabled, and direct investment in rural and tribal areas by equipping them with 100% broadband coverage.
American Families Plan
Estimated to cost over $1.8 trillion over the next ten years, the American Families Plan would include universal preschool; two years of free community college; paid family and medical leave; extensions of the Child Tax Credit, the Earned Income Credit, and the Child and Dependent Care Credit. It would also extend certain provisions set forth in the Biden administration’s economic stimulus bill, the American Rescue Plan.
Funding for the American Families Plan would come through a series of tax increases on high-income Americans, including: increasing the top individual income tax rate from 37% to 39.6%; taxing unrealized capital gains above $1 million at death; and adjusting the threshold for the 3.8% Medicare tax to all income above $400,000.
Made in America Tax Plan
The administration plans to pay for these initiatives with a “Made in America Tax Plan” over the next 15 years. It is estimated that the tax reform plan will raise over $2 trillion over the next decade and a half by increasing various taxes on American corporations, including:
Raising the corporate tax rate from 21% to 28%
Increasing the global minimum tax that multinational corporations must pay to 21%. This is much higher than the 12.5% minimum rate recently discussed by the Organization for Economic Cooperation and Development (OECD).
Intensifying tax enforcement of U.S. corporations that invert (relocate operations overseas) or claim tax havens
Imposing a 15% minimum tax on book income reported to investors.
Individual Tax Rates
The Biden administration’s proposals on individual taxation are intended to avoid increasing taxpayers with annual incomes less than $400,000. The plan aims to increase the tax rate for the top income bracket from the current 37% to 39.6%. The top rate on capital gains would nearly double, increasing from 20% to 39.6%. Further, the current net investment income surtax of 3.8% levied on high-income taxpayers presumably would still apply. This means that the new top federal tax rate on capital gains would total 43.4%, nearly double the current law top combined rate of 23.8%.
The IRS uses a computer program called the Discriminant Function System (DIF) to analyze tax returns and red flag them if they deviate from statistical averages. When a return draws a high DIF score, an agent evaluates it and decides if an audit is necessary. Your business should always be prepared for an audit, and that includes avoid these audit triggers when filing your small business taxes.
Higher Than Average Income
If you report a high amount of income, this may draw red flags for the IRS. Approximately 50% of the returns audited belong to taxpayers earning more than one million dollars per year. For taxpayers who earn more than $5 million, their odds of being audited more than doubles those of taxpayers who earn less.
Underreporting Cash Transactions
Don’t make the mistake of thinking that the IRS has no way to trace cash transactions. Credit card processors submit 1099-K forms to the IRS, which include a report of the total credit card transactions your business processed for the year. The IRS then applies these figures to an undisclosed formula in order to calculate the amount a business should have generated in cash sales. Therefore, if your reported cash sales reflect a lower figure than their formula detects, your business could be at risk for an audit. It’s a smart idea to keep detailed records of both cash and credit card transactions so you can support your claims should your business be audited.
Taking Too Many Deductions
Deductions are important to a small business owner, but claiming too many can raise red flags. Higher than average meal expenses and claiming your car as 100% business can set off alarm bells for the IRS and trigger and audit.
The IRS states that a legitimate business expense must be both ordinary and necessary to qualify as a deduction.
Ordinary expenses = common and accepted in your trade or business
Necessary expenses = helpful and appropriate for your trade or business. Note that an expense does not need to be indispensable to qualify as necessary.
Claiming Consistent Business Losses
Given the primary purpose of a business is to generate money, reporting losses year after year can lead the IRS to question the legitimacy of your business. If your business gets audited and you claimed losses, be prepared with documentation to demonstrate your business’ earnings and expenses throughout the year.
Be Prepared for an Audit
Your business may never need to go through an audit process, but you should manage your business always knowing that it’s possible. Keep precise records, make sure the numbers on your tax return are accurate and honest, report all income, and take suitable deductions. Lastly, consult with an accountant to be sure the totality of your revenue, expenses, and documents are free of missteps or miscalculations.
In late December of 2020, President Trump signed into law the Consolidated Appropriations Act, 2021 (the Act), which included the long-anticipated pandemic-related Tax Relief Act of 2020. It also included the Taxpayer Certainty and Disaster Relief Act of 2020, which extends or makes permanent numerous tax provisions, including tax breaks for individuals. The following is an overview of these key tax-related provisions for individuals.
Medical Expense Deduction
The Tax Cuts and Jobs Act (TCJA) set the threshold for itemized medical expense deductions at 7.5% of Adjusted Gross Income (AGI), but this threshold was scheduled to return to 10% of AGI as set in the Affordable Care Act. However, the expense deduction had been extended perpetually by Congress, allowing a taxpayer to continue to deduct their total qualified unreimbursed medical expenses that exceed only 7.5% of their AGI. The Taxpayer Certainty and Disaster Relief Act of 2020 made this threshold permanent.
Charitable Contribution Deduction
Generally, charitable donations are tax-deductible only if you itemize your taxes, but the Coronavirus Aid, Relief, and Economic Security (CARES) Act incorporated a provision that authorized individuals who don’t itemize to deduct up to $300 ($600 for married couples filing jointly) in cash donations in 2020. The Taxpayer Certainty and Disaster Relief Act of 2020 extended this provision into 2021 and makes it more valuable for married couples filing jointly.
Taxpayers who do itemize their deductions are typically limited to a 60% cap (i.e., the amount of charitable donations you could deduct generally could not exceed 60% of your AGI). As in 2020, that limit has been suspended in 2021.
Mortgage Insurance Premium Deduction
The Taxpayer Certainty and Disaster Relief Act of 2020 includes a one-year extension of the mortgage insurance premium deduction, so premiums paid or accrued through December 31, 2021 can be deducted on tax returns by those who itemized deductions and otherwise qualify for the mortgage insurance premium deduction.
Exclusion for Canceled Mortgage Debt
Cancelled or forgiven debt by a commercial lender can be counted as income for tax purposes. However, the Mortgage Forgiveness Debt Relief Act of 2007 generally allowed for taxpayers to exclude canceled mortgage debt from their taxable income, but only for a finite number of years. The Taxpayer Certainty and Disaster Relief Act of 2020 extended the Mortgage Forgiveness Debt Relief Act of 2007 through 2025.
Residential Energy-Efficient Property Credit
Individuals who have implemented certain energy-efficient upgrades to their homes (i.e., solar electricity, solar water heaters, geothermal heat pumps, and small wind turbines) are eligible for the residential energy-efficient property credit. The credit had been set to phase out after 2021, but the Taxpayer Certainty and Disaster Relief Act of 2020 extended it as follows:
Continuing the rate applicable to 2020, eligible property that is put into service in 2022 will qualify for a credit worth up to 26% of the property cost
Eligible property that is put into service in 2023 will qualify for a credit worth up to 22% of the property cost.
The Consolidated Appropriations Act, 2021 (the Act) signed into law by President Trump on Dec. 27, 2020 includes significant modifications to the Employee Retention Tax Credit (ERC) enacted under the CARES Act. The credit originally provided a 50% refundable tax credit for businesses that maintain employee payroll, even amidst temporary business closures due to government-mandated lockdowns, or considerable downturns in gross receipts due to loss of business. This article will highlight changes to the ERC for 2021.
Period of Credit Availability
The CARES Act originally provided credit for qualified wages paid after March 12, 2020 and before Jan. 1, 2021. The new law extends availability of the credit for qualified wages to the first two quarters of 2021 (before July 1, 2021).
Amount of Credit
Under the original law, the credit amount was set at 50% of the qualified wages paid to the employee, plus the cost to continue providing employee health benefits. The Act increases the credit amount to 70% of qualified wages, which is intended to include the cost of employee health benefits.
Maximum Credit Amount
The CARES Act capped the credit at $5,000 per employee for all qualified wages paid during 2020, but the Act increases the maximum credit to $7,000 per employee for each of the two quarters in 2021, so the maximum credit for 2021 will be $14,000.
Eligibility Requirements for the Credit
In order to qualify for the ERC under the original law, businesses must have been experiencing full or partial suspension of operations due to a Covid-19 lockdown order. They could also qualify if, for any quarter in 2020, gross receipts were less than 50% of gross receipts for the same quarter in 2019. With the passage of the Act, businesses whose operations are either fully or partially suspended by a government-mandated lockdown order due to Covid-19 or whose gross receipts are less than 80% of gross receipts for the same quarter in 2019 can qualify for the ERC.
Credit Eligibility Whether or Not Employees Are Working
For a company with more than 100 employees, the original law under the CARES Act did not provide credit for wages paid to employees who were performing services for the employer in some capacity. However, a company with 100 employees or less did qualify for the credit, even if the employee was working. The Act raises this threshold to 500 employees, so that for the first two quarters of 2021, a company with 500 or fewer will be eligible for the credit, even if employees are working.
PPP Loan Eligibility
A company that received a Paycheck Protection Program (PPP) loan was not eligible for the ERC under the original CARES Act. With the passage of the Act, companies that received a PPP loan in 2020 may also qualify for the ERC. To prevent double dipping, a credit may not be claimed for wages paid with the proceeds of a PPP loan that have been forgiven. However, amounts paid that were either not forgiven or are over and above the PPP loan amounts can be included for ERC purposes.
President Trump recently signed a second stimulus package—called the Consolidated Appropriations Act, 2021 (Act)—into law. The legislation includes over $300 billion in aid for small businesses. Below is a breakdown of some of the business tax changes and extenders in the new COVID-19 relief bill.
Payroll Tax Credit for Paid Sick and Family Leave
The refundable payroll tax credit for paid and sick family leave, established in the Families First Coronavirus Response Act, is extended until March 31, 2021. The tax credits are modified so that they now apply to practically any payments made to workers for these purposes.
Payroll Tax Repayment
The time frame for employees to repay deferred employment taxes under the President’s executive order, which was issued in August 2020, has been extended from April 2021 to December 31, 2021.
Employee Retention Credit
The Employee Retention Credit (ERC) under the CARES Act has extended to July 1, 2021. Further, the refundable tax credit has increased from 50% to 70%, the per-employee wages limitation has increased from $10,000 per year to $10,000 per quarter, and the determination of a large employer for purposes of the ERC has increased from 100 to 500 employees.
30-Year Depreciation of Certain Residential Rental Property
The new law determines that the recovery period relevant to residential rental property placed in service before Jan. 1, 2018, and held by an electing real property trade or business, is 30 years.
Business Meal Deduction
Rather than the current 50% business expense deduction for meals, the bill temporarily allows a 100% expense deduction for meals provided by restaurants in 2021 and 2022.
Deduction for Energy Efficient Commercial Buildings
The deduction for energy-efficient improvements to commercial buildings, such as lighting, heating, cooling, ventilation, and hot water systems was made permanent. The amount will be inflation-adjusted after 2020.
Changes to the Work Opportunity Tax Credit
If employers hire workers who are members of one of more of ten targeted groups under the Work Opportunity Tax Credit (WOTC) program, they are permitted to use an elective general business tax credit. Previously applicable to hires before 1/1/2021, the TCDTR extends the credit through 2025.
Employer Payments of Student Loans
Section 127, which permits employers to provide certain educational assistance to employees on a tax-free basis, was modified under the CARES Act to authorize the payment by an employer of principal or interest on specific employee qualified education loans through December 31, 2020. The Consolidated Appropriations Act expands this through December 30, 2025. As the pandemic subsides, employers may want to consider this valuable tax-free benefit.
Health and Dependent Care Flexible Spending Arrangements
The bill allows taxpayers to roll over unused funds in their health and dependent care flexible spending accounts from 2020 to 2021 and from 2021 to 2022. This arrangement also permits employers to grant employees a 2021 midyear prospective adjustment in contribution amounts.
Customarily, retirement savings plans such as 401(k)s are tough to withdraw from before age 59.5 without accruing penalties and tax withholdings, but the CARES Act, which was passed by Congress in response to the economic hit caused by the Covid-19 pandemic, temporarily eliminated such penalties. Now that you can more easily access assets that have been set aside for future use, should you?
Amended Penalties for Early Withdrawal
Recognizing that many Americans who live paycheck to paycheck would need access to funds in the face of lost income as a result of government shutdowns, Congress passed the CARES Act, which temporarily eliminates the 10% early-withdrawal penalty and the 20% federal tax withholding on early 401(k) withdrawals. Taxes on any withdrawn funds will still be applicable because the original contributions were pre-tax, but whereas those taxes are typically due within the same year as the withdrawal, the CARES Act permits the amount due to be stretched over a period of three years.
Be Aware of Potential Penalties
It may seem as though the vault has been unlocked, but before you decide to take advantage of the easily accessible funds, you should consider the potential ramifications of such a move. If the amount withdrawn isn’t returned within the three-year window (either in one lump sum or in multiple payments over three years), you will be responsible for paying income tax on the withdrawal. This could be a significant amount depending on the size of the withdrawal. It’s also worth remembering that for the amount of time the funds are out of your retirement savings, they discontinue making returns on your investment, which could result in potentially long-term consequences, including compound tax deferred growth benefits.
Remember the End Goal
If you are struggling in today’s economic downturn, the laxed rules and penalties to access retirement funds is tempting, but it’s important to keep the end goal in sight, which is retirement. The long-term impact to your savings, even when it’s paid back over time, may not be worth it. Unless you’re really struggling to make ends meet, the best move is to leave the money in your 401(k). Cashing out now, when the market reflects depressed values, means that you’d be selling low, which isn’t a recommended strategy.
