Democratic lawmakers got a legislative win with passage of the American Rescue Plan Act of 2021.
It includes a long-standing Democratic goal:
Fighting child poverty through the tax code.
There’s a revamped child tax credit for 2021. The law hikes the $2,000-per-child credit to $3,000 … $3,600 for kids under age 6 … lets 17-year-olds qualify, makes the credit fully refundable, and calls for IRS to pay 50% of it in advance to qualifying families.
Upper-incomers won’t get the higher credit. It begins to phase out at AGIs of $75,000 for singles, $112,500 for household heads and $150,000 for joint filers. The credit amount is reduced by $50 for each $1,000 of AGI over the applicable threshold amount. The phaseout is limited to the $1,000 or $1,600 temporary increased credit amount for 2021 and not to the $2,000 credit. So families who aren’t eligible for the $3,000 or $3,600 credit, but who have AGIs at or below $400,000 on joint returns or $200,000 on others, still get the $2,000 credit.
IRS is required to pay half of the credit in advance. If all goes as planned, it will send out a payment to qualifying families each month from July through Dec. It will determine eligibility for the credit and payments based on 2020 or 2019 returns. The amount a family will get each month is based on the AGI, the number of children and the ages of the kids. Families who qualify for the full $3,000 or $3,600 credit could see checks of $250 or $300 per child for six months. Those with higher incomes who qualify for the $2,000 credit could get monthly payments of $167 per child.
You’ll need to let IRS know of changes to your family circumstances or AGI.
IRS is developing an online tool so that you can update your 2021 income, marital status and the number of your qualifying children. You can also opt out of advance payments on the portal and instead take the full credit on your 2021 return.
The payments are advances of the 2021 child tax credit and aren’t taxable. On your 2021 Form 1040, you’ll reconcile the payments you got with your actual credit.
Some people who receive overpayments needn’t repay the excess to IRS. Families with 2021 AGIs at or below $40,000 for singles, $50,000 for household heads and $60,000 for joint filers won’t have to repay any credit overpayments they get. Families with 2021 AGIs of at least $80,000, $100,000 or $120,000, respectively, will need to repay the full amount of any overpayment when they file their 2021 returns. Those with 2021 AGIs between the thresholds need repay only part of the overpayment.
This expanded child tax credit is temporary. It applies only for 2021.
But Democratic lawmakers want to make it permanent, touting the impact that such a higher and fully refundable credit would have on reducing child poverty. See www.kiplinger.com/ktl/ctc for even more details on the revamped child credit.
More on Stimulus
There are a number of other tax easings in the American Rescue Plan.
A third round of stimulus checks of $1,400 for singles and household heads and $2,800 for joint filers, plus $1,400 more for each dependent claimed on the return. They begin to phase out at AGIs of $150,000 for couples, $112,500 for household heads and $75,000 for singles, and end at AGIs above $160,000, $120,000 and $80,000.
IRS will first look to 2020 returns to determine eligibility for the payments. If a 2020 return hasn’t yet been filed, IRS will look to 2019. Similar to before, Social Security recipients who typically don’t have to file returns needn’t file. Ditto for those individuals who get Social Security disability or veterans’ benefits.
People with direct deposit should have received the money or will get it soon. Eligible folks without direct deposit should get a paper check or debit card in the mail. Use IRS’s Get My Payment online tool to check the status of your stimulus payment.
The money is an advance payment of a tax credit on the 2021 return.
Up to $10,200 of unemployment benefits received in 2020 are not taxable for federal income tax purposes. For joint filers, it’s $10,200 of benefits per spouse. The relief applies only to individuals and couples with AGIs of less than $150,000. IRS has revised the instructions to Schedule 1 of the Form 1040 to reflect this change. IRS is also urging individuals who already filed their 2020 1040 not to amend it to claim the exclusion. The agency’s head says IRS plans to automatically issue refunds.
More individuals qualify for the health premium credit for 2021 and 2022 for buying insurance through an exchange. There are also increased subsidies.
The earned income tax credit for 2021 is higher for workers without children. Also, 2019 earned income can be used to figure the earned income credit for 2021.
Working parents get a higher child and dependent care credit for 2021. Up to $4,000 for one child and $8,000 for two or more kids … up from $1,050 and $2,100 for 2020. Parents with up to $125,000 of AGI are eligible for the full credit. Taxpayers with AGIs between $125,000 and $500,000 get a partial credit.
Working parents can contribute more to dependent care FSAs in 2021. They can put in up to $10,500 of pretax wages … up from $5,000 … if the plan allows.
And most student loan debt forgiven in 2021 through 2025 will be tax-free.
The law expands two COVID-19-related employer payroll tax credits: The payroll credit for sick and family leave paid by businesses to employees affected by the coronavirus. And the employee retention tax credit for businesses that are financially hurt by the pandemic but keep paying wages to employees.
The American Rescue Plan includes four revenue-raising provisions:
The cap on the write-off for business losses on individual returns lasts longer. Under the 2017 tax reform law, the amount of trade or business losses over $500,000 for couples and $250,000 for other filers was made nondeductible, with any excess carried forward. This was slated to expire after 2025. It is now set to end after 2026. Last year’s CARES Act suspended this loss limitation rule for 2018, 2019 and 2020.
The $1 million deduction cap for executive pay is broadened. Presently, publicly traded firms are denied deductions for compensation in excess of $1 million paid to the three highest-paid employees, the CEO and the CFO. Beginning in 2027, the cap will apply to the eight highest-paid employees plus the CEO and the CFO.
More payees will get Form 1099-K from PayPal, Airbnb and the like. Effective for 2022 and later, these third-party networks must send 1099-Ks to payees who were paid more than $600 in a year. Presently, the forms are sent only to payees with over 200 transactions, who were paid more than $20,000.
Another revenue-raiser affects multinational companies … more specifically, how they account for the allocation of their interest expenses among members of their worldwide group of companies and make efficient use of foreign tax credits.
Settlements
Settlement proceeds received from an attorney malpractice suit are taxable. A woman who was injured in a hospital after sitting in a broken wheelchair hired attorneys to sue the hospital. After a trial court ruled for the hospital, she sued her lawyers for malpractice, alleging they breached their duty of care in prosecuting her case against the hospital. The parties later settled for $125,000.
The proceeds were not received for physical injuries or physical illness. She claimed the settlement was nontaxable, arguing that but for the lawyers’ negligence, she would have gotten tax-free damages from the hospital. Not so, says the Tax Court, because there is no direct causal link between the settlement that she received and the physical injuries she sustained. The settlement agreement made clear the payment was in lieu of damages for legal malpractice (Blum, TC Memo. 2021-18).
Penalties
Sometimes a little bit of luck goes a long way taxwise. Here’s an example.
A couple walks away from a fraud penalty. IRS first imposed the penalty in the revenue agent’s report given to the couple in a meeting at the close of an audit. The couple disagreed with the penalty and wouldn’t sign the report. Two months later, the agent submitted the case file for approval of the penalty from her supervisor, who OK’d the penalty in writing that same day. The Tax Court nixed the fraud penalty because the agent didn’t get the requisite prior written supervisory approval before she met with the couple to present her report (Beland, 156 TC No. 5).
Estate Taxes
Valuation discounts apply to an estate’s split-interest donations of an LLC. A decedent owned 100% of an LLC valued at $25 million upon her death. Pursuant to the terms of her will, her estate donated 25% of the LLC to a church and 75% to the decedent’s family foundation, a tax-exempt 501(c)(3) organization. IRS asserted the value of the charitable gifts should be discounted for lack of control and lack of marketability, and the Tax Court agreed, notwithstanding the fact that 100% of the LLC’s value was included in the gross estate. Applying the discounts, the estate’s charitable write-off is $23 million (Est. of Warne, TC Memo. 2021-17).
Business Taxes
Legal marijuana firms can’t deduct depreciation or charitable contributions. It is IRS’s view that even in states where it is legal to sell and use marijuana, a federal tax statute prohibits business deductions (other than for cost of goods sold) for sellers of controlled substances that are considered illegal under U.S. law. In a recent case, a medical cannabis dispensary in Calif. claimed that depreciation is not a business expenditure and is not paid or incurred as required by the statute. The Tax Court shot that down, saying depreciation is incurred by a taxpayer. As for the charitable contributions, the Court said the dispensary made the donations in carrying on its trade or business (San Jose Wellness, 156 TC No. 4).
A microcaptive insurance transaction doesn’t pass muster with the Tax Court. A construction firm took a tax write-off for property and casualty insurance premiums paid to a newly formed Caribbean insurance firm that was owned by the shareholder of the construction firm. The only customers of the insurer were the company and some related entities. Although the insurer paid claims made on the policies, the Court decided that the insurer did not operate as an insurance company. According to the Court, the transaction didn’t constitute insurance because there was no risk distribution and the insurer wasn’t selling insurance in the commonly accepted sense (Caylor Land & Development, TC Memo. 2021-30).
IRS has its eye on businesses that use small captive insurance companies. The issue has been an enforcement priority for the agency during the past few years. In 2016, IRS issued guidance which labeled abusive microcaptive insurance schemes as transactions of interest. Firms that engage in these tax dodges must disclose them to IRS or face penalties. Cracking down on promoters of these schemes is also key.
State Taxes
Maryland has enacted the first digital advertising tax in the country. It’s imposed on firms with global gross revenues of $100 million or more that have at least $1 million of gross revenues derived from digital advertising services in the state, such as advertising on web-based banners. The tax rate ranges from 2.5% to 10% and is based on the amount of the business’s worldwide gross revenues.
Opponents of the tax have sued the state. The U.S. Chamber of Commerce and others claim the tax is unconstitutional and violates the Internet Tax Freedom Act.
A few more states have proposed such a tax, including N.Y., W.Va. and Ind. Others are likely waiting to see how the Md. tax fares before moving forward.
Tax Debts
Want to apply for or renew a passport? Make sure your taxes are paid up. The Dept. of State can deny or revoke U.S. passports of individuals with federal tax debts of $54,000 or more on whom a tax lien or levy has been filed. That doesn’t include those who are paying their taxes under an installment agreement, individuals in bankruptcy, people who live in a federally declared disaster area, or people with a tax debt that IRS has determined isn’t collectible because of hardship.
The Revenue Service gives names of affected taxpayers to the State Dept. It also sends letters, letting the taxpayers know that their names were submitted to State. Those who receive notice CP508C should contact IRS to resolve their debts.
Revoking a tax delinquent’s passport doesn’t violate the U.S. Constitution. A man who owed $400,000 in back taxes was told he could not renew his passport by the State Dept., after IRS certified that he had a seriously delinquent tax debt. He claimed this violated his constitutional right to travel. A court tossed the case, saying that IRS has a legitimate interest in collecting seriously delinquent tax debts. Additionally, this interest is rationally related to the government’s ability to revoke or deny passports to taxpayers with such outstanding tax debts (Jones, D.C., Ga.).
Tax Scams
With more stimulus checks on the way, be wary of scam e-mails, phone calls and text messages from fraudsters wanting to steal your financial information and intercept your payment. The communications may look like they are from IRS, but they’re not. Treasury inspectors warn that these scams are on the upswing.
Don’t respond to any such message or open any link. IRS won’t call, text or e-mail you to request information as a prerequisite to receiving a stimulus payment.
Filing Season
Individuals have until May 17 to file 2020 federal returns and pay taxes.
You don’t have to file for an extension. The one-month delay is automatic. For weeks, lawmakers and tax professional groups have been putting pressure on IRS to postpone the normal April 15 due date. At first, the Service pushed back, saying there was no need for a delay. It has now relented, giving relief to 1040 filers. The extra month gives taxpayers and preparers more time to digest the tax law changes in the midst of a continuing pandemic. It also provides IRS with a bit of breathing room. The agency is already falling behind on processing 2020 returns and paying refunds, not to mention the backlog of 2019 paper 1040 forms still waiting to be processed.
The first-quarter estimated-tax-payment due date of April 15 is not delayed.
The delay also doesn’t apply to business return filings, such as Form 1120.