CPAs assessing the start of this year's round of client tax return preparation can take some satisfaction in knowing that they're not likely to face a repetition of last year, when retroactive tax law changes required revisiting many of the returns they'd already completed. Even so, several pandemic relief measures for individual taxpayers enacted or extended by the American Rescue Plan Act (ARPA), P.L. 117-2, were effective for 2021, some building on provisions from 2020. So, while they're no surprise this time around, these provisions require still-novel calculations and considerations, with a few new wrinkles in some familiar items.
On top of all that is, at the time of this writing, major new tax legislation passed by the House on Nov. 19 and then moving to the Senate as part of the budget reconciliation bill known as the Build Back Better Act, H.R. 5376. While most of the provisions would take effect in tax years after 2021, some of them have potentially profound implications for tax planning, such as an expansion of the net investment income tax for high-income taxpayers and a high-income surtax.
"With the anticipation of these new and increased taxes, it may be best to consider some tax planning," said Brenda Graat, CPA, a partner with Baker Tilly US LLP in Milwaukee.
While some high-net-worth clients may have accelerated gains into 2021, those who have lost out on that opportunity may wish instead to defer them for a longer term. Suitable vehicles for that purpose may include Sec. 1031 exchanges, Sec. 1400Z-2 qualified opportunity zone investments, and installment sales, Graat said.
An article based on a roundtable discussion by members of the AICPA Tax Practice Management Committee on how they and their firms stay prepared for possible tax law changes — including retroactive ones — and communicate resulting risks and opportunities to clients is also available: "Tax Practice Management: Keeping on Top of Tax Changes," The Tax Adviser, Dec. 2021. And for handy references to key brackets, thresholds, and other amounts relevant to 2021 individual and business returns, see the "Filing Season Quick Guide — Tax Year 2021," in this issue, and, in the December 2021 JofA, the "Business Tax Quick Guide — Tax Year 2021." With that, this preview turns to a few of the "known unknowns."
INDIVIDUAL TAX PROVISIONS
Child tax credit and child and dependent care credit
Perhaps the most prevalent new individual return issue preparers are likely to encounter is the advance child tax credit (advance CTC) payment that most families will have received each month through the second half of 2021. The advance credit is $300 per month for each child under age 6 and $250 per month for each child age 6 to 17, which for the six months the payments were made should in most cases equal half of the eligible credit for the year. Thus, a requirement to repay excess advance credits should be uncommon.
Still, because in most cases the IRS based the advance CTC payments on taxpayers' 2020 (or 2019) return information, if the client's gross income increased dramatically in 2021 (e.g., from a return to full-time work after a bout of unemployment) into or beyond the phaseout range, or there was a decrease in the number of qualifying children (e.g., a child turned 18), and the taxpayer did not update his or her information with the IRS, the taxpayer could owe a repayment. A safe harbor under Sec. 24(j)(2)(B) may limit the payback amount, depending on modified adjusted gross income (MAGI). This safe harbor phases out for taxpayers filing jointly with MAGI exceeding $60,000 ($50,000 for head-of-household filers and $40,000 for all others) and is totally phased out for taxpayers filing jointly with MAGI exceeding $120,000 ($100,000 for heads of household and $80,000 for all others).
Also, as the AICPA has pointed out in a comment letter to congressional leaders (available at www.aicpa.org) on selected provisions of the Build Back Better Act, including an extension of the advance CTC to the 2022 tax year, there's reason for concern that the advance CTC could cause many of these clients to be underwithheld this year, when, under the bill, it would be paid for the full year. This could occur if, for example, the client receives the advance payments, but based on the client's Form W-4, Employee's Withholding Certificate, indicating the number of children qualifying for the credit, the client's employer does not take the advance payments into account in determining wage withholding amounts. Even with the half-year CTC advance payments in 2021, CPAs could see many more clients with families whose federal income taxes were underwithheld for this reason alone.
More to the point of preparers' workflow, every return with a CTC will require reconciling the total advance CTC amount with the full-year credit, which necessitates verification of the former. The IRS has said that it will send Letter 6419 in January 2022 to taxpayers, reporting their advance CTC payments disbursed in 2021.
On many of these same returns, preparers will likely also encounter clients' eligibility for ARPA's enhanced child and dependent care credit. Maximum qualifying expenses for the credit increased for 2021 to $8,000 for one qualifying individual and to $16,000 for two or more qualifying individuals, from, respectively, $3,000 and $6,000 previously, and the credit went from being nonrefundable to fully refundable, with higher credit amounts and phaseout ranges. CPAs thus will want to make sure working families can document their qualifying expenses with respect to not only amounts paid but also required identifying information for the service provider or providers and for the qualifying individual or individuals (Secs. 21(e)(9) and (10)). Some clients who might not have bothered to claim the credit previously because it didn't benefit them significantly may need a reminder. For a fuller review of both the CTC and child and dependent care credit changes for 2021, see "ARPA Expands Tax Credits for Families," The Tax Adviser, July 2021.
EIP, PTC, and EITC
ARPA authorized a third round of economic impact payments (EIPs) for 2021 of $1,400 ($2,800 for married joint filers), plus $1,400 for each dependent or, alternatively, a recovery rebate credit claimable on the return. In an ideal world, clients who received a payment would remember it or, better still, slip into their tax organizer a confirmatory IRS Notice 1444, which would prevent the kind of second-guessing many preparers no doubt remember from 2020's first and second EIP rounds.
ARPA excused any taxpayer who on a 2020 tax year return was required to reconcile advance payments of a premium tax credit (advance PTC) with the full PTC from having to add to taxable income any excess advance PTC (Sec. 36B(f)(2)(B)(iii)). For 2021, a different form of PTC relief may apply under Sec. 36B(g): Any taxpayer who received or was approved to receive unemployment compensation for any week during 2021 is treated as an "applicable taxpayer" for purposes of the PTC regardless of household income, and any household income over 133% of the poverty line for the taxpayer's family size is not taken into account for the credit.
Many taxpayers claiming an earned income tax credit (EITC) in 2020 were aided by a provision in the Consolidated Appropriations Act, 2021 (CAA), P.L. 116-260, allowing them to substitute 2019's earned income for that of 2020 in calculating the EITC. ARPA provides a similar special rule for 2021 as well, allowing a two-year lookback to 2019, and enhances the EITC in several other ways. Notably, for individuals with no qualifying children, ARPA increases the credit amount and phaseouts and lowers the qualifying taxpayer age range below 25 (to 18 for a qualified former foster youth or qualified homeless youth, 24 for a specified student, and 19 in all other cases) and raises it to above 64 (without limit).
Virtual currency and charitable contribution deduction for nonitemizers
Two other common provisions for tax year 2021 are similar but slightly different from their 2020 iterations. The question about virtual currency is still on the front of Form 1040, U.S. Individual Income Tax Return. However, its wording has been brought into line with the form's instructions, asking: "At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?" Last year, the question asked whether taxpayers received, sold, sent, exchanged, or otherwise acquired virtual currency.
Likewise, the maximum $300 ($600 for joint returns) deduction for cash charitable contributions by nonitemizers reappears, but in a different place. While 2020 returns deducted it "above the line" in calculating adjusted gross income (AGI), 2021 returns slip it "below the line," as a deduction from AGI to arrive at taxable income.
BUSINESS TAX PROVISIONS
Qualified leave credits and the ERC
Three key elements of business tax relief that ARPA enacted or extended into 2021 — the credit for qualified sick and family leave wages (paid through Sept. 30, 2021), the employee retention credit (ERC), as amended by the Infrastructure Investment and Jobs Act, P.L. 117-58, for wages paid through Sept. 30, 2021, or, for recovery startup businesses, Dec. 31, 2021, and the credit for premium assistance for COBRA continuation coverage — are all claimable against employment taxes and therefore not directly implicated in businesses' income tax returns. However, employers claiming the credits will probably have to deal with the credits' consequences for gross income.
Employers claiming a credit for qualified sick or family leave wages (qualified leave wages) must include the full amount of the credit in gross income (see IRS, "Special Issues for Employers," FAQ 49, available at www.irs.gov) but may deduct as a business expense amounts paid to employees for which the employer expects to claim the tax credits: qualified leave wages, any allocable qualified health plan expenses, and the employer's share of Medicare tax on the qualified leave wages (FAQ 50).
The result of claiming an ERC is almost the opposite: The ERC amount is not included in an eligible employer's income, but it reduces any income tax deduction for the credit's qualifying wages (including qualified health plan expenses) by the amount of the ERC, pursuant to rules similar to those under Sec. 280C(a) (see Notices 2021-20 (especially Section III.L., Q&A 61), 2021-23, and 2021-49). Employers claiming the COBRA continuation credit must increase their gross income by the amount of the credit (Sec. 6432(e)).
In addition, qualified sick and family leave wages paid in 2021 must be reported to employees, so businesses issuing Forms W-2, Wage and Tax Statement, in early 2022 must meet requirements for that reporting outlined in Notice 2021-53. Any taxpayer who was self-employed and an employee during the tax year and both claims the self-employed equivalent qualified leave credit and was paid qualified leave wages as an employee will need this W-2 information to compute the former.
Food or beverages provided by a restaurant
For 2021 (and 2022) tax years, despite the general limitation of Sec. 274(n)(1) of a deduction for any expense for food or beverages allowed under Sec. 274(k) of 50% of the cost, business taxpayers may deduct the full cost paid or incurred before Jan. 1, 2023, of food or beverages provided by a restaurant (Sec. 274(n)(2)(D)). The meaning of the phrase "provided by a restaurant" in this provision of the CAA was clarified by Notice 2021-25. Here, too, substantiation is important, not least to show that the erstwhile restaurant is not a disqualified "business that primarily sells prepackaged food or beverages not for immediate consumption."
Absence of key CARES Act special relief
Otherwise, business income tax returns for 2021 will be most notable for what they don't reflect, specifically, the five-year carryback of net operating losses, the temporary repeal of the 80% of taxable income limitation for the net operating loss deduction, the temporary increase in the Sec. 163(j)(1)(B) business interest deduction limitation to 50% (from 30%) of adjusted taxable income, and the temporary suspension of the Sec. 461(l)(1) rule limiting excess business losses of noncorporate taxpayers, which all expired at the end of 2020, as provided by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136. Practitioners may well have occasion, though, as they prepare 2021 business returns, to review returns for 2020 and previous years to make sure CARES Act elections were made properly and to clients' best advantage and, if advisable and still possible, suggest that clients make any necessary elections and/or amend those returns.
ALL EYES ON THE HILL
Considering all that the nation has been through, and compared with 2020 returns, those for 2021 seem from the foregoing likely to be reasonably regular and comprehensible to preparers and most taxpayers. Then again, tax law proposals now in the offing, including some game-changing provisions, could well eclipse most of these concerns by the time tax season 2022 launches.
"What I find exciting and interesting about tax is the evolving changes in the tax code," Graat said.
Wherever these new directions may lead going forward, CPA tax preparers can go to work each day of this new busy season and the next with, one hopes, that kind of excitement and interest.
About the author
Paul Bonner is a JofA senior editor. To comment on this article or to suggest an idea for another article, contact him at Paul.Bonner@aicpa-cima.com or 919-402-4434.
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"Get Your Clients Ready for Tax Season" (sponsored report), JofA, Oct. 2021
"Guidance Issued on 2021 Qualified Sick and Family Leave Wage Reporting," JofA, Sept. 8, 2021
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