The American Rescue Plan of 2021 is designed to provide economic relief to millions of Americans in the wake of the COVID-19 pandemic. In addition to "stimulus" payments, the Plan includes several lesser-known tax provisions. Understanding how they may affect you can help your income tax planning and withholdings in 2021 and beyond.
Tax Changes for Individuals
Exclusion of Unemployment Benefits from Income
Under the American Rescue Plan of 2021, as of the 2020 tax year, if the adjusted gross income (AGI) of the taxpayer for the tax year is less than $150,000, the gross income of the taxpayer does not include so much of the unemployment compensation received by the taxpayer (or, in the case of a joint return, received by each spouse) as does not exceed $10,200.
Checkmark Observation. New Code Sec. 85(c) does not provide for a phase-out based on AGI. Therefore, if a taxpayer makes $150,000 or more, the exclusion does not apply, and all the individual’s unemployment compensation would be included in gross income.
The same $150,000 limit applies to returns filed jointly, as head of household, or with single status. However, in the case of a joint return, the $10,200 exclusion applies separately to each spouse.
Some taxpayers already filed their returns before the passage of the American Rescue Plan Act of 2021. If these taxpayers included unemployment compensation in their gross income, they should file amended returns if they qualify for the exclusion.
Under the American Rescue Plan Act of 2021, an eligible individual is allowed an income tax credit for 2021 equal to the sum of: (1) $1,400 ($2,800 for eligible individuals filing a joint return) plus (2) $1,400 for each dependent of the taxpayer. The credit is refundable. For purposes of the credit, an "eligible individual" is any individual other than a nonresident alien or an individual who is a dependent of another taxpayer for the tax year. Estates and trusts aren't eligible for the credit.
The amount of the credit is ratably reduced (but not below zero) for taxpayers with adjusted gross income (AGI) of over: $150,000 for a joint return; $112,500 for a head of household; and $75,000 for all other taxpayers.
The credit is completely phased out (reduced to zero) for taxpayers with AGI of over: $160,000 for a joint return; $120,000 for a head of household; and $80,000 for all other taxpayers. (Code Sec. 6428B(d), as added by ARPA Sec. 9601(a))
Changes to the Child Tax Credit
Before the American Rescue Plan Act of 2021, the child tax credit (CTC) was $2,000 per “qualifying child.” A qualifying child was defined as an under age 17 child, whom the taxpayer could claim as a dependent (i.e., a child related to the taxpayer who, generally, lived with the taxpayer for at least six months during the year), and who was a U.S. citizen or national, or a U.S. resident.
Under the American Rescue Plan Act of 2021, for tax year 2021 the CTC is temporarily expanded as to eligibility, and amount, as follows:
1. The definition of a qualifying child is broadened to include a child who hasn’t turned 18 by the end of 2021.
2. The CTC is increased to $3,000 per child ($3,600 for children under age 6 as of the close of the year). But, the increased credit amounts are phased out at modified AGI of over $75,000 for singles, $112,500 for heads-of-households, and $150,000 for joint filers and surviving spouses. at a rate of $50 for each $1,000 (or fraction thereof) of modified AGI over the applicable threshold.
This phaseout is limited—so that it only applies to the temporarily increased amounts for 2021 (i.e., to $1,600 per child under age six, and $1,000 per child age six or older), and doesn’t apply to the $2,000 of CTC permitted under existing law. After applying this phaseout, the taxpayer’s $2,000 of CTC is subject to the phaseout rules under existing law.
3. The CTC is fully refundable for 2021 for a taxpayer (either spouse for a joint return) with a principal place of abode in the U.S. for more than one-half of the tax year, or for a taxpayer who is a bona fide resident of Puerto Rico for the tax year. That is, refundability will be determined without regard to either the earned income, or alternative, formula.
Child and Dependent Care Credit Enhanced and Made Refundable
An individual taxpayer who has one or more qualifying individuals (certain dependents) may qualify to receive a credit for expenses the taxpayer paid (“employment-related expenses”) for the care of the qualifying individual(s) so that the taxpayer can be gainfully employed.
Before the American Rescue Plan Act of 2021, the expenses considered in determining the credit couldn't exceed $3,000 for one qualifying individual or $6,000 for more than one. Before ARPA, the credit was 35% of employment-related expenses for taxpayers whose adjusted gross income (AGI) for the tax year was $15,000 or less. So, the maximum credit was $1,050 ($3,000 x 35%) if there was one qualifying individual and $2,100 ($6,000 x 35%) if there were two or more qualifying individuals.
The American Rescue Plan Act of 2021 makes several child and dependent care credit changes that apply for tax years that begin in 2021. The child and dependent care credit is refundable for taxpayers who have a principal place of abode in the U.S. for more than one-half of the tax year.
Increase in limits
For tax years beginning in 2021, the dollar limit on the amount taken into account is increased to $8,000 (from $3,000) if there is one qualifying individual with respect to the taxpayer, or $16,000 (from $6,000) if there are two or more qualifying individuals with respect to the taxpayer.
The applicable percentage is increased to 50%, reduced by one percentage point for each $2,000 (or fraction thereof) by which the taxpayer’s AGI for the tax year exceeds $125,000. Thus, for taxpayers with AGI of $125,000 or less, the maximum amount of the credit is $4,000 ($8,000 x 50%) for taxpayers with one qualifying individual and $8,000 ($16,000 x 50%) for taxpayers with two or more qualifying individuals. The applicable percentage is not reduced below the “phaseout percentage;” the phaseout percentage is 20% reduced (but not below zero) by one percentage for each $2,000 (or fraction thereof) by which the taxpayer’s AGI for the tax year exceeds $400,000.
Therefore, the applicable percentage is 50% for taxpayers with AGI of $125,000 or below. The applicable percentage decreases one percentage point for every $2,000 by which the taxpayer’s AGI exceeds $125,000 until AGI reaches $185,000. The applicable percentage is 20% for taxpayers with AGI greater than $185,000 but not greater than $400,000. For taxpayers with AGI above $400,000, the applicable percentage again decreases one percentage point for every $2,000. Thus, for taxpayers with AGI greater than $440,000, the credit is phased out completely.
Student Loan Discharges
The American Rescue Plan Act of 2021 excludes from gross income certain discharges of student loans after December 31, 2020, and before January 1, 2026. The “student loan discharge” exclusion applies to these types of loans:
1. Loans provided expressly for post-secondary educational expenses if the loan was made, insured, or guaranteed by a federal, state, or local governmental entity or an eligible educational institution.
2. Private education loans.
3. Any loan made by any educational institution qualifying as a 50% charity (for purposes of the income tax charitable deduction) if the loan is made under an agreement with any governmental entity or any private education lender that provided the loan to the educational organization, or under a program of the educational institution that is designed to encourage its students to serve in occupations with unmet needs or in areas with unmet needs and under which the services provided by the students (or former students) are for or under the direction of a governmental unit or a tax-exempt charitable organization.
4. Any loan made by an educational organization qualifying as a 50% charity or by an tax-exempt organization to refinance a loan to an individual to assist the individual in attending any educational organization but only if the refinancing loan is under a program of the refinancing organization
But, the discharge of a loan made by either an educational institution or a private education lender is not excluded under the above rules if the discharge is on account of services performed for either the organization or for the private education lender.
Tax Changes for Businesses
COBRA Premium Subsidy
Assistance-eligible individuals (AEIs) may receive a 100% subsidy for COBRA premiums for any period of COBRA coverage during the period beginning on April 1, 2021 (the first day of the first month beginning after enactment) and ending on September 30, 2021. An AEI is a COBRA qualified beneficiary (i.e., employee, former employee, covered spouse, or covered dependent) who, with respect to a period of coverage during the period beginning on April 1, 2021, and ending on September 30, 2021, is eligible for and elects COBRA coverage due to a qualifying event of involuntary termination of employment or reduction of hours.
Extended election period
Individuals who do not have a COBRA election in effect on April 1, 2021, but who would be an AEI if they did, are eligible for the subsidy. In addition, individuals who elected but discontinued COBRA coverage before April 1, 2021, are eligible if they would otherwise be an AEI and are still within their maximum period of coverage. Individuals meeting these criteria may make a COBRA election during the period beginning on April 1, 2021 and ending 60 days after they are provided required notification of the extended election period.
COBRA coverage elected during the extended election period will commence with the first period of coverage beginning on or after April 1, 2021 and may not extend beyond the AEI’s original maximum period of coverage.
The subsidy is available for any period of coverage during the period beginning on April 1, 2021 and ending on September 30, 2021. However, eligibility may end earlier if the qualified beneficiary’s maximum period of coverage ends before September 30, 2021, or if the qualified beneficiary becomes eligible for coverage under another group health plan (other than coverage consisting of only excepted benefits, or coverage under a health flexible spending arrangement or qualified small employer health reimbursement arrangement) or Medicare.
Group health plan sponsors may, but are not required to, allow AEIs to elect to enroll in different coverage. Enrollment must occur within 90 days after the date of notice informing the individual of the enrollment option. Enrollment in different coverage may be permitted only if:
1. The premium does not exceed the premium for the coverage in which the individual was enrolled at the time of the qualifying event.
2. The different coverage is also offered to similarly situated active employees at the time of the election, and
3. The different coverage is not coverage that provides only excepted benefits, or is a qualified small employer health reimbursement arrangement or health flexible spending arrangement.
AEIs must notify the group health plan if they cease to be eligible for the subsidy because they become eligible for another group health plan or Medicare. Notices must be provided in the time and manner specified by the Department of Labor.
Penalties of $250 (or more for intentional failures) may be assessed for failure to provide such notification. No penalties will be assessed for failures due to reasonable cause and not to willful neglect.
Group health plans must provide the following notices to AEIs:
1. Notice of assistance availability. Informs AEIs of the availability of the subsidy and the option to enroll in different coverage (if permitted by the employer). Must be provided to individuals who become eligible to elect COBRA during the period beginning on April 1, 2021 and ending on September 30, 2021. This notice requirement may be met by amending existing notices or including a separate document along with them. Specific content requirements apply.
2. Notice of extended election period. Must be provided to individuals eligible for an extended election period within 60 days after April 1, 2021.
3. Notice of expiration of subsidy. Must be provided between 45 and 15 days before the date on which an individual’s subsidy will expire, unless the subsidy is expiring because the individual has gained eligibility for coverage under another group health plan or Medicare. (ARPA Sec. 9501(a)(6))
Within 30 days of enactment, the Department of Labor is to issue model notices which can be used to notify eligible individuals of the availability of assistance and the availability of an extended enrollment period. Within 45 days, the Department is to issue model notices regarding the expiration of the subsidy.
Employers will be allowed a quarterly tax credit against the Medicare payroll tax equal to the premium amounts not paid by AEIs. If the credit amount exceeds the quarterly Medicare payroll tax, the excess will be treated as a refundable overpayment. The quarterly credit may be paid in advance according to forms and instructions to be provided by the Department of Labor.
AEIs are not eligible for the health coverage tax credit (HCTC) for any period of coverage in which they receive a COBRA subsidy. Subsidy amounts will not be included in the gross income of AEIs.
Increase in the Exclusion for Employer-Provided Dependent Care Assistance
For 2021 only, the exclusion for employer-provided dependent care assistance is increased from $5,000 to $10,500, and from $2,500 to $5,250 in the case of a separate return filed by a married individual.
Targeted Economic Injury Disaster Loan Advances
Under the American Rescue Plan Act of 2021, eligible small businesses may receive targeted economic injury disaster loan (EIDL) advances from the Small Business Administration. Amounts received as targeted EIDL advances are not included in the gross income of the person who receives the amounts.
No deduction or basis increase is denied, and no tax attribute is reduced by reason of the gross income exclusion.
In the case of a partnership or S corporation that receives targeted EIDL advances, any amount of the advance excluded from income is treated as tax-exempt income. Since the targeted EIDL advances are treated as tax-exempt income, they will be allocated to the partners or shareholders and increase their bases in their partnership interests. Under the single-class-of-stock rule, shareholders receive allocations of tax-exempt income from the targeted EIDL advances in proportion to their ownership interest in the S corporation.
Restaurant Revitalization Grants
Under the American Rescue Plan Act of 2021, eligible restaurants, food trucks, and similar businesses may receive restaurant revitalization grants from the Small Business Administration. Amounts received as restaurant revitalization grants are not included in the gross income of the person who receives the amounts. No deduction or basis increase is denied, and no tax attribute is reduced by reason of the gross income exclusion.
In the case of a partnership or S corporation that receives a restaurant revitalization grant, any amount of the grant excluded from income is treated as tax-exempt income. Since the restaurant revitalization grants are treated as tax-exempt income, they will be allocated to the partners or shareholders and increase their bases in their partnership interests. Under the single-class-of-stock rule, shareholders receive allocations of tax-exempt income from the restaurant revitalization grants in proportion to their ownership interest in the S corporation.
Expansion of Rule on Deduction of Compensation of Publicly Held Corporation Employees
A publicly held corporation's compensation deduction is limited to $1 million per year for compensation paid to any “covered employee.” For tax years that begin after December 31, 2026, the above rule is changed to provide that “covered employee” includes the eight other highest-paid employees, rather than the three other highest-paid employees.
However, the above rule regarding employees who were in one of the covered employee categories in preceding years, does not apply to employees who are covered employees only because of the new rule.
Mr. Charles A. Borek is Special Counsel to Elville and Associates and Founder of The Borek Group, LLC. He is a business and tax attorney with almost 30 years of experience representing individuals, small businesses, and nonprofits. He has taught law students as a visiting professor and adjunct professor of law at American University and the University of Baltimore and has lectured at Dickinson Law School of Penn State University. Chuck has written for Thomson-Reuters, Bloomberg BNA, and the American Institute of Certified Public Accountants. His book on contract drafting is used by lawyers throughout Maryland and has been cited by the Maryland courts. Additionally, Chuck presents seminars to CPAs and lawyers around the country though his company, The Borek Group, LLC, including presentations to “Big 4” accounting firms and Fortune 500 companies. Mr. Borek may be reached at chuck@elvilleassociates.com, or 443-393-7696.
