IRS adds Employee Retention Credit claims to its 2023 Dirty Dozen list.

The Internal Revenue Service recently announced its annual Dirty Dozen list of tax scams for 2023 with a reminder for taxpayers, businesses and tax professionals to watch out for these schemes throughout the year, not just during tax season.

New on the list in 2023 are Employee Retention Credit (ERC) claims, due to the “aggressive pitches” from scammers who promote large refunds related to the ERC and encourage ineligible people to claim the ERC credit.  These promotions are often based on inaccurate information related to eligibility for and computation of the credit.

The ERC is a refundable tax credit designed for businesses who continued paying employees while shutdown due to the COVID-19 pandemic or had significant declines in gross receipts from March 13, 2020 to December 31, 2021. Eligible taxpayers can claim the ERC on an original or amended employment tax return for a period within those dates.

To be eligible for the ERC credit, employers must have:

• Sustained a full or partial suspension of operations due to orders from an appropriate governmental authority limiting commerce, travel or group meetings due to COVID-19 during 2020 or the first three quarters of 2021
• Experienced a significant decline in gross receipts during 2020 or a decline in gross receipts during the first three quarters of 2021
• Qualified as a recovery startup business for the third or fourth quarters of 2021

As a reminder, only recovery startup businesses are eligible for the ERC in the fourth quarter of 2021. Additionally, for any quarter, eligible employers cannot claim the ERC on wages that were reported as payroll costs in obtaining PPP loan forgiveness or that were used to claim certain other tax credits.

Due to the level of ongoing fraud, businesses filing ERC claims may have a heightened risk of an IRS audit. If you filed an ERC claim, it is recommended that you maintain records and documentation that properly demonstrate eligibility. Employers that meet the eligibility criteria and want to file a claim, they have until April 15, 2024 for 2020 quarters and April 15, 2025 for 2021 quarters.

The top twelve schemes that made the 2023 Dirty Dozen list include:

1. Employee Retention Credit claims
2. Phishing (unsolicited emails) and smishing (unsolicited texts)
3. Online account help from third-party scammers
4. False Fuel Tax Credit claims
5. Fake charities
6. Unscrupulous tax return preparers
7. Social media: Fraudulent form filing and bad advice
8. Spearphishing and cybersecurity for tax professionals
9. Schemes aimed at high-income filers
10. Bogus tax avoidance strategies
11. Schemes with international elements
12. Offer in Compromise mills

Many of these schemes peak during filing season as people prepare their tax returns. These scams can occur throughout the year as fraudsters look for ways to steal money, personal information, data and more.

“Scammers are coming up with new ways all the time to try to steal information from taxpayers,” said IRS Commissioner Danny Werfel. “People should be wary and avoid sharing sensitive personal data over the phone, email or social media to avoid getting caught up in these scams. And people should always remember to be wary if a tax deal sounds too good to be true.”

If you believe you qualify for the ERC, we highly recommend evaluating the costs and benefits before moving forward with any company. If you have questions about ERC or suspect or are unsure about tax related solicitations, please contact your trusted advisor to clarify.

• Client Business Meals: 50% deductible if ordinary and necessary in carrying on business, taxpayer is present, provided to current or potential client or consultant and not lavish or extravagant
• Entertainment Related Meals: 50% deductible if charges are stated separately from the cost of entertainment, no deduction otherwise
• Meals Provided for the Convenience of Employer: 50% deductible
• Meals Provided to Employees Occasionally and Overtime Employee meals: 50% deductible
• Meals in Office during meetings of employees, stockholders, agents or directors: 50% deductible
• Meals During Business Travel: 50% deductible

Barring further action by Congress, many of the TCJA rules are scheduled to expire after 2025 and some may revert to tax rules that were effective in 2017. To learn more, review our chart of meal + entertainment deductions by category and tax year.  

NEW STIMULUS PACKAGE PASSED DECEMBER 21, 2020

The U.S. House of Representatives and U.S. Senate passed the Consolidated Appropriations Act, 2021 (bill), a massive tax, funding, and spending bill that contains a nearly $900 billion coronavirus aid package. The emergency coronavirus relief package aims to bolster the economy, provide relief to small businesses and the unemployed, deliver checks to individuals and provide funding for COVID-19 testing and the administration of vaccines. The over 5,500-page bill has been sent to President Trump, who is expected to sign it within the next week.

The coronavirus relief package contains another round of financial relief for individuals in the form of cash payments and enhanced federal unemployment benefits. Individuals who earn $75,000 or less annually generally will receive a direct payment of $600. Qualifying families will receive an additional $600 for each child. According to Treasury Secretary Mnuchin, these checks could be distributed before the end of 2020. To provide emergency financial assistance to the unemployed, federal unemployment insurance benefits that expire at the end of 2020 will be extended for 11 weeks through mid-March 2021, and unemployed individuals will receive a $300 weekly enhancement in unemployment benefits from the end of December 2020 through mid-March. The CARES Act measure that provided $600 in enhanced weekly unemployment benefits expired on July 31, 2020.

The bill earmarks an additional $284 billion for a new round of forgivable small-business loans under the Paycheck Protection Program (PPP) and contains a number of important changes to the PPP. It expands eligibility for loans, allows certain particularly hard-hit businesses to request a second loan, and provides that PPP borrowers may deduct PPP expenses attributable to forgiven PPP loans in computing their federal income tax liability and that such borrowers need not include loan forgiveness in income.

The bill allocates $15 billion in dedicated funding to shuttered live venues, independent movie theaters and cultural institutions, with $12 billion allocated to help business in low-income and minority communities.

The bill also extends and expands the employee retention credit (ERC) and extends a number of tax deductions, credits and incentives that are set to expire on December 31, 2020.

This alert highlights the main tax provisions included in the bill.

Paycheck Protection Program

The PPP, one of the stimulus measures created by the CARES Act, provides for the granting of federally guaranteed loans to small businesses, nonprofit organizations, veterans organizations and tribal businesses in an effort to keep businesses operating and retain staff during the COVID-19 pandemic. (PPP loans are administered by the Small Business Administration (SBA)).

A recipient of a PPP loan under the CARES Act (the first round) could use the funds to meet payroll costs, certain employee healthcare costs, interest on mortgage obligations, rent and utilities. At least 60% of the loan funds were required to be spent on payroll costs for the loan to be forgiven.

Eligible businesses

Business are eligible for the second round of PPP loans regardless of whether a loan was received in the first round. The bill changes the definition of a “small business.” Small businesses are defined as businesses with no more than 300 employees and whose revenues dropped by 25% during one of the first three quarters of 2020 (or the fourth quarter if the business is applying after January 1, 2021). The decrease is determined by comparing gross receipts in a quarter to the same in the prior year. Businesses with more than 300 employees must meet the SBA’s usual criteria to qualify as a small business.

Borrowers may receive a loan amount of up to 2.5 (3.5 for accommodation and food services sector businesses) times their average monthly payroll costs in 2019 or the 12 months before the loan application, capped at $2 million per borrower, reduced from a limit of $10 million in the first round of PPP loans.

The bill also expands the types of organizations that may request a PPP loan. Eligibility for a PPP loan is extended to:

• Tax-exempt organizations described in Internal Revenue Code (IRC) Section 501(c)(6) that have no more than 300 employees and whose lobbying activities do not comprise more than 15% of the organization’s total activities (but the loan proceeds may not be used for lobbying activities)
• “Destination marketing organizations” that do not have more than 300 employees
• Housing cooperatives that do not have more than 300 employees
• Stations, newspapers and public broadcasting organizations that do not have more than 500 employees

The following businesses, inter alia, are not eligible for a PPP loan:

• Publicly-traded businesses and entities created or organized under the laws of the People’s Republic of China or the Special Administrative Region of Hong Kong that hold directly or indirectly at least 20% of the economic interest of the business or entity, including as equity shares or a capital or profit interest in a limited liability company or partnership, or that retain as a member of the entity’s board of directors a China-resident person
• Persons required to submit a registration statement under the Foreign Agents Registration Act
• Persons that receive a grant under the Economic Aid to Hard Hit Small Businesses, Nonprofits and Venues Act

Uses of loan proceeds

The bill adds four types of non-payroll expenses that can be paid from and submitted for forgiveness, for both round 1 and round 2 PPP loans, but it is unclear whether borrowers that have already been approved for partial forgiveness can resubmit an application to add these new expenses:

• Covered operational expenditures, i.e., payments for software or cloud computing services that facilitate business operations, product or service delivery, the processing, payment or tracking of payroll expenses, human resources, sales and billing functions, or accounting or tracking of supplies, inventory, records and expenses
• Covered property damage, i.e., costs related to property damage and vandalism or looting due to public disturbances that took place in 2020, which were not covered by insurance or other compensation
• Covered supplier costs, i.e., expenses incurred by a borrower under a contract or order in effect before the date the PPP loan proceeds were disbursed for the supply of goods that are essential to the borrower’s business operations
• Covered worker protection equipment, i.e., costs of personal protective equipment incurred by a borrower to comply with rules or guidance issued by the Department of Health & Human Services, the Occupational Safety and Health Administration or the Centers for Disease Control, or a state or local government

To qualify for full forgiveness of a PPP loan, the borrower must use at least 60% of the funds for payroll-related expenses over the relevant covered period (eight or 24 weeks).

Increase in loan amount

The bill contains a provision that allows an eligible recipient of a PPP loan to request an increased amount, even if the initial loan proceeds were returned in part or in full, and even if the lender of the original loan has submitted a Form 1502 to the SBA (the form sets out the identity of the borrower and the loan amount).

Expense deductions

The bill confirms that business expenses (that normally would be deductible for federal income tax purposes) paid out of PPP loans may be deducted for federal income tax purposes and that the borrower’s tax basis and other attributes of the borrower’s assets will not be reduced as a result of the loan forgiveness. This has been an area of uncertainty because, while the CARES Act provides that any amount of PPP loan forgiveness that normally would be includible in gross income will be excluded from gross income, it is silent on whether eligible business expenses attributable to PPP loan forgiveness are deductible for tax purposes. The IRS took the position in guidance that, because the proceeds of a forgiven PPP loan are not considered taxable income, expenses paid with forgiven PPP loan proceeds may not be deducted. The bill clarifies that such expenses are fully deductible—welcome news for struggling businesses. Importantly, the effective date of this provision applies to taxable years ending after the date of the enactment of the CARES Act. Thus, taxpayers that filed tax returns without deducting PPP-eligible deductions should consider amending such returns to claim the expenses.

Loan forgiveness covered period

The bill clarifies the rules relating to the selection of a PPP loan forgiveness covered period. Under the current rules, only borrowers that received PPP proceeds before June 5, 2020 could elect an eight-week covered period. The bill provides that the covered period begins on the loan origination date but allows all loan recipients to choose the ending date that is eight or 24 weeks later.

Loan forgiveness

PPP loan recipients generally are eligible for loan forgiveness if they apply at least 60% of the loan proceeds to payroll costs (subject to the newly added eligible expenditures, as described above), with partial forgiveness available where this threshold is not met. Loans that are not forgiven must be repaid.

Currently, PPP loan recipients apply for loan forgiveness on either SBA Form 3508, Form 3508 EZ or Form 3508S, all of which required documentation that demonstrates that the claimed amounts were paid during the applicable covered period, subject to reduction for not maintaining the workforce or wages at pre-COVID levels.

The bill provides a new simplified forgiveness procedure for loans of $150,000 or less. Instead of the documentation summarized above, these borrowers cannot be required to submit to the lender any documents other than a one-page signed certification that sets out the number of employees the borrower was able to retain because of the PPP loan, an estimate of the amounts spent on payroll-related costs, the total loan value and that the borrower has accurately provided all information required and retains all relevant documents. The SBA will be required to develop the simplified loan forgiveness application form within 24 days of the enactment of the bill and generally may not require additional documentation. Lenders will need to modify their systems used for applications to make an electronic version of the new forgiveness application available to eligible borrowers.

Employment Retention Credit and Families First Coronavirus Response Credit

The bill extends and expands the ERC and the paid leave credit under the Families First Coronavirus Response Act (FFCRA).
ERC

The ERC, introduced under the CARES Act, is a refundable tax credit equal to 50% of up to $10,000 in qualified wages (i.e., a total of $5,000 per employee) paid by an eligible employer whose operations were suspended due to a COVID-19-related governmental order or whose gross receipts for any 2020 calendar quarter were less than 50% of its gross receipts for the same quarter in 2019.

The bill makes the following changes to the ERC, which will apply from January 1 to June 30, 2021:

• The credit rate is increased from 50% to 70% of qualified wages and the limit on per-employee wages is increased from $10,000 for the year to $10,000 per quarter.
• The gross receipts eligibility threshold for employers is reduced from a 50% decline to a 20% decline in gross receipts for the same calendar quarter in 2019, a safe harbor is provided allowing employers to use prior quarter gross receipts to determine eligibility and the ERC is available to employers that were not in existence during any quarter in 2019. The 100-employee threshold for determining “qualified wages” based on all wages is increased to 500 or fewer employees.
• The credit is available to certain government instrumentalities.
• The bill clarifies the determination of gross receipts for certain tax-exempt organizations and that group health plan expenses can be considered qualified wages even when no wages are paid to the employee.
• New, expansive provisions regarding advance payments of the ERC to small employers are included, such as special rules for seasonal employers and employers that were not in existence in 2019. The bill also provides reconciliation rules and provides that excess advance payments of the credit during a calendar quarter will be subject to tax that is the amount of the excess.
• Treasury and the SBA will issue guidance providing that payroll costs paid during the PPP covered period can be treated as qualified wages to the extent that such wages were not paid from the proceeds of a forgiven PPP loan. Further, the bill strikes the limitation that qualified wages paid or incurred by an eligible employer with respect to an employee may not exceed the amount that employee would have been paid for working during the 30 days immediately preceding that period (which, for example, allows employers to take the ERC for bonuses paid to essential workers).

The bill makes three retroactive changes that are effective as if they were included the CARES Act. Employers that received PPP loans may still qualify for the ERC with respect to wages that are not paid for with proceeds from a forgiven PPP loan. The bill also clarifies how tax-exempt organizations determine “gross receipts” and that group health care expenses can be considered “qualified wages” even when no other wages are paid to the employee.

FFCRA

The FFCRA paid emergency sick and child-care leave and related tax credits are extended through March 31, 2021 on a voluntary basis. In other words, FFCRA leave is no longer mandatory, but employers that provide FFCRA leave from January 1 to March 31, 2021 may take a federal tax credit for providing such leave. Some clarifications have been made for self-employed individuals as if they were included in the FFCRA.

Other Tax Provisions in the CAA

The bill includes changes to some provisions in the IRC:

• Charitable donation deduction: For taxable years beginning in 2021, taxpayers who do not itemize deductions may take a deduction for cash donations of up to $300 made to qualifying organizations. The CARES Act revised the charitable donation deduction rules to encourage donations following a decline after the enactment of the Tax Cuts and Jobs Act in 2017.
• Medical expense deduction: The income threshold for unreimbursed medical expense deductions is permanently reduced from 10% to 7.5% so that more expenses may be deducted.
• Business meal deduction: Businesses may deduct 100% of business-related restaurant meals during 2021 and 2022 (the deduction currently is available only for 50% of those expenses).
• Extenders: The bill provides for a five-year extension of the following tax provisions that are scheduled to sunset on December 31, 2020:
  • The look-through rule for certain payments from related controlled foreign corporations in IRC Section 954(c)(6), which was extended to apply to taxable years of foreign corporations beginning before January 1, 2026 and to taxable years of U.S. shareholders with or within which such taxable years of foreign corporations end
  • New Markets Tax Credit
  • Work Opportunity Tax Credit
  • Health Coverage Tax Credit
  • Carbon Oxide Sequestration Credit
  • Employer credit for paid family and medical leave
  • Empowerment zone tax incentives
  • Exclusion from gross income of discharge of qualified principal residence indebtedness
  • Seven-year recovery period for motorsports entertainment complexes
  • Expensing rules for certain productions
  • Oil spill liability trust fund rate
  • Incentive for certain employer payments of student loans (notably, the bill does not include other student loan relief so that borrowers will need to resume payments on such loans and interest will begin to accrue).
• Permanent changes: The bill makes several tax provisions permanent that were scheduled to expire in the future, in addition to the medical expense deduction threshold mentioned above:
  • The deduction of the costs of energy-efficient commercial building property (now subject to inflation adjustments)
  • The gross income deduction provided to volunteer firefighters and emergency medical responders for state and local tax benefits and certain qualified payments
  • The transition from a deduction for qualified tuition and related expenses to an increased income limitation on the lifetime learning credit
  • The railroad track maintenance credit
  • Certain provisions, refunds and reduced rates related to beer, wine and distilled spirits, as well as minimum processing requirements for certain craft beverages produced outside the U.S.

As 2020 draws to a close, we would like to remind you that this year-end may not be the same as 2019 when it comes to payroll taxes and compensation and benefits matters. This alert highlights various areas of change and what employers should be focusing on.

New Form for Reporting Non-Employee Compensation

A new form (Form 1099-NEC) is to be used to report 2020 non-employee compensation, replacing Form 1099-MISC. Entities of all sizes and types that would typically provide a Form 1099-MISC to independent contractors and the IRS need to be aware of new IRS Form 1099-NEC. Persons who paid income to non-employees during 2020 must provide the income recipient with a Form 1099-NEC and the form must be submitted to the IRS no later than January 31, 2021. Form 1099-MISC will continue to be used to report payments of certain royalties, rents, prizes and other payments of income (other than non-employee income). The form has been redesigned, so entities that use Form 1099-MISC should expect that reporting may differ somewhat from past years.

W-2 Reporting of FFCRA Qualified Sick and Family Leave Wages

Employers with 500 or fewer employees may wish to review IRS Notice 2020-54 (issued in July 2020) regarding how to report on employees’ 2020 Form W-2 the amount of mandatory, federal paid sick and family leave that the employer paid to employees under the Families First Coronavirus Response Act (FFCRA). Employers must report such wages on Form W-2 or on a separate statement, even though the employer’s out-of-pocket cost is zero after the employer receives federal payroll tax credits. The reporting requirement can be satisfied via Form W-2, Box 14 or on a separate statement.

Discriminatory Flexible Spending Accounts

Entities with health care or dependent care flexible spending accounts (FSA) that usually operate in a nondiscriminatory manner might be surprised by 2020 nondiscrimination testing if the highly compensation employees (HCE) had disproportionate usage of those benefits due to COVID-19 changes in work arrangements. For example, perhaps HCEs continued to pay third parties to care for their children while rank and file employees working from home did not, causing the average benefit provided to non-highly compensated employees to fall below the 55% level that is required to avoid taxation to the highly compensated employees. The results of discriminatory FSA can result in taxable compensation reportable on the HCE’s 2020 Form W-2.

Personal Credits for Unused Nonrefundable Airline Tickets

During 2020, many employees obtained nontransferable credits from airlines for nonrefundable airline tickets that were originally purchased for a business trip that was canceled due to the coronavirus pandemic. Since the employee now has a personal credit with the airline that can only be used by the employee, employers may wish to consider whether they should tax this as property transferred to the employee in connection with the performance of services under Internal Revenue Code (IRC) Section 83, since the employee has unrestricted use of the airline credit (i.e., use of the credit is not limited to a business purpose). The answer depends on the facts and circumstances of the situation, so please contact your local advisor for more information.

COVID-19 Qualified Disaster Payments to Employees

Generally, anything of value that an employer provides to an employee is deemed to be taxable wages to the employee, unless an exception applies. Since COVID-19 was declared a national emergency on March 13, 2020, employers can use IRC Section 139 to make tax-free, tax-deductible “qualified disaster payments” to employees. Such payments can be made on tax-free basis until the national emergency is lifted.

With respect to COVID-19, employers can pay for, reimburse or provide in-kind benefits reasonably believed by the employer to result from the COVID-19 national emergency that are not covered by insurance. For example, employers could pay for, reimburse or provide employees with tax-free payments for over-the-counter medications, hand sanitizers, home disinfectant supplies, child care or tutoring due to school closings, work-from-home expenses (e.g. setting up a home office, increased utilities expenses, higher internet costs, printer, cell phone, etc.), increased costs from unreimbursed health-related expenses and increased transportation costs due to work relocation (such as taking a taxi or ride-sharing service from home instead of using public mass transit).

There is no Form W-2 or Form 1099 reporting for IRC Section 139 payments.

Leave Donation

Due to COVID-19, many employees canceled vacations, doctors’ appointments, planned medical procedures, etc., leaving them with unused but accrued paid time off (PTO). Some employers allow employees to donate unused PTO to other employees who may need it. If not handled correctly, both the donating employee and the recipient employee may have taxable income. However, if IRS rules are followed, employers would not include the donated PTO in the donor’s Form W-2 but would include it in the recipient employee’s 2020 Form W-2. Also, Notice 2020-46 provides that cash payments that employers make to charities that provide relief to COVID victims in exchange for employees forgoing PTO are not taxable wages for the donor-employees and would not be included in the donor’s 2020 Form W-2.

Higher Imputed Income for Personal Use of Company Cars

Personal use of a company car is imputed wage income for an employee. Employers can choose not to withhold federal income tax if the employee is properly notified by January 31 of the election year or 30 days after a vehicle is provided and the value is properly reported on a timely filed Form W-2. However, employers must withhold FICA taxes on such benefits.

Due to COVID-19 restrictions during 2020, some employees who use company cars may have experienced an unexpected shift in the percentage of business versus personal use of company-provided vehicles. As a result, some employees may have significantly higher imputed income because the company car was not used as much for business during 2020. For example, if the company car was parked at the employee’s home (even if unused), the employee had personal use of the car for the period of time that the car was not used for business. This may come as a surprise to many employers and employees. The IRS has not yet published any relief that would change the normal imputed income inclusion rules for these circumstances.

Employer-Paid Student Loan Debt

During 2020, the CARES Act allows employers to pay up to $5,250 of their employees’ student loan debt and not treat such payments as taxable wages. The payments can only be made under a non-discriminatory, written tuition assistance plan that complies with IRC Section 127.

Year-End Employee Benefit Plan Elections

Due to COVID-19 uncertainties, employees should carefully consider irrevocable elections that may have to be made by year-end with respect to certain 2021 employee benefits, such as health and welfare benefits provided under a flexible benefits plan (also known as a “cafeteria” plan under IRC Section 125). These elections could include dependent care flexible spending accounts or health care flexible spending accounts (both of which have “use it or lose it”) rules. Employees should also consider whether any adjustments are needed to their qualified transportation fringe benefit elections for tax-free payments of parking, mass transit or other commuting benefits available under IRC Section 132(f). Although those elections can generally be changed monthly, year-end is a good time to carefully review any elections that employees may have in place.

Payroll Tax Deferrals

The CARES Act allows employers to defer the deposit of the employer’s share of FICA on wages earned from March 27 to December 31, 2020, with 50% of the deferred amount required to be repaid by December 31, 2021 and the other 50% repaid by December 31, 2022. A presidential executive order allows employers to defer deposit of the employee’s share of FICA on wages earned from September 1 to December 31, 2020, with repayment due ratably from January 1 to April 30, 2021. Both deferral opportunities expire on December 31, 2021, so employers should ensure that regular FICA tax withholding and deposit rules apply to wages earned on January 1, 2021.

Background

The forgivable loan program known as the Paycheck Protection Program (PPP) was established by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) to provide financial resources to small and mid-size businesses to enable them to maintain payroll and cover certain expenses during the coronavirus pandemic. PPP loans may be forgiven upon application. Although loan forgiveness typically creates a taxable event, under the CARES Act, PPP loan proceeds are specifically excluded from taxable income. However, PPP loan recipients should be aware that forgiveness of the loan, in whole or in part, may cause 2020 qualified research expenses (QREs) to become ineligible for the research and development (R&D) tax credit. Under Internal Revenue Code Section 41(d)(1)(A), a taxpayer cannot claim an R&D tax credit on expenditures (employee wages tend to be a large component of the qualified research expenses) that are not deductible, and based on guidance issued by the IRS in March 2020 (Notice 2020-32), expenses paid using forgiven PPP loan funds will be nondeductible for tax purposes even if they would otherwise be deductible. Consequently, any wages paid to employees using forgiven PPP loan proceeds are not eligible as QREs, thus, decreasing federal and state R&D credits.

Understanding PPP Loan Forgiveness

It is important to understand how forgivable PPP loan funds must be allocated among a taxpayer’s costs so that eligible R&D expenses incurred might still qualify for the R&D tax credit. Current guidance provides that PPP forgivable loan funds must be applied to the following expenses:

• At least 60% of the funds must be used for eligible payroll costs, including cash compensation, employee benefits and owner compensation.
• Up to 40% of the funds may be applied to the following nonpayroll costs:
  • Rent
  • Utilities
  • Interest on mortgage obligations
  • Interest payments on any other debt obligations that were incurred before February 15, 2020

PPP loan forgiveness application forms include a requirement that the borrower maintain all records relating to the borrower’s PPP loan (including documentation necessary to support the borrower’s loan forgiveness application, such as the names of individual employees and wages).[1] However, there is no requirement on how the PPP loan funds have to be allocated to individual employees, which allows the borrower to make its own determination as to which employees the PPP forgivable loan funds should be applied.

Mitigating the Effect of PPP Loan Forgiveness on the R&D Costs

By applying the PPP forgivable loan funds to nonpayroll costs (up to 40% of the PPP loan funds) and employees that do not perform qualified research activities, borrowers could preserve the wages paid to employees involved in qualified research activities as deductible, thus mitigating the impact of the forgiven PPP loan funds on their R&D credit.

Companies claiming R&D tax credits and that have filed or have yet to file for PPP loan forgiveness should consider analyzing the eligible costs and allocating the forgivable funds in the following order (up to the certain limitations):

1. Interest on mortgage obligations
2. Rent
3. Utilities
4. Interest on any other existing debt obligations
5. Certain employee benefits relating to healthcare
6. Payroll costs that are non-taxable
7. Payroll costs for employees who are not performing R&D-qualified services, e.g., accounting, finance, human resources
8. Payroll costs for employees who are performing R&D-qualified services[2]

Example

The following example shows how PPP forgiven loan funds used for QREs can reduce the amount of R&D tax credit available to borrowers.

Insights

PPP loan recipients should review their PPP eligible costs to determine whether they can reduce the impact on the R&D tax credit by allocating some or all of their forgivable PPP loan funds to expenses other than research-related expenses. Key items to review include whether and to what extent the loan recipient:

• Plans to file for or has received full or partial forgiveness of the PPP loan funds
• Allocates the potentially forgivable PPP loan funds to QREs
• Files for forgiveness, subject to limitations, on nonpayroll costs and non-QREs to reduce the impact on the R&D tax credit

Future IRS guidance may create additional requirements relating to the allocation of the PPP forgivable loan funds to costs, so it is important for taxpayers with PPP loans that want to qualify for the R&D tax credit to monitor developments carefully.

[1]  Form 3508 Schedule A Worksheet requires borrowers to list the names of individual employees to whom the requested PPP forgivable loan funds were applied.  Form 3508 Schedule A Worksheet must be maintained by the borrower but is not required to be submitted with the PPP loan forgiveness application to the lender.

[2] For each individual employee, the total amount of cash compensation eligible for PPP loan forgiveness may not exceed an annual salary of $100,000, as prorated for the covered period.

Earlier in the year, the Small Business Administration (SBA) announced in an updated FAQ on the program that it will be auditing all Paycheck Protection Program (PPP) loans of $2 million or more. Borrowers whose loans meet this threshold amount might receive a Loan Necessity Questionnaire from their lender soon after they apply for loan forgiveness.

Even though the official channels indicate the questionnaire is not yet final, we understand that SBA is already sending letters to lenders instructing them to send the questionnaire to specific borrowers within five business days. Borrowers have only 10 business days of receipt of the questionnaire to return a completed version to the lender, which the lender must then submit to SBA within five business days. Both borrowers and lenders may be surprised by the short turnaround time and the extent of detailed information requested, as well as signatures, certifications and supporting documentation. Since the requested information may not be readily available and could take considerable time and effort to compile, borrowers should begin gathering the information on the questionnaire even before they receive the request from their lender.

Insight:

SBA has already sent the questionnaire to some PPP lenders for delivery to borrowers, although SBA has not officially announced the finalization of the form and the process.

For-profit employers will receive Form 3509 asking about business operations, while non-profit employers will receive Form 3510.

Unlike the PPP loan application and loan forgiveness forms, SBA has not yet posted Form 3509 or 3510 on its website. However, copies of Forms 3509 and 3510 have been widely circulated on the internet.

Despite the short turn-around time and complex data required to complete the questionnaire, it seems that extensions of time to complete the questionnaire will not be available. SBA has 90 days under the CARES Act to approve PPP loan forgiveness (regardless of the size of the loan), which may make it unlikely for SBA to grant extensions on information that might be relevant to its approval process.

The following is a summary of the purpose of new Forms 3509 and 3510 (for profit-making borrowers and non-profit borrowers, respectively), which contain the questionnaire, as well as the key items included on both forms.

What is the purpose of the new forms?

It seems that SBA will use the new Forms 3509 and 3510 to evaluate borrowers’ good-faith certifications of their economic need for the PPP loan. Some critics view the forms as SBA’s attempt to change PPP rules retroactively to penalize borrowers that (in hindsight) did not actually have the requisite financial need to qualify for a PPP loan.

Remember that the PPP was intended to provide disaster relief to small employers (generally those with 500 or fewer employees) facing economic uncertainty (for example, due to COVID-19 governmental shut-down or stay-at-home orders) and for whom the loan was necessary to support the ongoing operations of the business. In the early days of the PPP, some entities received sizable PPP loans even though they were not eligible (often because they did not face the requisite economic uncertainty for the PPP loan).

Widely circulated media reports identified several well-funded publicly traded companies, universities with significant endowment funds and affiliates of such entities that had quickly received PPP loans and may have caused the program’s original funding to run out prematurely. Many of those ineligible borrowers returned their loans during an amnesty period that expired in May 2020. To further address possible abuse, the Treasury Secretary said that SBA will closely review all PPP loans of $2 million or more, seemingly using the Loan Necessity Questionnaires to do so.

Insight:

In the October 26, 2020 Federal Register, SBA estimated that 52,000 borrowers will need to complete these new forms (about 42,000 for-profit borrowers and 10,000 non-profit borrowers).

Notably, the new forms may be sent to borrowers that received a PPP loan of less than $2 million if they, together with their affiliates, received an aggregate of $2 million or more in PPP loans. Original PPP program rules generally limited the availability of PPP loans to one loan per controlled group of entities, but in reality, various members of a controlled or affiliated group may have received separate PPP loans. To address that situation, SBA included a box that borrowers must check on their PPP loan forgiveness applications (the Form 3508 series) if they, together with affiliates, received $2 million or more of PPP loans. SBA will review all loans within that controlled group.

The questions on the new forms seem to indicate that SBA will be evaluating the “economic necessity” for the borrower’s PPP loan both on the PPP loan application date and thereafter. The loan application only required borrowers to make a good faith certification of economic necessity as of the loan application date, so it is unclear why SBA is asking about what actually happened to the borrower’s operations afterwards.

What are the key items on the new forms?

Each of the forms has two sections: a “Business Activity Assessment” and a “Liquidity Assessment.”

Business Activity Assessment

This section asks for-profit borrowers for detailed information and documentation about the impact of COVID-19 on their businesses, including whether the business was subject to mandatory or voluntary closures and whether it made any changes in its operations. The borrower also must report gross revenue for Q2 2020 and Q2 2019 and indicate whether it made any capital improvements between March 13, 2020 (i.e., the date that COVID-19 was declared a national disaster) and the end of the borrower’s “covered period” (a maximum of 24 weeks from the date their PPP loan was funded). Borrowers can include additional comments on any of these questions. Non-profit borrowers must provide similar information, but the definition of gross receipts includes grants, gifts and contributions, and non-profit borrowers must submit Q2 expenses for 2019 and 2020.

Liquidity Assessment

This section asks for the following information:

• All borrowers must disclose:
  • Whether the borrower prepaid any outstanding debt before it was contractually due, between March 13, 2020 and the end of the borrower’s covered period.
  • The number of employees (including owners) paid more than $250,000 on an annualized basis and the total number of employees and total compensation paid to those employees during the covered period.
  • Whether the borrower received funds from any CARES Act programs other than the PPP, excluding tax benefits.
  • Any additional comments that have bearing on any of the liquidity assessment questions.

• For-profit borrowers must disclose:
  • The borrower’s cash position as of the end of the quarter immediately before the PPP application date and whether the borrower has paid any dividends or other capital distributions (other than estimated taxes) between March 13, 2020 and the end of their covered period.
  • Whether the borrower (or any affiliate) is publicly traded in the United States or a foreign country (and if so, total market capitalization must be reported).
  • Whether at least 20% or more of the borrower was owned by a private equity, venture capital or hedge fund.
  • Its book value (i.e., shareholder’s equity) on the last day of the calendar quarter immediately before the PPP application date.

• Non-profit borrowers must disclose:
  • Cash, cash equivalent and short-term investment position as of the end of the calendar quarter immediately before the PPP application date, as well as the value of non-cash investments.
  • Whether the borrower has restrictions on using net income, cash, savings or investments for payroll and nonpayroll costs otherwise eligible for the PPP forgiveness.
  • Whether the borrower holds assets in endowment funds.
  • If the borrower is a school, college or university, whether it offered additional financial assistance to students and if it had declines in tuition revenue due to COVID-19.
  • If the borrower provides healthcare services, the amount of its program service revenue relating to patient care in Q2 2019 and 2020.

As a reminder, the PPP loan eligibility and loan forgiveness process continues to evolve; hopefully, SBA or the Treasury Department will soon clarify how the answers to these questionnaires may impact borrowers’ PPP loan forgiveness.

Understanding obligations and available state tax relief will help businesses navigate the pandemic.

As businesses continue to assess the myriad implications of the COVID-19 pandemic, one area of focus should be on the impact of legislation, regulations and guidance issued at the state and local levels. This becomes increasingly more complex for businesses that operate or have employees in multiple states. Over the past several months, state and local governments have released various tax-related measures in response to the coronavirus pandemic, addressing areas such as state income tax, sales and use tax, property tax and unclaimed property. These measures could affect state tax obligations. In addition, some states have introduced measures that provide relief and/or incentives to businesses.

State Income Tax

The COVID-19 pandemic is forcing millions of employees to work remotely, and there are three potential state tax impacts that could result: nexus, payroll tax withholding and apportionment. With limited—and sometimes inconsistent—guidance from states, businesses will need to monitor these issues closely and address them as they arise.

The first issue is whether having an employee work remotely due to COVID-19 will create a taxable presence (or nexus) for the employer in that state even if the employer does not carry out any other nexus-creating activities in that state. To date, at least 15 states have issued guidance regarding teleworking employees and nexus. In most cases, states have indicated that nexus is not created by an employee teleworking in the state due to COVID-19. While this is a welcome clarification, some questions remain unanswered, such as the nexus implications for businesses once a state lifts its emergency order or where the business lifts its own stay-at-home requirement, but the employee continues to work from home. In states that have not issued guidance on the nexus implications of employees working remotely, businesses may have nexus and new filing and compliance requirements.

Second, state payroll tax withholding obligations should be considered. To date, only six states have issued guidance on the withholding tax requirements for wages paid to employees working remotely. In some cases, states have indicated that employers do not need to withhold tax for employees who are working in that state due to COVID-19, while other states have taken the opposite position. In addition, employees working from home in a state other than the state where the employer’s facilities are located must determine whether their residence state will grant a credit for taxes paid to the employer’s state. In certain situations, teleworking employees could be subject to double taxation if both the employer and employee’s states require wage withholding.

Third, teleworking employees impact business’ apportionment factors. Only a few states have provided guidance in this area, likely because most states have shifted to a single sales factor formula without a payroll factor; thus, the state does not have to address how to source a teleworking employee’s wages for payroll factor purposes. However, businesses that generate service revenues will need to consider those states that adopt cost-of-performance sourcing for service revenues. Those revenues may need to be sourced to a different state due to the location of the teleworking employees. Changes in revenue sourcing could create a higher or lower apportionment factor depending on whether the business or teleworking employees or both are located in a cost of performance state.

Sales and Use Tax

COVID has also had an impact in the sales and use tax area, such as nexus and filing obligations in new states, the introduction of new sales and use tax exemptions, and sales and use tax filing extensions and penalty abatements.

It has been more than two years since the U.S. Supreme Court issued its landmark decision in South Dakota v. Wayfair, in which the court held that a physical presence is not required for a remote seller to collect sales tax in the state provided the seller meets an economic threshold. Based on Wayfair, states are empowered to require remote sellers to administer sales tax; only two states (Florida and Missouri) have not revised their sales tax laws to adopt “economic nexus.” However, all states that have enacted the concept of economic nexus (except Kansas) provide a safe harbor for small sellers. Many businesses are still evaluating the impact of economic nexus and in which states they are required to administer sales tax.

Businesses that were taking a no-nexus position in a state due to a safe harbor (e.g., annual sales under $100,000 and fewer than 200 transactions) may now have nexus because they have employees working remotely in that state. A few states (including New Jersey and Rhode Island) provide an exception when nexus is triggered because an employee is temporarily working from home due to COVID-19.

Some states have introduced new sales and use tax exemptions as a result of the coronavirus pandemic. For example, there is an exemption from self-assessing and remitting use tax on eligible items that are withdrawn from inventory and donated for COVID-19 assistance; in Indiana, the exemption extends to medical supplies, food and cleaning supplies.

Some states, like Florida and Texas, have expanded their back-to-school sales tax exemptions to include personal protective equipment (PPE), such as face masks and shields. Other states have bills pending to exempt the purchase of PPE from sales tax, although enactment of these proposals is likely to face some challenges. State general assemblies may not be in session until 2021 and, more fundamentally, states may object to new exemptions because they need the tax revenue to provide essential services.

Finally, some states have provided tax return filing extensions or abatements of automatic penalties. It should be noted that even if a state has not announced automatic relief, most states provide for an abatement of penalties due to “reasonable cause.” Companies seeking an abatement of penalties should consider taking steps to avoid paying penalties, rather than paying and subsequently requesting relief.

Credits and Incentives

Many states have introduced new incentive programs and/or revamped existing ones to allow more businesses to benefit. While some of these programs have been widely publicized, other incentive programs must be sought out. California has expanded the Employment Training Panel Grant to give approval preference to industry groups that include many “essential businesses” and has raised the cap on allowed safety training. North Carolina has created a Job Retention Program specifically in response to COVID-19, which allows companies to apply for cash grants based on the prior year’s payroll costs. Several states, including Massachusetts, Missouri and Ohio, have enacted grant programs to incentivize existing businesses to retool their facilities to produce PPE.

To help companies keep their employees safe and adjust to new protocols, some states, including Arizona, California and North Carolina, have updated existing training programs to include COVID-19-related training for incumbent workers. Other states have created specific COVID-19 safety training, developed by health and safety experts, which is offered to businesses free of charge.

Some states have postponed compliance requirements for existing incentive agreements. For example, Indiana and Ohio have announced they will not hold companies to 2020 employment commitments and are relaxing the enforcement of compliance reporting deadlines. Other states, such as Georgia, are adjusting headcount increase measurements for purposes of job tax credits; Georgia will allow companies to use 2019 headcount details if the 2020 headcount is skewed by short-term COVID-19-related job reductions.

In addition to programs offered at the state level, many city and county jurisdictions have developed their own programs to help companies deal with the detrimental economic effects of COVID-19. These programs include cash grants and zero-interest loans.

Property Tax

The effects of the coronavirus pandemic on property values will have a direct impact on real and personal property tax liabilities during the next property tax cycle. As jurisdictions prepare to counterbalance any loss in property tax revenue, businesses should be prepared to capture any detriments to value for the upcoming lien date(s). Some jurisdictions have adopted measures to preserve their tax bases, including the expansion of audits, aggressive audit assessments, abolition of exemptions, increases in the tax rate and proposed legislation that would impact assessments.

In California, voters will vote on legislation in November that would eliminate Proposition 13 (which limits property tax increases and reassessments) for most commercial businesses. This initiative, referred to as the “split roll,” would be created to maintain Proposition 13 for specific property, while Proposition 15 would allow for the revaluation of commercial property on a consistent basis and eliminate the statutorily limited annual increase. If the initiative is passed, it could result in a significant increase in the California real estate tax for many businesses.
Businesses should begin gathering data to analyze the potential impacts to property values. Consideration should be given to factors associated with any reduced revenue, increase in expenses, changes in the workforce, non-utilization of assets, deferred maintenance and additional requirements as a result of COVID-19. Detriments to value should be incorporated through personal property filing on the 2021 renditions, as well as through reviews of real property assessments to potentially lower real property values for the appeal deadlines throughout 2021.

Unclaimed Property

All states have laws regulating the reporting and remittance of unclaimed property (also referred to as abandoned property or escheat). Unclaimed property can include various types of intangible property, as well as some tangible personal property, depending on state law. Common types of unclaimed property include uncashed payroll or commission checks; uncashed vendor checks; unresolved voids, unredeemed gift certificates and gift cards; customer credits, layaways, deposits, refunds and rebates; overpayments and unidentified remittances; and accounts receivable credits, including credits that have been written off and recorded as income or expense (e.g., bad debt, miscellaneous income, etc.).

A holder of unclaimed property is required to report the property to the appropriate state after the time prescribed by the state has passed (the dormancy period). The purpose is to ensure that the property is returned to its rightful owner, the premise being that the state is in a better position to hold the property and return it to the rightful owner, and, in the interim, property held and derivative funds earned on the property may be used for the public good. Jurisdiction over unclaimed property is in the state of the rightful owner’s address, and if the owner’s address is unknown, the state where the holder is incorporated/formed; thus, even organizations that operate in only one state can have unclaimed property obligations in multiple states.

COVID-19 has significantly impacted how businesses address unclaimed property compliance for two main reasons.

First, many businesses have furloughed staff or implemented reduction in workforce measures that have created delays in complying with escheat compliance deadlines. Escheat compliance filings are categorized into (a) spring filings, January 1 through July 1, and (b) fall filings, October 31 or November 1. Some states, including California, Illinois, Michigan, Pennsylvania and Vermont, have granted extensions or waived penalties or interest (automatically or upon request) for the spring filings. However, no extensions or automatic waivers of penalties or interest have been provided for fall filings. Instead, most states have provided holders with online filing and payment instructions. Missed deadlines could result in penalties and interest or create additional audit risk.

The risk of penalties and interest is potentially increased based on the 2019 New York high court decision in New York ex. rel. Raw Data Analytics LLC v. JPMorgan Chase & Co., N.Y. Supp. Ct., No 100271/2015 (August 30, 2019, appealed October 3, 2019), in which the court ruled that JP Morgan was not entitled to judgment as a matter of law for its failure to self-assess and pay interest on late-reported unclaimed property. Presumably, if this case stands, holders in New York will be required to self-assess interest. Failure to do so could result in additional costs. Other states will likely follow suit.

Second, many businesses’ finance, treasury and/or accounting functions operate on a remote work or hybrid platform. This makes reviewing state mailings or notices in a timely fashion or accessing manual records or ancillary systems to assist in escheatment projects difficult. For example, Delaware sends notices to holders requiring them to enter into the state’s Voluntary Disclosure Agreement (VDA) program or risk being audited. Many holders missed the opportunity to enroll in the Delaware VDA program by failing to file the form within 60 days of receiving an initial letter from the state. This is largely because individuals were not in the office to receive and review the letter and distribute to appropriate management. Delaware sent letters February 20, 2020, and extended the VDA deadline to July 18, 2020, but many businesses still missed the deadline and received audit letters the following week. Furthermore, the inability to be in the office where necessary records are kept can result in delays in compliance with voluntary disclosure and audit requirements. To date, most states and auditors have been flexible with the timing of requests due to COVID-19, but this flexibility is expected to decrease in Q4 2020 and into 2021.

Businesses are likely to continue to operate in understaffed capacities and in a remote environment for an indeterminate period of time. Notwithstanding, holders of unclaimed property should consider dedicating some internal resources to address escheat compliance obligation or outsource the function to a third party to avoid the significant costs associated with non-compliance.

Insights

In summary, businesses should consider the following when navigating the complexities resulting from the effect of COVID-19 on their workforce:

• Be aware of and understand the tax legislation, regulations and guidance released at the state and local levels. While some states have announced that they will not assert nexus simply because employees are working remotely during the pandemic, in other cases businesses may have additional state tax filing obligations, such as income, sales and use, and payroll tax filings.
• Take advantage of state legislation and programs designed to assist businesses during the pandemic, such as new sales and use tax exemptions for PPE, new or revamped credit and incentive programs to expand training grants to include COVID-19, opportunities to reduce personal and real property tax assessments due to reductions in value as a result of the pandemic, and any additional opportunities to participate in unclaimed property VDA programs.
• Take advantage of filing extensions granted by the states, such as for state income tax, sales and use tax, credit and incentives, compliance reporting and unclaimed property filings. Businesses should be aware of and request penalty and interest abatements in cases where they have filed late; in some instances, an abatement may be automatic due to COVID-19 but in other cases the abatement must be requested.

Two of the most formidable hurdles businesses face are limited resources and competing priorities. Addressing risk, while understanding potential savings opportunities, will prepare businesses to emerge stronger from the uncertainty created by the pandemic.

THE 2020 TAX PLANNING PARADOX – ACCELERATE INCOME TO LOWER YOUR TOTAL TAX LIABILITY

As 2020 winds down, it’s time to consider year-end planning. It’s an unusual year, with taxpayers experiencing losses due to the economic downturn and the possibility of higher income tax rates next year. Consequently, we need to rethink the traditional year-end advice of deferring income and accelerating deductions to minimize one’s total tax liability over the years. Accelerating income in 2020 has several advantages. First, the Tax Cuts and Jobs Act reduced the maximum individual tax rate from 39.6% to 37%. Second, many taxpayers will be in a lower tax bracket this year from losses incurred in this economic downturn. Third, accelerating income increases a taxpayer’s adjusted gross income (AGI) limitation for charitable contributions. The CARES Act suspends the traditional 60% AGI limitation and permits individual taxpayers to take a charitable contribution deduction for qualifying cash contributions made in 2020 to the extent such contributions do not exceed the taxpayer’s AGI.

Here’s a rundown of some ways to accelerate income in 2020.

Convert a traditional Individual Retirement Account (IRA) to a Roth IRA

Assets held in traditional IRAs have several disadvantages compared to assets held in Roth IRAs: Distributions in excess of basis are taxable as ordinary income, required minimum distributions must begin once a taxpayer reaches age 70½ (72 for taxpayers who attain age 70½ after December 31, 2019), and early withdrawals before age 59½ are subject to a 10% penalty unless one of several exceptions apply.

One way to mitigate these disadvantages while accelerating income in 2020 is to convert the traditional IRA to a Roth IRA. In doing so, the taxpayer will accelerate the ordinary income tax liability that would otherwise be due upon distribution had the assets remained in the traditional IRA.  Conversion in 2020, while the asset values are likely to be temporarily lower than normal, reduces the tax liability while allowing the future recovery in value plus all appreciation to avoid taxation. The earning power of the account is maximized because there will be no required minimum distributions during the taxpayer’s lifetime (heirs will be subject to the required minimum distribution rules). While the income taxes have been paid on the converted amount, distributions from the converted amounts only remain subject to the 10% early withdrawal penalty for five years unless the taxpayer has attained age 59½.

The earnings and appreciation on the account can be distributed tax and penalty-free, provided the account is at least five years old and the IRA owner is at least 59½. Other distributions qualifying for tax-free treatment include those (i) made to a beneficiary (or estate) after the death of the Roth IRA owner, (ii) made due to the Roth IRA owner’s disability, or (iii) made under first-time homebuyer exception.

Elect out of installment sales

The installment sale rules require taxpayers who sell property where at least one of the payments will be received in a subsequent taxable year to recognize a portion of the gain as each payment is received. By electing out of the installment method, a taxpayer may recognize the entire gain in the year of sale. The election must be made on a timely filed return (including extensions) and is irrevocable once made.

Trigger an inclusion event for opportunity zone investments

The Tax Cuts and Jobs Act permitted taxpayers to defer tax on capital gains invested in a qualified opportunity fund (QOF) until the earlier of an inclusion event or December 31, 2026. Presidential candidate Joe Biden has proposed subjecting capital gains to a 39.6% ordinary income tax rate for those taxpayers with over $1 million in income. Thus, there exists the possibility that a deferral until December 31, 2026, will result in a capital gains tax on the deferred gain at a rate of 39.6% instead of the current 23.8%. Inclusion events include a gift, disposition or sale of the QOF. In addition, for those QOFs held in a grantor trust, the termination of the grantor trust status for reasons other than the death of the grantor is also an inclusion event.

Harvest capital gains

Harvesting capital gains is an ideal strategy to hedge against a future increase in the capital gains tax rate. Here, a taxpayer can increase their cost basis by selling an appreciating investment and then use the sales proceeds to repurchase the same or a similar investment. While the sale will realize a taxable gain, the repurchase of the investment will provide a stepped-up cost basis and later yield a lower gain when the investment is sold in the future – when the capital gains tax rate is higher. The wash sale rules, which dissuade harvesting tax losses, do not apply to harvesting capital gains.

Forgo like-kind exchanges 

The Tax Cuts and Jobs Act limited the nonrecognition of gain from like-kind exchanges to exchanges of real property not primarily held for sale. When a transaction qualifies as a like-kind exchange, nonrecognition treatment is mandatory. To avoid the imposition of the like-kind rules, a taxpayer merely needs to actually or constructively receive cash or other boot in the transaction. For deferred gains on prior like-kind exchanges, taxpayers can trigger the gain recognition by selling the replacement property.

Exercise stock options

Nonqualified stock options (NQSO) are a useful tool for taxpayers who are looking to accelerate income because they generate taxable compensation equal to the fair market value of the shares less the exercise price when exercised. Employees may be offered the ability to defer their income tax liability on the exercise by making a Section 83(i) election. The Section 83(i) election is a useful cash conservation strategy that allows an employee to exercise more options before additional appreciation drives up the amount taxed as ordinary compensation without an immediate cash outlay for income taxes. However, the election to defer will not be useful to those looking to accelerate income to the current year for tax planning purposes.

Incentive stock options (ISO) are taxed upon disposition of the ISO shares rather than upon exercise of the option. The sale proceeds minus the exercise price of ISO stock are taxed at capital gain rates, provided the sale occurs not sooner than 1 year after exercise and 2 years after grant of the option.  Earlier dispositions of the ISO shares generate taxable compensation equal to taxation as a NQSO, with any excess gain taxed as capital gains.

Restricted stock awards are generally taxed to the employee when the shares vest unless the employee elects to be taxed upon receipt of the unvested shares by making a Section 83(b) election.

Declare and pay C corporation dividends

C corporations are well-known for their “double taxation” concept. That is, a C corporation is taxed on its earnings, and any dividend paid from the C corporation’s earnings are also taxable to the shareholder while not being deductible to the corporation. To avoid the second layer of tax, shareholders often cause the C corporation to retain earnings rather than distribute dividends. However, shareholders may find the low tax rates and losses in 2020 an ideal time to pull cash out of their C corporations by taking dividends.

Summary

The novel coronavirus (COVID-19) pandemic is changing the way we work. More specifically, it is changing where we work. At first blush, simply working from home might not raise any tax-related red flags. Why should it matter for a business whether its employees work from home temporarily or if they work remotely in a state other than where the employer’s base of operations is located?

In the discussion that follows, we explore three important state and local tax (SALT) effects that could result from teleworking employees. First, what are the employer’s state payroll tax withholding obligations when employees are temporarily working from home in a state different than the normal base of operations, and, what impact could the employer’s withholding have on the teleworking employee’s residence state tax returns? Second, does teleworking due to COVID-19 create nexus in a state? Third, how does teleworking impact the apportionment factors of a multistate business?
Details

Payroll Tax Withholding
When it comes to payroll taxes and teleworking employees, there are implications for the employer and employee. Will an employer’s payroll tax withholding obligations on employees’ wages be affected when those employees are now teleworking at home in another state? For those employees, will their resident state credit withheld payroll taxes of the employer’s state while the employee is teleworking from home? The second issue, unfortunately, is not receiving the attention it deserves from states. As a result, teleworking employees could be subjected to multiple taxation, if the employer’s state allows the employer to follow the status quo, but the employee’s residence state thinks otherwise.

Further, a state such as New York may follow a “convenience of the employer” rule and require withholding of payroll taxes on employee wages while an employee of a New York employer is teleworking outside of New York at their home. New York permits an allowance for days worked outside New York, if “based upon the performance of services which out of necessity, as distinguished from convenience, obligate the employee to out-of-state duties in the services of his employer.” While one could reasonably consider the COVID-19 pandemic to satisfy such an allowance, it appears New York tax authorities may think otherwise.

At least six states have issued guidance on withholding on wages paid to teleworking employees, including Maryland, Massachusetts, Mississippi, New Jersey, Ohio, and Pennsylvania. However, so far, only Massachusetts and New Jersey have provided their residents a corresponding credit for wages subject to withholding by another state due to COVID-19.

In its technical information release, Massachusetts indicates the following:

• A resident employee suddenly working in Massachusetts due to a state’s COVID-19 state of emergency who continues to incur an income tax liability in that other state because of that state’s sourcing rule will be eligible for a credit for taxes paid to that other state under G.L. c. 62, § 6(a). In addition, the employer of such employee is not obligated to withhold Massachusetts income tax for the employee to the extent that the employer remains required to withhold income tax with respect to the employee in such other state.

States like Pennsylvania and Mississippi, on the other hand, have instructed employers to continue to withhold on wages paid to employees, as if the employees were not temporarily teleworking in other states. It might seem that those states are doing the companies a favor by allowing them to continue to follow the status quo and not requiring the employer to change its withholding practices. However, the residence state where the employees are now teleworking may see things differently. For example, a Delaware employer with an employee now teleworking from a home in Maryland, the employee’s state of residence, will be required to withhold tax on those wages, because Maryland does not have a reciprocity agreement with Delaware. However, the employer would be excused from withholding if services were being performed by an employee teleworking from a Virginia residence, since Maryland and Virginia are parties to a reciprocity agreement.

State payroll tax withholding as a result of COVID-19 and teleworking raises a host of questions as varied as are the teleworking circumstances of employers and employees. Convenience of employer rules, status quo guidance, reciprocity agreements, and resident state credits are all factors that must be considered.

Nexus
More so than payroll withholding requirements, states have been addressing whether income tax nexus is created by employees temporarily teleworking in a state due to COVID-19 when the employer-business has no other nexus-creating contacts or activities with the state. To date, nine states have issued guidance regarding teleworking employees and nexus – Washington D.C., Indiana, Massachusetts, Minnesota, Mississippi, New Jersey, North Dakota, Ohio, and Pennsylvania.

So far, most of the states listed above have issued high-level guidance in the form of frequently asked questions (FAQs). For example, a Minnesota FAQ stated that “the department will not seek to establish nexus for any business tax solely because an employee is temporarily working from home due to the COVID-19 pandemic.” Similarly, a Pennsylvania FAQ states that “as a result of COVID-19 causing people to work from home as a matter of safety and public health, the department will not seek to impose CNIT nexus solely on the basis of this temporary activity occurring during the duration of this emergency.”

While this is taxpayer-friendly guidance, it does leave some open questions. What exactly does “temporarily” and “due to the COVID-19 pandemic” mean? Does that mean once a state lifts its emergency order, or once the business lifts its own stay-at-home requirement, or even perhaps once the employee decides that her individual health and safety are no longer at risk and ventures back to the office? Outside of factor-based presence thresholds, nexus is traditionally a facts-and-circumstances based analysis.

Indiana’s guidance also indicated that the state will not contend that a teleworking employee performing services or activities not protected by Public Law 86-272 from a home office will cause an out-of-state business to lose the protections of Public Law 86-272 as a result of COVID-19. Further, Indiana recognized that nexus and/or loss of Public Law 86-272 protections are a double-edge sword. For example, nexus in another state can now make Indiana’s sales factor “throwback” rule inapplicable to an Indiana taxpayer that ships sales of tangible personal property from Indiana, or could allow an affiliated group to file an Indiana nexus consolidated return. As a result, Indiana’s guidance also provides that “an employer may not assert that solely having a temporarily relocated employee in Indiana [during the COVID-19 pandemic] creates nexus for the business or exceeds the protections of P.L. 86-272 for the employer.”

Apportionment Factors
Of the three SALT issues discussed in this alert, apportionment is – by far – the least addressed by the states. A possible reason could be that a majority of states have shifted from the traditional three-factor formula to a single-sales factor formula. States without a payroll factor in their apportionment calculation do not need to address whether to include a teleworking employee’s wages in the numerator of a payroll factor.

North Dakota still uses a three-factor formula and has provided payroll factor guidance in an FAQ that provides that compensation of an employee teleworking in North Dakota as a result of COVID-19 will not be assigned to the payroll factor numerator. Likewise, Mississippi’s guidance also states that a taxpayer’s Mississippi apportionment formula will not be impacted by employees temporarily teleworking from homes in the state due to COVID-19.

What about sourcing of services receipts for purposes of the sales factor? This question may not be important for most states, since they have adopted market-based sourcing. For most states, services receipts will continue to be sourced to the location where the benefit of the service is received or where the service is delivered. However, teleworking employees performing services at home and in a state different than the business’s location could present sourcing issues for states that still follow costs-of-performance sourcing, such as Florida or Virginia, or that require pass-through entities to still use costs-performance sourcing, like Michigan and New York. The COVID-19 pandemic and service providers using services performed by teleworking employees could impact where those costs of performance are now incurred.
Insights:

• The COVID-19 pandemic is presenting a host of impacts to businesses and individuals locally, nationally, and globally. State payroll tax withholding, income tax nexus concerns, and the effect on income apportionment are just the tip of the iceberg. Nonetheless, these state tax issues could continue to impact state taxpayers not only for the current tax year but also future tax years.
• With regard to state payroll tax withholding, it is critical for employers and employees to understand their obligations and how teleworking as a result of COVID-19 will impact those obligations. From reciprocity agreements to convenience of the employer rules to current state guidance, state payroll tax withholding compliance has suddenly become substantially more complex with potentially substantial repercussions for the employer and employee.
• Similarly, teleworking presents a number of new income tax nexus and apportionment considerations. State taxpayers should understand that COVID-19 will present income tax nexus and apportionment tail risks that may not become manifested until later in the income tax audit cycle. As a result, documentation, record maintenance, and planning should be pursued now so as to proactively prepare for the questions that will be raised not only today, but in the future.

The Paycheck Protection Program Flexibility Act of 2020 (H.R. 7010) (PPP Flexibility Act), enacted on June 5, 2020, makes welcome changes to the forgiveness rules for Paycheck Protection Program (PPP) loans made to small businesses in response to the novel coronavirus global pandemic (COVID-19). The PPP Flexibility Act greatly increases the likelihood that a large percentage of a borrower’s PPP loan will be forgiven. PPP loans (and related forgiveness) were created by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (Public Law 116-136), which was enacted on March 27, 2020. The PPP Flexibility Act also eliminates a provision that made recipients of PPP loan forgiveness ineligible to defer certain payroll tax deposits.

Insight:

The PPP Flexibility Act does not address whether employers can deduct the expenses underlying their PPP loan forgiveness. In Notice 2020-32, the IRS announced that employers could not deduct such expenses, but congressional leaders vowed to reverse the IRS’s position in future legislation. On June 3, Chairman of the House Ways and Means Committee, Richard Neal (D-MA), said that in the next COVID-19 stimulus bill he intends to clarify that the loan forgiveness expenses are tax deductible. But negotiations on that bill are still in the early stages.

PPP Loan Forgiveness Expanded

The PPP Flexibility Act makes the following changes:

1. Extends the “covered period” for PPP loan forgiveness from eight weeks after loan origination to the earlier of (i) 24 weeks after loan origination or (ii) December 31, 2020. Borrowers who received their loans before this change can elect to use their original or alternative payroll eight-week covered period.

Insight:

In connection with passing the PPP Flexibility Act, a Statement for the Record was issued by several Democrats and Republicans in the House and Senate, clarifying that the Small Business Administration (SBA) will not accept applications for PPP loans after June 30, 2020. The statement says: “Our intent and understanding of the law is that, consistent with the CARES Act as amended by H.R. 7010, when the authorization of funds to guarantee new PPP loans expires on June 30, 2020, the SBA and participating lenders will stop accepting and approving applications for PPP loans, regardless of whether the commitment level enacted by the Paycheck Protection Program and Health Care Enhancement Act has been reached.” Given this affirmation, very few loans will have fewer than 24 weeks as a covered period.

2. Replaces the June 30, 2020, date for the rehire safe harbor with December 31, 2020. 

Insight:

Additional guidance is needed to determine if a borrower who elects their original or alternative payroll eight-week covered period would also retain the June 30, 2020, date for the rehire safe harbor.

3. Expands the rehire exception based on the non-availability of former employees and applies that exception when the need for workers is reduced to comply with COVID-19 standards. Specifically, PPP loan forgiveness would not be reduced due to a lower number of full-time equivalent (FTE) employees if:

• The employer is unable to rehire individuals who were employed by the employer on February 15, 2020, and the employer shows the inability to hire similarly qualified employees for unfilled positions on or before December 31, 2020, or
• The employer documents its inability to return to the same level of business activity as it had before February 15, 2020, due to having to comply new COVID-19 standards for sanitation, social distancing or other safety requirements during the period of March 1 through December 31, 2020.

4. Allows up to 40% of the loan proceeds to be used on mortgage interest, rent or utilities (previously such expenses were capped at 25% of the loan proceeds), while at least 60% of the PPP funds must be used for payroll costs (down from the 75% that was noted in SBA guidance). This applies even if the borrower elects to use the eight-week covered or alternative payroll covered period. If the borrower does not use at least 60% of the loan on payroll costs, then it appears that no forgiveness would be available (i.e., the 60% would be a “cliff,” even though it was previously unclear whether the 75% limit would allow for partial loan forgiveness for payroll costs of less than 75% of loan proceeds).

Insight:

Some members of Congress are considering a “technical correction” that would provide that the new 60% limit is not a “cliff” (thereby allowing partial loan forgiveness if less than 60% of PPP loan proceeds are used for payroll costs).

5. Provides a five-year term for all new PPP loans disbursed after June 5, 2020. Loans disbursed before that date would retain their original two-year term unless the lender and borrower renegotiate the loan into a five-year term.

6. Changes the six-month deferral period for loan repayments and interest accrual so that payments on any unforgiven amounts will begin on either (i) the date on which loan forgiveness is determined or (ii) 10 months after the end of the borrower’s covered period if forgiveness is not requested.

Insight:

Although the PPP Flexibility Act doesn’t clearly say as much, it appears that the $100,000 maximum on cash compensation paid to any one employee that is eligible for PPP loan forgiveness would continue to apply, such that the $15,385 cap (for eight weeks) would now be $46,153 (for 24 weeks).

The PPP Flexibility Act does not address whether the loan forgiveness cap for “owner-employees” (i.e., 8/52 of their 2019 compensation) would change to 24/52 of their 2019 compensation.

Notwithstanding some commentary that has been released, the statute does not appear to allow borrowers to request PPP loan forgiveness as soon as they spend all of their PPP funds in the ninth to 24^th weeks following receipt of their PPP funds. That is because the CARES Act has been amended to substitute “24 weeks” for “eight weeks,” so absent additional guidance, it seems that borrowers must wait until the end of the 24-week period to request PPP loan forgiveness, unless they elect to use the original eight-week period (regular or alternative payroll covered period).

These changes garnered nearly unanimous, bipartisan support in both the House and Senate because the CARES Act assumed that most businesses would be up and running in a matter of weeks. But more time is needed to incur forgivable costs, because many businesses are at or near the end of their initial eight-week loan forgiveness period, yet they remain partially or fully suspended by governmental orders.
 

Payroll Tax Deferral Expanded

In addition to PPP loan changes, the bill allows all employers, even those with forgiven PPP loans, to defer the payment of 2020 employer’s Social Security taxes, with 50% of the deferred amount being payable by December 31, 2021, and the balance due by December 31, 2022. Previously, the CARES Act prohibited such payroll tax deferral after a borrower’s PPP loan was forgiven.