On March 11, 2021, President Biden signed into law the American Rescue Plan of 2021 (“ARPA”). This Alert will summarize the significant tax and employee benefit provisions that are contained in ARPA.
Recovery Rebates to Individuals
ARPA enacted new Internal Revenue Code (the “Code”) Section 6428B, which provides individuals with a $1,400 recovery rebate credit ($2,800 for married taxpayers filing jointly) plus $1,400 for each dependent for 2021. As with the two recovery rebates enacted in 2020, the Internal Revenue Service (“IRS”) will make advance payments, which the IRS has been calling “economic impact payments”. The recovery rebate credit phases out for taxpayers with adjusted gross income (“AGI”) over $75,000 and will be completely phased out for taxpayers with an AGI over $80,000. For married taxpayers who file jointly, the phase-out will begin at an AGI of $150,000 and end at AGI of $160,000. For heads of households, the phase-out will begin at an AGI of $112,500 and be completely phased out at AGI of $120,000. ARPA uses 2019 AGI to determine eligibility unless the taxpayer has already filed a 2020 return.
Child Tax Credit
ARPA temporarily makes changes to the child tax credit for 2021. Code Section 24 currently provides for a $2,000 tax credit per qualifying child under the age of 17. ARPA increases the tax credit to $3,000 per qualifying child under the age of 18 for the 2021 tax year. In the case of a qualifying child who has not attained the age of six as of the close of the calendar year, the credit is increased to $3,600. The $3,000 tax credit phases out for taxpayers with incomes over $150,000 for married taxpayers filing jointly, $112,500 for heads of household, and $75,000 for others. ARPA also makes the child tax credit fully refundable for taxpayers with a principal place of abode in the United States for more than one-half of the taxable year.
In addition, ARPA enacts new Code Section 7527A, which requires the IRS to establish a program to make monthly advance payments of the child tax credit to eligible taxpayers and pay monthly in advance one-twelfth of the annual estimated amount for the tax year. The monthly advance payments are only to be made from July through December 2021.
Earned Income Tax Credit
ARPA makes significant changes to the Earned Income Tax Credit (“EITC”), which is a refundable tax credit under Section 32 of the Code. The changes not only enable more eligible taxpayers to qualify for a larger EITC but also expand eligibility for the EITC to taxpayers who were previously ineligible.
ARPA makes the following changes to the persons eligible for the EITC:
- Reduces from age 25 to age 19 the minimum age for persons without qualifying children to become eligible for the EITC.
- New Code Sections 32(n)(1)(C), (D) and (E) add new statutory definitions for the terms “specified student,” “qualified former foster youth” and “qualified homeless youth.”
- Eliminates the maximum age of 65 from the eligibility requirements, which will now permit persons 65 and older who were previously ineligible to now claim the EITC.
- For eligible taxpayers without qualifying children, ARPA doubles the dollar amount of the credit from 7.65% of the “earned income amount” to 15.3% of the “earned income amount.”
- For eligible taxpayers without qualifying children, ARPA doubles the phase-out percentage in the calculation of the EITC from 7.65% to 15.3%.
- For eligible taxpayers without qualifying children, ARPA increases the earned income amount for the EITC calculation from $4,220 to $8,820 for the credit portions of the calculation, and increases the earned income amount for the phase-out portion of the calculation from $5,280 to $11,610. (For joint taxpayers, the phase-out limit continues to be $5,000 higher, as adjusted for cost-of-living adjustment increases.)
ARPA repeals Section 32(c)(1)(F) of the Code, which enables an eligible person who has qualifying children (but for whom the taxpayer does not comply with the TIN notification for such children on his or her return) to instead file for the EITC under the rules applicable to individuals without qualifying children.
ARPA amends Section 32(d) of the Code to permit married spouses who are separated (within the meaning of new subsection 32(d)(2)) and who file separate tax returns to be eligible to claim the EITC.
ARPA amends Section 32(i) of the Code to increase from $2,200 to $10,000 (subject to further increases for cost-of-living adjustments) the amount of investment income a taxpayer may receive in a tax year and still remain eligible for the EITC.
ARPA add new Section 7530 of the Code to apply the EITC in U.S. possessions, including Puerto Rico; the U.S. Virgin Islands; Guam; the Commonwealth of the Northern Mariana Islands; and American Samoa.
ARPA provides for a special election for taxpayers whose 2019 earned income is greater than their 2021 earned income that will allow these persons to calculate their EITC for 2021 under the amended ARPA rules by using their 2019 earned income rather than their 2021 earned income. This special election will enable taxpayers to maximize the amount of their EITC in the event their 2021 earned income has dropped for any reason, whether COVID-related or not. For joint returns, the special election will apply to both spouses, meaning that the 2019 earned income for both spouses must be used, even if the 2019 earned income for one spouse is lower than his or her earned income for 2021.
Dependent Care Tax Credit
ARPA temporarily expands the dependent care tax credit for 2021. Code Section 21 currently provides for a tax credit for dependent care services “necessary for gainful employment”. ARPA increases the amount of expenses that can be applied to the credit from $3,000 to $8,000 if you have one child, and from $6,000 to $16,000 if you have two or more children (with a maximum credit percentage of 50%, increased from 35%, for taxpayers who make up to $125,000, at which point the percentage that can be claimed begins to decrease). The credits will be refundable for 2021.
Code Section 129 permits employers to establish a dependent care assistance program (often called a dependent care flexible spending account), to reimburse employees on a tax-free basis for dependent care expenses. Prior to ARPA, there was a $5,000 limit for amounts that could be reimbursed through a dependent care flexible spending account each year. This amount has been much maligned by employers who recognize that $5,000 is generally inadequate to cover annual dependent care expenses, but it has not been increased until now. ARPA increases this amount to $10,500 for the 2021 tax year. Plan sponsors may amend their plans for this change if they do so by the end of the tax year, as long as the plan is operated consistently throughout the year.
Premium Tax Credits
ARPA temporarily expands the premium assistance credit, a refundable tax credit under Code Section 36B. Under Code Section 36B, an individual or family that purchases private health insurance through a state-based competitive marketplace, referred to as an Affordable Insurance Exchange, such as Access Health CT here in Connecticut, is allowed a health insurance premium tax credit to reduce the out of pocket health care premium costs through an Affordable Insurance Exchange. The tax credit is generally available for individuals with household incomes between 100 percent and 400 percent of the Federal poverty level for the applicable family size. The amount of the premium assistance credit is based on the lesser of: (1) the premium for the health plan in which the individual or family enrolls; and (2) the premium for the second lowest cost silver plan in the rating area where the individual resides, reduced by the individual’s or family’s share of premiums.
ARPA temporarily increases the value of the Health Insurance Premium Tax Credit to lower or eliminate the health insurance premiums so that enrollees will not pay more than 8.5% of their household income for health insurance coverage through an Affordable Insurance Exchange for 2021 and 2022. ARPA also makes the premium assistance credit available to taxpayers with incomes above the present law limitation of 400 percent of Federal poverty level for the applicable family size. This applies for the 2021 and 2022 tax year.
Employee Retention Credits
ARPA expands the Employee Retention Credit established by the Coronavirus Aid, Relief, and Economic Security Act of 2020 (the “CARES Act”). The Employee Retention Credit enabled businesses that were fully or partially suspended due to COVID-19 or incurred significant reductions in gross receipts for 2020 compared to the prior year to claim a credit against certain federal payroll taxes. The ARPA extends the Employee Retention Credit by two calendar quarters to apply to wages paid before January 1, 2022.
ARPA makes the following changes to the Employee Retention Credit, which apply prospectively to credits claimed for the third and fourth calendar quarters of 2021:
- The credit is now refundable against the employer’s 1.45% share of the Hospital Insurance tax (i.e. the Medicare tax), rather than a credit against the employer’s share of the Old Age, Survivors, and Disability Insurance tax (i.e., the Social Security tax).
- The credit is now available for employers who qualify as a “recovery startup business”, which is an employer who began a trade or business after February 15, 2020 and whose average annual gross receipts do not exceed $1 million.
- In calculating the amount of qualified wages, “severely financially distressed employers”, which is an employer that experienced a greater than 90% decline in gross receipts, can include all wages paid during the calendar quarter into account.
COBRA Premium Assistance
ARPA provides an “assistance eligible individual” (an ARPA-defined term that generally means a person eligible for COBRA whose employment is terminated by the employer, not from the employee voluntarily terminating his or her employment) with no-cost COBRA premiums during the portion of the person’s COBRA coverage period beginning with the month of April (e.g., the first month beginning after ARPA is enacted) and ending on September 30, 2021. (Note that the COBRA premium assistance ends when the assistance eligible individual becomes eligible for coverage under another group health plan or under Medicare.) ARPA defines assistance eligible individual to include both the employee and his or her eligible qualified beneficiaries, and also applies the COBRA premium assistance benefit to persons whose qualifying events precede the enactment of ARPA. ARPA also permits an assistance eligible individual who elects COBRA to choose to enroll in a group health plan that is different from the plan the person was enrolled in at the time of his or her qualifying event, provided that the employer chooses to offer that choice to the assistance eligible individual. ARPA provides for special notices that must be furnished to an assistance eligible individual to notify him or her of these special COBRA rules.
ARPA adds new Code Section 6432 that essentially reimburses the employer or the group health plan that furnishes the COBRA premium assistance by providing the employer or group health plan with a refundable tax credit that is claimed on the entity’s quarterly Form 941 payroll tax return.
ARPA also adds new Code Section 139I to provide that an assistance eligible individual’s receipt of COBRA premium assistance is not includible in his or her gross income for tax purposes.
Unemployment Compensation Benefits
ARPA provides an income tax exemption that exempts the first $10,200 of unemployment compensation paid in 2020 from federal income tax. The tax exemption applies to individuals and married couples with adjusted gross income that is less than $150,000. For married couples, each spouse can claim the exemption for up to $10,200. The timing of this 2020 exemption would seemingly require taxpayers who have already filed their 2020 returns to amend those returns to claim the $10,200 exemption. However, the IRS indicated that amended returns may not be necessary and stated the following:
The IRS will provide taxpayers with additional guidance on those provisions that could affect their 2020 tax return, including the retroactive provision that makes the first $10,200 of 2020 unemployment benefits nontaxable. For those who received unemployment benefits last year and have already filed their 2020 tax return, the IRS emphasizes they should not file an amended return at this time, until the IRS issues additional guidance.