The American Rescue Plan, Take Two: Breaking Down the Tax Changes

We previously published an article highlighting key provisions in the American Rescue Plan Act of 2021 (ARP or Rescue Plan) for small businesses. The $1.9 trillion relief package was signed into law on March 11, and contains several tax changes.

Partial income tax exclusion for unemployment compensation received in 2020

Generally, an individual’s gross income includes unemployment compensation. For taxpayers whose adjusted gross income (AGI) is less than $150,000, the ARP excludes up to $10,200 of unemployment compensation received in 2020 from gross income. In the case of a joint return, the $10,200 exclusion applies to each spouse. The exclusion does not apply to taxpayers whose AGI is $150,000 or more; in this instance, all of the taxpayer’s unemployment compensation is taxable. The IRS has urged taxpayers who have already filed their 2020 tax return not to file an amended return or take any action because reductions in taxable income and refunds, if appropriate, will be processed automatically.

Another round of stimulus checks

The ARP authorizes a third round of stimulus checks. The stimulus payments are structured as refundable tax credits against 2021 income taxes, but the IRS has already started distributing advanced credits based on information from taxpayers’ 2020 income tax returns (or 2019 returns, if a taxpayer’s 2020 return has not been filed when the advanced credit is issued).

Payments are equal to $1,400 per eligible individual ($2,800 for married couples filing jointly) and $1,400 for each eligible dependent. For single taxpayers, the payment begins phasing out at an AGI of $75,000 and is completely phased out for individuals with an AGI of more than $80,000. The phase-out for married couples filing jointly begins at an AGI of $150,000 and ends at an AGI of $160,000. For heads of household, the payment begins phasing out at an AGI of $112,500 and is completely phased out at an AGI of $120,000.

Expansion of the child tax credit and child and dependent care credit

Child tax credit

For 2021, the ARP temporarily increases the amount of the child tax credit by modifying several provisions of existing law. The ARP makes the credit fully refundable and increases the maximum age for an eligible child to seventeen. It also increases the maximum amount of the credit from $2,000 to $3,000 per child ($3,600 for children under age six). The increased credit amount phases out for taxpayers with an AGI of more than $75,000 for single filers, $112,500 for heads of household, and $150,000 for married couples filing jointly.

The IRS is directed to issue half of a taxpayer’s expected 2021 credit in periodic payments from July through December of 2021. The remaining half of the 2021 credit will be claimed on the taxpayer’s 2021 income tax return (filed in 2022). The amount of the payments advanced during 2021 will be estimated by the IRS based on the taxpayer’s 2020 income tax return (or 2019 return if the taxpayer has not filed a 2020 return).

Child and dependent care credit

The ARP also makes several changes to the child and dependent care credit for 2021. This credit is available to taxpayers who pay expenses for the care of a child or other qualifying individual to enable the taxpayer (and the taxpayer’s spouse, if filing a joint return) to work or actively look for work. The amount of the credit is equal to a percentage of expenses paid to a provider for the care of the child or other qualifying individual. Notably, the ARP makes the child and dependent care credit refundable, allowing taxpayers with little to no income tax liability to benefit from the credit.

Generally, the total expenses that may be used to calculate the credit cannot exceed $3,000 (for one child or qualifying individual) or $6,000 (for two or more children or qualifying individuals). The ARP temporarily increases the cap on expenses to $8,000 and $16,000, respectively.

The ARP also increases the credit rate for certain taxpayers. For taxpayers with AGI of less than $125,000, the credit is equal to 50% of eligible expenses. The 50% credit rate phases down for taxpayers with AGI of $125,000 or more, until it reaches 20% for taxpayers with AGI of $185,000. The rate remains at 20% for taxpayers with AGI up to $400,000 and then phases down to 0% for taxpayers with AGI of more than $440,000.

The ARP also increases the maximum amount of employer-provided dependent care assistance that taxpayers can exclude from their income from $5,000 to $10,500. Like the changes to the child and dependent care credit, this change is effective for 2021 income tax returns only.

Extension of excess business loss limitation

The Tax Cuts and Jobs Act (TCJA), enacted at the end of 2017, introduced a limitation on business losses deductible by individuals and other non-corporate taxpayers (trusts and estates) against non-business income. Specifically, the TCJA disallowed 2018 net tax losses from active businesses in excess of $250,000 (for individual taxpayers) and $500,000 (for joint filers), adjusted annually for inflation. Under the TCJA, the excess business loss (EBL) limitation was effective for tax years 2018 through 2025. In March of 2020, the CARES Act retroactively postponed the effective date of the EBL limitation until tax years beginning in 2021, resulting in taxpayers filing amended returns to claim their full net tax loss.

On a less favorable note, the ARP extends the EBL limitation for one year, through 2026.

Miscellaneous tax provisions

The ARP contains a handful of miscellaneous tax provisions, including:

Providing for temporary, fully subsidized COBRA continuation coverage premiums for eligible individuals and reimbursing the taxpayer to whom the premiums are payable through a premium assistance credit, taken against the employer’s share of Medicare tax;
Specifying that gross income does not include any amount resulting from the discharge of any student loan occurring between 2021 and 2025;
Repealing the election to allocate interest expenses of members of a worldwide affiliated group on a worldwide basis, effective for tax years beginning after December 31, 2020; and
Broadening the provision that limits a publicly-held corporation’s deduction for compensation paid to certain employees by expanding the list of covered employees for years after 2026.

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