After the Rush: Tax Considerations You May Not Have Considered for COVID-19 Stimulus Programs
You have undoubtedly heard of the various state and federal government programs to blunt the financial impact of COVID-19 – from $1,200 individual stimulus payments to forgivable SBA loans to state and federal tax filing and payment deferrals. The news only goes so deep, though. There is still little guidance on what these programs mean to individuals and businesses long term, especially when it comes to tax mitigation and planning. And when this pandemic ends, the government will need to pay for both the stimulus programs and the cost of COVID-19 containment and treatment. Which means that the government will soon be looking for taxes.
It is extremely important for individuals and businesses, no matter how wealthy or large, to consider the tax implications of these stimulus programs to avoid being whipsawed by government taxing agencies months or years down the road. Below is a shortlist of tax considerations individuals and businesses should be thinking about with regards to the COVID-19 stimulus programs.
Tax Considerations for Individuals
Economic Impact Payment. Individuals with an adjusted gross income under $99,000 and married couples with an adjusted gross income under $198,000 will receive an economic impact payment from the federal government ranging from $5 to $1,200 (and an additional $500 for each child) within the next few weeks. To receive the payment, the taxpayer generally must have filed a 2018 or 2019 federal individual income tax return. If you have not yet filed your 2019 income tax return, and believe you had a lower adjusted gross income in 2018, you may want to wait to file your 2019 income tax return to maximize your economic impact payment as the IRS. Also, the payment you receive will not be taxable at the federal level, but that does not prevent states that impose an income tax from taxing the payment. You may want to monitor your state’s guidance regarding the payment over the next year.
Unemployment Benefits. Many people have already been laid-off and filed for unemployment benefits and it is likely many more will. When filing for unemployment benefits, you will have the option to have state and federal income taxes withheld from the payment. If you are financially able, you should have taxes withheld from your unemployment benefits because the payments are taxable and having taxes withheld will avoid the shock of a potentially significant tax bill next year.
Retirement Accounts. The federal government recently authorized the relaxation of rules related to retirement account distributions and loans, such as from your 401(k) or IRA. For instance, $100,000 worth of distributions taken by a qualified individual during 2020 are considered “coronavirus-related distributions” which are not subject to the 10% early withdrawal penalty or the mandatory 20% withholding. However, such a distribution is taxable over three years unless the distribution is repaid within 3 years. Additionally, retirement account loans have been increased to the greater of 100% of the account value or $100,000 but the loan must be taken before September 22, 2020, after which the maximum loan amount falls back to the greater of 50% of the account value of $50,000. The federal government has also suspended the requirement that certain individuals (generally those over 70 ½ or 72 years of age) take a required minimum distribution from their retirement account in 2020 thereby allowing such individuals to leave their investments alone during the current stock market downturn and hopefully allow them to recover to pre-COVID-19 levels. Managing any retirement account distributions, even in normal times, depends on your unique situation and must be done carefully to avoid serious tax implications.
Property Taxes. Homeowners and other real property owners are well aware of property taxes but one common misconception is that the state tax agency collects property taxes, which isn’t true. Counties administer and collect real property taxes and therefore any payment deferral or stimulus measure with respect to property taxes would come from each county if the county has the authority to do so under state law which is unlikely. Property taxes should be paid-in-full and on-time since counties have the power to foreclose the property tax lien that arises upon non-payment of property taxes.
Mortgage Payment Deferrals. Anyone who has a federally backed mortgage that is experiencing financial hardship due to COVID-19 may ask their mortgage servicer to defer mortgage payments for up to 180 days. The tax implications of requesting such a deferral include a lower mortgage interest deduction when you file your 2020 individual income tax return (meaning you will pay more income tax). In addition, you need to consider if your insurance or property taxes are being paid through your mortgage escrow. If so and you aren’t making mortgage payments, the mortgage servicer isn’t collecting the property tax and insurance payment that it is eventually required to payout, you may experience shortfalls that need to be made up later.
Collection Enforcement. The IRS and many states have announced they will relax collection actions against individuals with outstanding tax debts. Generally, this means the IRS and states will not begin new collection actions such as filing liens and issuing bank levies. It also means that those with existing installment agreements and offers-in-compromise with the IRS have had their payments due under those agreements suspended until July 15. The IRS is continuing to take collection actions against high-income taxpayers, however, and expect both the IRS and state taxing agencies to resume collection actions against all taxpayers with outstanding tax debts after the immediate COVID-19 threat passes. It is also possible that if you currently owe back taxes your economic impact payment or any distribution or loan you take from a retirement account could be intercepted by the state or federal government to pay those back taxes. To avoid this potential, you should work with the tax agency to obtain a temporary collection hold, enter into a payment plan, or a different arrangement to prevent the tax agency from intercepting such funds.
Loans Forgiveness Equals Income – Usually. One major, but often overlooked, consideration when obtaining a loan from a private lender (whether a bank loan or using credit cards) to fund business operations is that if you default on the loan and the lender later forgives the debt, state and federal tax laws will impute that forgiven debt as taxable income to you unless an exception applies (e.g., insolvent immediately before the forgiveness) and this will flow through to the business owner’s personal income tax return (in most cases). Thus, funding business operations with private loans and credit cards must be considered carefully because serious tax implications can arise later on. If you need a loan, you may want to consider one of the government loans and stimulus programs discussed below as some of them avoid the forgiveness of the debt tax issue described here.
Federal Government Loan and Stimulus Programs. The federal government has announced numerous loan and stimulus programs available to most small businesses. These programs include:
- Paycheck Protection Program: This is a loan designed so small businesses can keep their workers on the payroll and the government may forgive the loan if certain requirements are met, which you can read about here. Any amount forgiven is not subject to the forgiveness of debt provisions discussed in relation to private loans above.
- Employee Retention Credit: A refundable payroll tax credit equal to 50% of qualified wages paid by certain businesses within certain timeframes and up to a certain amount can now be claimed on a quarterly basis with certain limitations. However, businesses that take advantage of the Paycheck Protection Program cannot claim this credit.
- Delaying Payment of Payroll Taxes: Businesses can defer the employer portion of Social Security taxes and self-employed individuals can defer 50% of such cases through December 31, 2020. Half of the deferred tax must be paid by December 31, 2021, and the other half is due December 31, 2022. However, businesses that take advantage of the Paycheck Protection Program cannot defer payment of these taxes.
- Net Operating Losses: The IRS will now allow net operating losses (“NOL”) incurred in a tax year beginning in 2018, 2019, or 2020 to be carried back for five years and removes the 80% of taxable income NOL limitations imposed by the 2017 Tax Cuts and Jobs Act, which may benefit corporations, pass-through entities, and sole proprietorships. As an example, taking advantage of the relaxation of NOL rules may allow certain corporate taxpayers to obtain up to a 35% larger federal tax refund, but similar benefits may not occur at the state level.
State Government Loan and Stimulus Programs. Nearly every state has announced a business loan or other stimulus program, and below are just two examples.
- Minnesota Small Business Emergency Loan Program: As you can read here Minnesota’s Department of Employment and Economic Development announced temporary loan assistance for certain qualifying Minnesota small businesses. Part of the loan may be forgiven, in which case the forgiveness of the debt tax issue discussed above is likely to apply because this would be a way for Minnesota to recoup a portion of the cost of the program by increasing the taxable income of the business and its owners later on. A business that takes advantage of this program also needs to be aware that the part of the loan that must be repaid could be referred to the Minnesota Department of Revenue for collection if not repaid.
- State Sales Tax Deferrals: Nearly every state imposes a sales tax on the sale of certain services and property. And nearly all of these states have deferred the due date to file sales tax returns and/or pay the tax to the state. Nothing can destroy a business faster than using the sales tax it collects from its customers to finance business operations, which the states consider a form of theft. Most states have laws to provide greater collection authority for sales tax (e.g., personally assessing the tax against the owners and officers of the business, revoking professional licenses, etc.) and in some cases, states assess personal liability for officers for theft. A business can manage this by holding the tax in trust until it is required to remit the tax to the state. Even if your state has granted a sales tax filing or payment deferral, you should remit the sales tax you collect from your customers to the state on time and not use it to fund operations or you risk not only losing your business but also destroying your personal finances.
Property Taxes. The property tax discussion related to individuals above would apply equally here for a business’s real property. However, many businesses are subject to property taxes on tangible business personal property which may be imposed at the state, county, or even city level. A review of various jurisdictions indicates that generally states, counties, and cities are not providing reporting or payment deferrals likely due to the simple fact that smaller units of government such as counties and cities cannot absorb the loss of revenue as well as a state or the federal government. Even so, every jurisdiction is different so be sure to check with your local jurisdiction regarding any property tax deferrals are available.
Collection Enforcement. As with individuals, the IRS and many states are relaxing collection enforcement activities against businesses as well. This means the considerations discussed above regarding individuals are also generally applicable to businesses. However, an additional consideration for businesses that owe taxes to multiple taxing authorities that take advantage of a stimulus program is the timeline for when the business receives the funds. For example, a business may owe a state tax debt and receives a federal stimulus program payment in August, but the state has already begun ratcheting up their collection efforts because the immediate COVID-19 threat has passed. As a result, the state issues a bank levy against the account of the funds that were recently deposited. Thus, being proactive with any outstanding tax debts and not falling behind now is important for every business during this uncertain time.
The above is just a small taste of the tax complexities and considerations individuals and businesses should be aware of as governments at nearly every level are taking steps to contain and treat COVID-19 while attempting to lessen the blow to the economy. While tax concerns may not be at the top of mind right now, taking a few preventative steps and even a minute to think through possible tax ramifications can ensure you and your business survive financially intact. At FMJ, we can walk you through your specific tax question or issue, and discuss specific tax ramifications of the COVID-19 stimulus programs. If you are an affected taxpayer or business and have questions, please contact attorneys Nathan Haynor at firstname.lastname@example.org or Kevin Johnson at email@example.com.