There have been quite a few changes to tax laws and legislation over the past two years, and in order to help you stay up-to-date, we’re focusing this episode on a few important changes and highlighting the most recent ones that can impact you and your business. More specifically, we want to give you some high-level information on Section 139, PTE (Pass-Through Entity tax), and the child tax credit. We are speaking today with Katina Peters, Partner at PJS & Co. CPAs, and getting her valuable insights on these important legislative changes. Because these changes will impact everyone differently, we highly suggest speaking with your advisors to fully understand the full effects. If you'd like to listen to the full episode, subscribe via Apple Podcasts or listen here on our website.
What we cover in this episode:
- 03:50 – Section 139
- 10:31 – PTE (Pass-Through Entity Tax)
- 14:37 – Child Tax Credit
When we say Section 139, we are referring to the IRS Code Section 139, which is a section of the tax code that provides tax breaks for “qualified disaster relief payments,” including the most recent payments on account of COVID-19, which was declared a federal disaster in the spring of 2020. Section 139 allows for employers to pay employees, including themselves, for reimbursement of reasonable and necessary personal and family expenses with regards to a qualified disaster. So this may differ from what most business owners are used to, where they typically pay only for valid expenses that are related to the business. This section allows for a much more broad definition of a business expense, and you just need to be able to support that it’s related to the qualified disaster. These payments are deductible by the company but do not have to be included in income or compensation to the individual receiving the funds.
There are some nuances that you should be aware of, but this is a way for the government to help businesses, and help their people without creating an additional tax burden for them. If you are working with a payroll company, you want to make sure the payments are coded correctly so they are not taxable to the recipient. But we actually recommend that you treat these payments like an expense reimbursement check since they are not payroll-related.
COVID-19 Examples That Could be Included
A few quick examples of things that can be included in regards to the COVID-19 pandemic are doctor visit co-pays, nonprescription drugs, or critical care for COVID-19 treatment. Other expenses that can be incurred and are included are the cost of masks, hand sanitizer, disinfectant cleaning products, and grocery delivery services. In addition, if there were to be an employee or family member who passed away due to COVID-19, funeral expenses can be covered. Equipment or services needed to work remotely, such as computers, printers, and internet service can be included in these reimbursements, as well as new or increased expenses for children as a result of virtual learning requirements or school closings. As you can see, this is a pretty expansive list and can cover many different types of expenses. You’ll want to make sure again though, that you have the documentation you need to justify the reimbursements to your payees. The one thing you must not include in these payments are things that would normally be considered compensation, such as sick pay, vacation time, or anything payroll-related, etc… There should be a clear delineation between these types of reimbursements, as they are not included in the covered items for reimbursement under Section 139.
Implement Best Practices
We encourage our clients to utilize some best practices when implementing this process, including implementing this prior to the end of the year and consulting with their tax preparer and/or financial advisor. You should adopt a formal plan, make sure you have a comprehensive way to track any reimbursements you plan to make (including receipts to validate the amounts), and you should also have, and keep on file, the acknowledgments of the person or persons receiving the payments and that they are reimbursements and not compensation.
PTE (Pass-Through Entity Tax)
The next item we want to discuss is the PTE (Pass-Through Entity Tax). This applies to you if you’re in a pass-through entity, for example, a partnership where you collect a K-1 at the end of the year. Let’s go over a bit of background on this topic to make it a bit easier to understand. The Tax Cuts and Jobs Act (TCJA) that was passed in 2017 limits the amount of state and local taxes that individuals can deduct for federal income tax purposes to not more than $10,000 ($5000 in the case of a married individual filing a separate return). This creates quite a problem for individuals with pass-through entities in high taxing jurisdictions because they lost the ability to itemize and deduct large amounts of state taxes on their individual federal returns. People in these high taxation states may have a large state income tax liability. It could have been as high as $40,000 to $50,000 and having this deduction capped at $10,000 with the TCJA makes a big difference in tax liability. Since the passage of the TCJA, states have been working on a way to help their constituencies that have been affected by this, and many have been passing what now is being called the PTE tax.
What some states are doing is allowing their taxpayers with pass-through entities to elect to pay their tax that is related to their pass-through income at the corporate level rather than the individual level. This shift makes that tax a deductible business expense on the books and lowers the federal income pass-through. This also results in your K-1 having less income flowing through to you personally, so you are paying less personal tax.
This sounds simple in theory, but in practice, you have to remember that every state is different, and can have different rules surrounding this PTE tax. Some states are simpler than others, and some can be very complicated. For instance, there are situations where some states require all of the partners or all of the other shareholders in a pass-through entity to agree, but each partner has the opportunity to decide what is best for themselves and make their own elections. This can provide an advantageous tax planning tool, but it needs to be carefully considered.
It’s very important that you speak with your advisor and tax professional to help navigate this PTE tax, because at this time, the PTE tax is not a national tax. The current count is at 18 states that have passed legislation to this effect, but there are more states that have this legislation either drafted or pending.
Child Tax Credit
This last topic we want to discuss today is the new Child Tax Credit payments program that kicked off in July 2020, and it has also had some confusion surrounding it when it was announced. This again will affect everyone differently because it’s not the same for everyone, and not everyone qualifies. We want to reiterate that you should speak to an advisor or your CPA to answer any direct questions on how this program may affect you and your family.
The IRS began disbursing payments (direct deposits and paper checks) to eligible families on July 15, 2021, under this program, and these are payments to eligible families with children ages 17 or younger. Basically, for every child under the age of 6, families will get up to $3,600 under the expansion, or $300 per month. For every child ages 6-17, the amount is $3,000, or $250 per month. These amounts are increases from your normal annual child tax credit on your tax return of $2,000 per year, and they are basically prepaying you for the child tax credit at this point.
The expansion boosts the credit from $2,000 to $3,600 for each child under the age of 6, or $3,000 for children from ages 6 – 17. This also makes the child tax credit (CTC) “refundable” – which means people can get it even if they don’t owe federal income tax, which increases the number of low-income households that qualify for the payments.
In order to qualify and receive the full enhanced child tax credit, single taxpayers must earn less than $75,000 per year, and joint filers must earn less than $150,000 per year, with payments reduced by $50 for every $1,000 of income above those limits, and are phased out for single taxpayers earning $95,000 per year, and joint filers earning $170,000 per year. Most households that earn above these amounts per year will still qualify for the regular $2,000 per child tax credit. There of course are nuances, and exceptions, but these are the basic qualifications.
So what does this mean for you and your family? It can be confusing, and we encourage you to reach out to your financial advisor or CPA to get specific details for your situation. The biggest questions – or unknowns – we’ve heard from most people seem to center around how accepting these payments now will affect their year-end taxes. The IRS automatically opts you into this new program based on your prior year’s return, and you do have to opt-out if you choose not to receive the prepayments. Depending on how many children you have within these ages, it may mean a sizable difference than what you are expecting as a refund, or as owing at the end of the year on your annual return. We’ve also heard people believing that these child tax credits are the same as the previously disbursed stimulus check, which is incorrect, and definitely not treated the same way at the end of the year.
Our goal in this episode was to give you some high level of information so you can be prepared to ask the right questions when you meet with your advisor. We want you to have the information for your personal situation and be armed with enough knowledge to avoid surprises come tax time. The latest legislative changes to Section 139, PTE and Child Tax Credits may be hard to navigate on your own, and we encourage you to reach out to your advisor or tax professional to help you with questions and concerns around these new programs and how they affect your personal situation. When legislative changes happen, we keep up to date here at PJS & Co CPAs and want you to feel free to reach out and contact us with your questions. If you found this episode helpful, please subscribe, rate and review.