Income taxes are a perennial chore for business owners. While many tax items—deductions, credits, etc.—have new limits for 2021 due to cost-of-living adjustments and new laws, certain new items stand out. Don’t overlook the following:
1. Reporting PPP loan forgiveness
A Paycheck Protection Program (PPP) loan may have helped you get through the pandemic, but there are tax consequences to handle. While you aren’t taxed on the forgiveness of a PPP loan, there’s still some reporting to handle. The forgiveness of a PPP loan creates tax-exempt income, which in turn affects owner’s basis in entity. Rev. Proc. 2021-48 permits pass-throughs to treat tax-exempt income resulting from the forgiveness of a PPP loan as received or accrued
- As, and to the extent that, eligible expenses are paid or incurred;
- When the S corporation applies for forgiveness of the PPP loan; or
- When forgiveness of the PPP loan is granted.
This reporting requires a statement to be attached to the return. And adjustments to Schedules M-1 and M-2 must be made reflecting the tax-exempt income.
Keep in mind that while income from the loan forgiveness isn’t taxable, it still counts as gross receipts. For example, this may impact the “gross receipts test” used for determining eligibility to use the cash method of accounting, not having to maintain inventory tax records, and for other purposes.
2. New Schedules K-2 and K-3
If you are an owner in a partnership, multi-member limited liability company, or S corporation, you’re familiar with Schedule K-1. This schedule allocates to the owner his or her share of business income, deductions, credits, etc. Most small businesses are domestic; their activities are confined within the U.S. and Schedule K-1 is all that’s needed. But if there are certain foreign income or activities that generate “items of international relevance,” this requires the filing new schedules with 2021 returns. Usually this means having foreign partners or foreign income. Schedule K-2 lists the entity’s foreign items; Schedule K-3, like Schedule K-1, allocates them to owners.
Even if there are no foreign activities, the schedules may still be required. For example, a partnership with no foreign source income, no assets generating foreign source income, and no foreign taxes paid or accrued may still need to report information on Schedules K-2 and K-3 if the partner claims a credit for foreign taxes paid by the partner.
The IRS said that because this was the first year for these schedules, it would waive penalties as long as there’s been a good faith effort to comply with the new reporting requirements.
3. 100% meals allowance
With the pandemic subsiding, business owners and employees are resuming in-person meeting, with food and beverages often accompanying discussions. Business meals provided at restaurants during 2021 are fully deductible. This applies as well to the meals portion of per diem rates used to substantiate the cost of business lodging and meals. ADD
For the cost of pre-packaged food or beverages purchased at a grocery store; specialty food store; beer, wine, or liquor store; drug store; convenience store; newsstand; or a vending machine or kiosk the usual 50% limitation. In any event, required substantiation is necessary for claiming a deduction (50% or 100%) for the cost of business meals.
4. Bigger charitable contribution deductions
Businesses are very charitable and may reap considerable tax breaks for their actions. Cash donations made in 2021 have higher limits:
- For C corporations: 25% of taxable income (instead of the usual 10%)
- For owners of pass-through entities: 100% of adjusted gross income (instead of 60%)
Businesses that made donations of food inventory for the care of the “ill, needy, or infants,” can deduct them up to 25% of aggregate net income for pass-throughs or taxable income for C corporations (up from 15%).
If your company had a leave-based donation program in 2021 and you contributed the cash equivalent to the donated leave time before January 1, 2022, to a charity providing COVID-19 relief, you can deduct this donation.
5. Employee retention credit
The employee retention credit is an employment tax credit that was supposed to run through the end of 2021 but was retroactively terminated on September 30, 2021, other than for “recovery startup businesses.” This is a business that (i) began carrying on any trade or business after February 15, 2020, (ii) for which the average annual gross receipts for the 3-taxable-year period ending with the taxable year that precedes the calendar quarter for which the credit is determined does not exceed $1 million, and (iii) that is not otherwise an eligible employer due to a full or partial suspension of operations or a decline in gross receipts. For income tax purposes, the deduction for wages must be reduced by the amount of the credit received.
If a recovery startup business takes the credit for the fourth quarter of 2021, which is reported on Form 941 in 2022, in which year should the wages be reduced? The IRS says the wages paid in 2021 must be reduced by the credit that’s claimed in 2022. The year of payment deductions when the deduction disallowance applies.
Alert: The Employee Retention Tax Credit Reinstatement Act (H.R. 6161; similar measure in the Senate) would allow the credit for the 4th quarter of 2021, so monitor Congressional action on this measure if your business may be eligible for it.
If all of this sounds complicated, it’s because it is. The good news is that tax preparation software or cloud solutions as well as tax professionals can handle these new rules. Good luck in this tax season.