Highlights of the Latest COVID-19 Legislation - Aspiriant

Highlights of the Latest COVID-19 Legislation

After threats of a veto and last-minute attempts to increase stimulus checks, the Consolidated Appropriations Act of 2021 was signed by the president on December 27, 2020. The long-negotiated legislation contains new and additional coronavirus relief provisions, as well as other tax extenders, designed to provide additional economic support for people and build a bridge to a future without COVID-19 as distribution of vaccines accelerate.

While much has been said about the act, this guide focuses on some of the less-reported individual tax provisions that may be of interest to you.

Retirement plan provisions

Penalty-free qualified disaster distributions from retirement plans

The Consolidated Appropriations Act allows for penalty-free distributions for people impacted by natural disasters in specific federal disaster areas between January 1, 2020, and February 25, 2021.

Notably, the disaster declaration must be for a reason other than COVID-19. Eligible people may withdraw up to $100,000 from employer-sponsored retirement plans and IRAs in calendar year 2020.

These Qualified Disaster Distributions enjoy several benefits:

  • Exempt from 10% early distribution penalty. The distribution is not subject to the additional 10% tax on early distributions for those under age 59½, but it is still taxable income.

  • No mandatory tax withholding. The distribution is not subject to mandatory withholding requirements. Typically, distributions from employer-sponsored retirement plans are subject to mandatory federal withholding of at least 20%. Federal disaster distributions, however, are exempt from this requirement.

  • Taxable income may be spread over three tax years. The distribution may be counted as gross income pro rata over a three-year period beginning in the year received (2020 or 2021), if the taxpayer elects to do so. However, this may not always be the best option. See note below.

  • The distribution may be repaid without tax or penalty over three tax years. Beginning the day after an individual receives a distribution, they may repay it over a three-year period and not include the amounts distributed or repaid in gross income.

  • The distribution may be repaid to any Eligible Retirement Plan including:
    • An individual retirement account described in section 408(a)
    • An individual retirement annuity described in section 408(b) (other than an endowment contract)
    • A qualified trust
    • An annuity plan described in section 403(a)
    • An eligible deferred compensation plan described in section 457(b) that is maintained by an eligible employer described in section 457(e)(1)(A)
    • An annuity contract described in section 403(b)

To qualify as a qualified disaster distribution, the recipient must:

  • Reside within a federally declared disaster area
  • Have suffered a financial loss from the disaster

An employer-sponsored retirement plan may make such distributions without loss of its tax-favored status. In the case of distributions from employer-sponsored retirement plans, the $100,000 limit on distributions to an individual applies to all plans in the aggregate maintained in the employer’s group.

Note that this opportunity is separate from, and depending on the facts and circumstances may be in addition to, the $100,000 of allowed coronavirus distributions (from employer-sponsored retirement plans) taken in 2020 under the CARES Act for people affected by the coronavirus. This Appropriations Act does not extend coronavirus distributions into 2021.

Planning note: Electing to spread the distributed income over three years may not be optimal if you experience very low (or no) income in 2020. Care should be taken to determine when best to recognize the income. If all the income is captured in the 2020–2022 tax returns, the returns would need to be amended if you pay back the distribution to the plan within the three-year window.

Increased limits on disaster-related loans from retirement plans

Like the CARES Act, the law permits a maximum loan up to $100,000 and allows a loan to be issued for up to 100% of the participant’s vested accrued benefit for those affected by a federally declared disaster unrelated to COVID-19 between January 1, 2020, and February 25, 2021. The loan must be issued during the 180-day period beginning December 27, 2020.

Charitable contributions

For taxpayers who itemize deductions

The act extends through 2021 the temporary increase in the AGI limit on cash contributions made to public charities, excluding private foundations, supporting organizations and donor advised funds (DAFs). Individual taxpayers who itemize deductions can elect to deduct up to 100% of their adjusted gross income (AGI) remaining after factoring in all other charitable contributions that are subject to AGI limitations. As such, you can completely wipe out your 2021 tax liability with charitable contributions. Any excess cash contributions that are not deducted in 2021 can be carried forward subject to the 60% of AGI limit in the succeeding five years.

Planning note: While deducting up 100% of AGI as charitable contributions can produce a zero-dollar income tax bill, that benefit may sub-optimize the use of marginal tax brackets. Consequently, some people with high income may achieve a better multi-year tax result by spreading the total deduction over several years.

For taxpayers who don’t itemize deductions

The legislation also extends through 2021 the deduction when computing AGI of up to $300 for cash contributions to public charities (again excluding private foundations, supporting organizations or DAFs) made during tax years beginning in 2020. Notably, the legislation increases the above-the-line deduction for joint filers in 2021 to $600, thus removing what some observers considered a marriage penalty. Charitable contribution carryovers from prior years do not qualify for this deduction.

Medical expense deduction hurdle rate

The legislation permanently restores the AGI “hurdle rate” for medical expense deductions to 7.5% of AGI. The hurdle rate had been 10% in 2019 and 2020.

More flexibility for flexible spending accounts (FSAs)

The legislation provides further flexibility to roll over unused amounts in health care and dependent care FSAs from 2020 to 2021 and from 2021 to 2022. It also permits employers to let employees make a 2021 mid-year prospective change in contribution amounts. Before the relief bill, employees generally would have irrevocably set their contribution amount at the beginning of the year, and any amounts remaining unused at the end of the year are generally forfeited.

Return of the three-martini lunch

One provision that may benefit business owners is the restoration of a 100% business deduction for “food or beverages provided by a restaurant.” The act permits a full deduction for meal expenses (but not business “entertainment” expenses) in 2021 and 2022. Absent the relief bill, the deduction would have been limited to 50% for those expenses.

Additional recovery rebates

Recovery rebates were a key sticking point in Congress when negotiating another coronavirus economic stimulus bill. In the end, rebates for eligible taxpayers were essentially cut in half from those included in the CARES Act: $600 for a single person or $1,200 for married couples filing jointly. Qualifying children under the age of 17 will generate an additional $600 each. An eligible individual cannot be a nonresident alien, claimed as a dependent on another taxpayer’s return, or an estate or trust.

The following are requirements for a child to qualify:

  • Must be the taxpayer’s child, stepchild, adopted child, foster child, sibling, stepsibling or descendant who was under the age of 17 by December 31, 2020, and lived with the taxpayer for more than half of the year
  • The child did not provide over half of their own support for the year
  • Is a U.S. citizen, national or resident
  • Is claimed as a dependent on the taxpayer’s tax return
  • Has a Social Security number or other identification number that is reported on the tax return

The total amount of the credit is phased out by 5% of the taxpayer’s AGI in excess of the AGI Phase-Out Threshold below. For example, a married couple with an AGI of $160,000 would see their payment reduced by $500 (5% of $10,000). The recovery rebate is not available to taxpayers with AGI more than the maximum amounts shown, assuming they have no qualifying children:

CARES Act Recovery Rebate Income Threshold
Filing StatusAGI Phase-Out ThresholdMaximum AGI to Qualify
(Assumes no qualifying kids)
Married Filing Jointly$150,000$174,00
Head of Household$112,500$124,500

While the payments will ultimately be based on the taxpayer’s 2020 AGI, 2019 AGI is initially being used to determine eligibility.

If you don’t file taxes at all but collect Social Security, the IRS will determine your eligibility by looking at your Social Security benefits. This means that taxpayers who experience a major decrease in AGI in 2020 (or has new children born in 2020) won’t fully benefit from the credit until they file their 2020 tax return in 2021. However, like the CARES Act, if you receive a rebate in 2020 based on your 2019 AGI, and it turns out your 2020 AGI exceeds the maximum AGI amount, you get to keep the money received. If you did not receive a rebate and are entitled to one, the computed amount is allowed as a refundable credit against the individual’s 2020 income tax.

Student loan breaks

The act also extends through 2025, the CARES Act provision that loan payments made by employers are tax-free to the employee. Normally, if an employer makes student loan payments on behalf of an employee, the employee must claim the payments as taxable income. Under the act, employers can continue to contribute up to $5,250 before January 1, 2026, toward student loans and other current education assistance (tuition, fees and books), and the payments are not included in the employee’s income.

Extended unemployment insurance for workers

Also hotly debated in Congress, the new federal unemployment benefit is $300 per week until March 14, 2021. It includes workers who are not usually eligible for unemployment insurance such as the self-employed, independent contractors and those with limited work history. This benefit is half that passed in the CARES Act but is still a substantial addition to the amount of money individuals are entitled to temporarily receive via state unemployment compensation benefits, as the average weekly state unemployment benefit nationwide is below $400. Accordingly, many people’s unemployment checks will increase by 75% or more.

The Appropriations Act also provides a 11-week extension of Pandemic Unemployment Assistance, through April 5, 2021, which provides an additional $100 per week benefit to self-employed, independent contractors and gig workers.

Consult your advisors

Nearly a year ago, it was hard to imagine that a virus could ravage our families, economy and livelihoods so dramatically and for so long. The original CARES Act was designed to sustain us through 2020. But as we enter a new year, COVID-19 has infected more than 200,000 Americans a day, overwhelming hospitals in many communities. Over 400,000 Americans have died.

To curb COVID-19’s spread, states and counties have re-instituted severe social restrictions and business shut-downs. As a result, more than 10.7 million people remain out of work, according to the Bureau of Labor Statistics.

But there is hope. Vaccines are being rolled out, which should stem this deadly tide. And President Joe Biden and a Democratic Congress say more fiscal relief is on the way. In the meantime, the latest appropriations act is meant to help us.

As we begin a new tax filing season, consult your tax accountant and wealth manager to make sure you are maximizing the act’s benefits available to you.