Filing taxes has never been simple for freelancers and business owners, but the pandemic has made it far more complex.
Tax time is always complicated for freelancers and business owners, but this year, it’s especially swampy.
Pandemic relief programs that helped small companies and self-employed individuals created new tax challenges. And many people had unusually jumbled patchworks of jobs and income sources last year.
“I’m kind of scared,” said Celeste Holcomb, an artist and designer. In 2020, her income included book royalties; fees for illustration, design jobs and work done through a gig platform; wages from a contract job at a university publisher; and, for several months, unemployment benefits. Ms. Holcomb, who plans to do her taxes herself, expects to spend hours wading through records and tax documents to figure out what she owes.
Even tax pros are struggling, thanks to a raft of last-minute changes Congress included in December’s economic relief package. “We have more than 100 clients, and if I have five that file on time this year, it’ll be a miracle,” said Meghan Blair-Valero, the founder of Fogged In Bookkeeping, which specializes in small business accounting.
Here are some of the tax issues small business owners are facing this year and advice for navigating them.
Paycheck Protection Program
The government’s primary small-business relief program backed $523 billion in loans last year — to more than five million businesses. The loans are to be forgiven by the government if the recipients comply with the rules. Forgiven debt is usually taxed as income, but Congress exempted Paycheck Protection Program loans from that requirement.
In December, Congress went further and allowed recipients to deduct on their federal taxes expenses paid with P.P.P. loan proceeds. That double dip is a windfall for business owners. But there’s one P.P.P. tax whammy still looming: Some states have broken with the federal approach and are either taxing the proceeds of a forgiven loan or barring businesses from deducting expenses paid for with them.
And in many, the issue is still being thrashed out. Massachusetts, for example, had planned to tax forgiven P.P.P. loans included on individual filers’ returns. That would have been a liability for business owners like Stephen Bowler, who got loans for each of his two restaurants in Nantucket.
“I’m of two minds on it,” Mr. Bowler said. “Not getting taxed federally on it is a huge bonus. But this isn’t really income — it’s a forgivable loan to get us through Covid — so why does Massachusetts think they should benefit from it?”
But Massachusetts’s legislative leaders reached a deal to exempt the forgiven loans from taxation as individual income. They are drafting a bill that will then need the governor’s approval.
Dozens of states haven’t yet clarified whether they’ll follow the federal approach. In places where lawmakers are still considering legislation to adjust the rules, the decisions may not be made before tax filing deadlines.
“I expect a lot more extended returns this year,” said Eileen Sherr, director of tax policy at the American Institute of Certified Public Accountants, a trade group.
Economic Injury Disaster Loans
Another federal aid program, the Economic Injury Disaster Loan system, made $195 billion in low-interest, long-term loans to more than three million businesses last year. Unlike P.P.P. loans, these must be paid back, so they’re not taxable.
But the program also gave many applicants loan “advances” of up to $10,000 that are functionally grants, because they don’t have to be repaid. Congress exempted those advances from federal taxation, but some states are treating them as taxable income.
The employee retention credit
The CARES Act, a $2 trillion relief package signed into law last March, created an employee retention credit, giving employers an incentive to pay workers through the pandemic, but the law barred businesses that took Paycheck Protection Program loans from claiming the credit.
In December’s relief bill, Congress eliminated that restriction and allowed employers to retroactively claim the credit for quarters in 2020. It also expanded the credit for 2021 and lowered the threshold for qualifying for it. This year, the credit — which businesses usually claim through a quarterly filing — is available to businesses that had a 20 percent decline in 2021 quarterly gross receipts compared with the same quarter in 2019. They can get up to $10,000 an employee, per quarter, through June.
The revamped credit “is a better program — there’s more money, and it’s available to more employers,” said Shelly Abril, the head of tax compliance at Gusto, a payroll services provider. “But with that comes all this extra complexity.”
Frequently Asked Questions About the New Stimulus Package
The stimulus payments would be $1,400 for most recipients. Those who are eligible would also receive an identical payment for each of their children. To qualify for the full $1,400, a single person would need an adjusted gross income of $75,000 or below. For heads of household, adjusted gross income would need to be $112,500 or below, and for married couples filing jointly that number would need to be $150,000 or below. To be eligible for a payment, a person must have a Social Security number. Read more.
Buying insurance through the government program known as COBRA would temporarily become a lot cheaper. COBRA, for the Consolidated Omnibus Budget Reconciliation Act, generally lets someone who loses a job buy coverage via the former employer. But it’s expensive: Under normal circumstances, a person may have to pay at least 102 percent of the cost of the premium. Under the relief bill, the government would pay the entire COBRA premium from April 1 through Sept. 30. A person who qualified for new, employer-based health insurance someplace else before Sept. 30 would lose eligibility for the no-cost coverage. And someone who left a job voluntarily would not be eligible, either. Read more
This credit, which helps working families offset the cost of care for children under 13 and other dependents, would be significantly expanded for a single year. More people would be eligible, and many recipients would get a bigger break. The bill would also make the credit fully refundable, which means you could collect the money as a refund even if your tax bill was zero. “That will be helpful to people at the lower end” of the income scale, said Mark Luscombe, principal federal tax analyst at Wolters Kluwer Tax & Accounting. Read more.
There would be a big one for people who already have debt. You wouldn’t have to pay income taxes on forgiven debt if you qualify for loan forgiveness or cancellation — for example, if you’ve been in an income-driven repayment plan for the requisite number of years, if your school defrauded you or if Congress or the president wipes away $10,000 of debt for large numbers of people. This would be the case for debt forgiven between Jan. 1, 2021, and the end of 2025. Read more.
The bill would provide billions of dollars in rental and utility assistance to people who are struggling and in danger of being evicted from their homes. About $27 billion would go toward emergency rental assistance. The vast majority of it would replenish the so-called Coronavirus Relief Fund, created by the CARES Act and distributed through state, local and tribal governments, according to the National Low Income Housing Coalition. That’s on top of the $25 billion in assistance provided by the relief package passed in December. To receive financial assistance — which could be used for rent, utilities and other housing expenses — households would have to meet several conditions. Household income could not exceed 80 percent of the area median income, at least one household member must be at risk of homelessness or housing instability, and individuals would have to qualify for unemployment benefits or have experienced financial hardship (directly or indirectly) because of the pandemic. Assistance could be provided for up to 18 months, according to the National Low Income Housing Coalition. Lower-income families that have been unemployed for three months or more would be given priority for assistance. Read more.
Devon Lind plans to seek retroactive 2020 credits for his workers at Blender, a collection of businesses in Spokane, Wash. Blender’s two core businesses — Photoboxx, which sells photo printing and display technology, and Smash, a mobile “rage room” where people can destroy plates — both depend on events, and sales plunged last year. The company had nine employees before the pandemic. It laid off five.
Because Blender took a Paycheck Protection Program loan, it was initially ineligible for the retention credit, but Mr. Lind now plans to seek it for two quarters last year. The credit “is really going to help us continue to retain employees as we’re gaining back business,” he said.
But extracting the most money allowed from the credit is complicated because of the way it interacts with P.P.P. proceeds — and the Internal Revenue Service hasn’t yet provided detailed guidance.
“There’s just tons of nuance in the credit,” said Andre Shevchuck, a partner at the accounting firm BPM. “We have instructed a lot of clients to first check in with their payroll provider to see how the rubber meets the road, and it may also make sense for businesses to talk to a C.P.A or a lawyer.”
Unemployment benefits
Self-employed workers are normally not eligible for unemployment compensation, but the CARES Act extended benefits to them. Ms. Holcomb filed for unemployment when her contract job temporarily eliminated her hours.
Some who collected the money are in for a tax-time shock, though: The payments are taxed as income. States are supposed to offer recipients the option of having federal taxes withheld, but in their scramble to deal with a deluge of claims, some states didn’t do it — and many people, faced with urgent bills and a reduced income, declined the option. Researchers at the Century Foundation estimate that fewer than 40 percent of unemployment payments last year had taxes withheld.
A bit of relief is on the way: The $1.9 trillion stimulus bill that makes the first $10,200 of benefits in 2020 tax-free for households with incomes of less than $150,000.
Ms. Holcomb, who lives in Winston-Salem, N.C., discovered when she got her tax paperwork that no taxes had been withheld from her payments. Having a chunk of the money shielded from taxes “is amazing — that will be extremely useful for me,” she said.
The double-tax trap
The pandemic threw business owners other curveballs.
Those who relocated and worked in a state other than the one in which they permanently reside risk being double-taxed under rules that vary widely from state to state. Businesses that received grants from local relief programs will generally face state and federal taxes on that income. An array of novel federal tax breaks and credits have accountants working overtime to ferret out everything their clients can claim.
And the I.R.S. is still thrashing out the rules for many of the changes included in December’s relief package.
“I hate to keep using the word ‘unprecedented,’ but in 20 years, I’ve never had a tax season like this,” Ms. Blair-Valero said. “It’s a guessing game — the government changed a bunch of rules just days before the year ended. Business owners are up to their eyeballs in new and different stresses on their businesses this past year, and now they’ve got to navigate this mess? It’s really overwhelming.”
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