The deadline has passed to elect Section 475 MTM for tax year 2020, but it’s still possible to do so for 2021. In this article, we’ll cover the basics about when and how to make the election.

Section 475 Basics

Eligible traders have the option to make a Section 475 election, which allows mark-to-market (MTM) accounting and treatment of trading gains and losses on commodities and securities as ordinary income. Without the election, traders use the cash method of accounting and are taxed on capital gains and losses when they are realized, with losses subject to the $3,000 limitation.

MTM accounting allows traders to offset losses against every type of income, including wages; in years where they have heavy losses, they are not subject to the loss limitations. MTM accounting also works the other way, so if you have large unrealized gains in your positions, then you’ll have to recognize those even though you haven’t liquidated those positions. Another benefit is that it exempts securities trades from wash sale loss adjustments. 

Making the election is generally a good idea at the outset of operations or for existing taxpayers who have new losses from trading year-to-date up to the election deadline, giving ordinary loss treatment to these transactions. You can revoke the election in future years subject to certain rules.

Making the Election

Existing individual taxpayers need to file a Section 475 election statement with their return or extension by April 15, 2021. Then a Form 3115 needs to be filed with the 2021 tax return.

Conclusion

The Section 475 election can be a great benefit for active traders; however, the rules are complex so it’s best to consult with your CPA if are considering the election.

The Tax Reform Act of 1984 enacted a provision that commercial leases need to be tested under Internal Revenue Code section 467. The intent of section 467 is to prevent tax sheltering of income that could arise due to differences between cash and accrual basis income taxpayers by placing both the lessor and lessee on the same revenue and expense recognition terms, thereby eliminating the timing difference between the two accounting methods.

COVID and the Avalanche of Lease Modifications

Section 467 is re-emerging as a hot topic due to the economic fallout of COVID-19. The economic downturn is significantly impacting commercial real estate; especially in the office, retail and industrial sectors as lessors struggle to maintain and attract tenants. Commercial tenants are seeking rent relief and negotiating concessions in an effort to either survive or take advantage of the market conditions. In either case, when these negotiations result in a significant modification of the lease terms, it requires that a new section 467 analysis be performed.

How Section 467 Works

If the changes to the lease arrangement are large enough, section 467 requires the lessee and lessor to use the accrual method, regardless of their regular accounting method. Moreover, if the lease contains significant prepaid rent or deferred rent, the lease could be deemed to constitute a loan agreement forcing the recognition of interest income and expenses. 

A contract for the use of tangible property, with increasing or decreasing rents, or deferred or prepaid rents, and total rents exceeding $250,000 is a section 467 rental agreement. The results of a lease modification can vary widely, so let’s dig into an example to see how it works in practice. 

Example 1: Lease with Rent Allocations and Payments

Assume we have a five-year lease with rental allocations and payments as follows:

•          Year 1: Zero rent payment and no rent allocation
•          Year 2: $150,000 rent allocation, but no rent payments
•          Year 3: $150,000 rent allocation and $300,000 in payments
•          Year 4: $150,000 rent allocation and $300,000 in payments
•          Year 5: $150,000 rent allocation, but no rent payments

Since there is no rent due for year one, the fact that there is no rental payment in year two is not considered deferred rent. Similarly, the rent allocation through the end of year two of $150,000 is less than the rent paid by the end of year three, so there is no deferred rent at this point. Moving into year three, the first payment of $300,000 is not considered pre-paid rent because it is less than the total rental payment allocations through the following year four of $450,000.

On the surface, this lease arrangement appears to skirt the section 467 test; however, that is not the case. Any lease that “specifically allocates” fixed rent can cause a disconnect between the timing of the allocation and actual cash payments, causing section 467 issues. The escalating rent schedule causes this lease to qualify, forcing both the lessor and lessee to use the accrual basis of accounting for the lease, regardless of their respective accounting methods generally applied.

Example 2: Lease with Deferred Rent

As we look at our next example, keep in mind that “deferred rent” under section 467 exists where the cumulative rent allocated at the end of a year is more than the total rent payable at the end of the next year. 

Let’s assume a tenant holds an eight-year lease with rental costs of $50,000 per month. Due to COVID-19, they secure a lease modification for a deferral of 24 months’ rent, payable at the end of the lease. In total, $1.2 million in rent has been deferred (24 x $50k) under section 467.

Assume that the landlord recognizes $500,000 in gross rental income under the accrual method. Since the tenant doesn’t need to pay the rent for the first year of deferral, a deemed loan of $600,000 to the tenant is created. The tenant receives a rent expense deduction for $500k (same as the landlord’s take), with the $100,000 in payment deferred treated as imputed interest and recognized over the life of the loan.

Conclusion

The rules around section 467 can be complex, but the important thing to keep in mind is that with the economic impact of COVID-19 causing renegotiations and commercial lease modifications, any substantial changes need to be assessed to see if the new lease terms require any different accounting treatment as a result of section 467.

The CARES Act created the Employee Retention Credit as part of the government’s relief package to mitigate the economic impact of COVID-19. Recently, on Dec. 28, 2020, Congress enacted the Consolidated Appropriations Act, 2021, which clarified and expanded the scope of the Employee Retention Credit (ERC).

Below is a summary of the changes in key provisions of the credit and the new guidance. Noteworthy updates include a broader application of the credit and news that changes are retroactive.

Time of Availability

Previously, the credit only applied to qualified wages paid between March 12, 2020, through Dec. 31, 2020. The new legislation extends the credit period for six more months – through June 30, 2020.

Eligibility Requirements

There are two main triggers for eligibility. The first applies in all instances, with the credit available to any business whose operations were partially or totally suspended by a governmental COVID-19 order during the time the order is in effect.

The second option to become eligible differs under the new act. Previously, businesses were eligible if gross receipts were less than half of the same quarter in 2019 and remained eligible until reaching 80 percent – compared to the prior year. Under the revision, gross receipts were still compared to the same quarter in 2019. Still, beginning Jan. 1, 2021, eligibility starts at less than 80 percent for the comparable period (you don’t have to get to less than 50 percent). Further, if a business didn’t begin operations until 2020, they can compare to 2020 instead of 2019.

Percentage of Wages and Maximum Credit

The percentage of wages qualified for the credit increased from 50 percent to 70 percent. The cost of providing healthcare benefits to employees remains deductible as before.

Coupled with this is an increase in the maximum credit amount. Previously, the annual maximum credit per employee was $5,000; but starting Jan. 1, 2021, this increases to $7,000 for both the first and second quarters, for a $14,000 annual maximum.

Employer Size for Whether an Employee is Working or Not

The employer size threshold is another notable change. The original act prevented companies with more than 100 employees from taking the ERC for any employee still performing services – even if at a reduced capacity. Starting in 2021, this increases to 500 employees.

Paycheck Protection Program Loans versus ERC

Previously, companies who participated in the PPP loan program were not eligible for the Employee Retention Credit, including affiliated companies. The updated law retroactively changes this requirement. Companies that received PPP loans are now eligible for the ERC credit, but there are restrictions.

The change applies to wages paid on or after March 13, 2020. Prior PPP loan recipients cannot claim the credit for wages paid with proceeds from a PPP loan receiving forgiveness. If the company paid qualified wages over the amount of the forgiven quantity, they could claim the credit retroactively. The IRS is expected to issue more guidance on this topic.

Advance Payments

There was no advance payment option; employers were required to pay employee wages before they could receive the credit. While this is still not settled, it is expected that the IRS will draft guidance allowing for advance payment of the ERC for companies with 500 or fewer employees based on 70 percent of the average quarterly payroll for the comparable quarter in 2019.

Eligibility of Governmental Entities

Previously, the ERC was not available to governmental agencies at any level; however, starting Jan. 1, 2021, public colleges and universities, agencies that provide medical care, and select other agencies such as federal credit unions are now eligible.

Conclusion

The Consolidated Appropriations Act, 2021 extended and clarified many of the Employee Retention Credit provisions up through June 30, 2021. Overall, the ERC is expanded in terms of amount, employer size, and more flexible gross receipts test. Further, PPP loan recipients are now also eligible for the credit if they meet certain criteria.

Most likely, employers will need to file amended payroll tax returns for the second and third quarters, but guidance is still pending for this and PPP loan recipients who want to access the credit.

The changes can be complex, and compliance can be cumbersome, so if any of the information outlined above applies to you, be sure to reach out to us to help you capture the most value from the changes to the Employee Retention Credit rules.

According to the Brookings Institution, economists are predicting that 58 percent of unemployed workers who were laid off as a result of COVID-19 lockdowns are likely to return to their old jobs. But with the majority of laid-off workers facing an uncertain employment future, the question remains of how workers and employers will transition into a post-coronavirus world of work.

The Committee for Economic Development (CED) explains that employers are a major source of ongoing employee training. But with events like the COVID-19 pandemic, these former employees have been dislocated from an upward career path.

According to the CED and the Bureau of Labor Statistics, during June 2020, approximately one-third of unemployment insurance went to the self-employed, individuals who do not benefit from employer-based training. This presents a challenge for those workers, who might require more training to enter the market as an employee.

One potential scenario for these pandemic-dislocated workers, according to the CED, is through “publicly supported training in a time of crisis.” Recommendations, especially for individuals on the bottom earning tiers, are for increased public investment in community colleges. Providing virtual training could help these individuals learn new skills and become employable again. Be it a community college or similar, and the CED explains that it could be subsidized by either a modified Pell Grant or direct payments to the individual taking classes to become a member of the workforce again.

Much as the pandemic’s course is uncertain, only time will tell until how these newly created job problems will be addressed.

Sources

https://www.brookings.edu/research/turning-covid-19s-mass-layoffs-into-opportunities-for-quality-jobs/

https://www.ced.org/2020-solutions-briefs/meeting-the-upskilling-challenge-training-in-the-time-of-covid-19

With COVID, there’s a good chance that you are working from home. For example, in May the Dallas Federal Reserve reported that approximately 35 percent of U.S. employees worked from home full-time, with almost 72 percent of those who were able to work from home choosing to do so.

Working from home is likely the new normal for many people, and accompanying these are rules and practices of which taxpayers need to be aware.

Employee Status

The line between an employee versus an independent contractor continues to blur, especially with work from home increasing. Now, just because you are working from home does NOT mean that you can be considered self-employed, but it can make the case more likely if you were already on the line.

If there was a debate between being classified as an employee or an independent contractor when you began working for an organization, now may be the time to revisit your status – but only if you would rather be considered as an independent contractor. There are numerous pros and cons to each for the worker, but keep in mind that W-2 employees cannot take the home office deduction.

Maximize Your Employer Benefit

Check with your human resources department to see if your employer offers benefits such as cell phone reimbursements, a stipend for home office expenses, reimbursements for expenses, or other perks that you might not have needed or otherwise been entitled to before working from home.

Crossing State Lines

Perhaps the biggest confusion and potential change impacts employees who normally work in an office in one state, but live and are now working from another state as a result of working from home. Working at home in one state when your company is in another state could mean that you’re now subject to taxation in both places, especially if either state has a physical presence rule.

The rules around this are numerous and complex and you can easily make mistakes if you don’t keep the right records. Given the complexity, the details are beyond the scope of this article; however, if you are now working in two states due to working from home part-time or from a different state as a result of working from home, it’s probably a good idea to consult your tax professional.

Creature Comforts

Working from home full-time or even semi-regularly might mean you need to upgrade your home office by purchasing equipment or making structural upgrades, such as soundproofing. These expenses can be deductible as long as they meet the home office deduction criteria.

Conclusion

Working from home could become the new normal for millions of people; and if you play it smart, you can end up in both comfort and safety without any adverse financial consequences.