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.” 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.”
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.”