Breaking Down Changes Ertc

ERTC or Employee Retention Tax Credit is a key tax incentive that encourages employers to retain experienced employees and incentivizes early retirement of less experienced workers. While there has been some momentum building in Congress towards making major changes to ERTC, the recently-passed omnibus budget bill, signed by President Trump, preserves the current system. In Part 1 of this series, I focus on the “second step” or “orchestration steps” to ERTC.

First Step: Assigner and Employer Matching

For purposes of calculating the employer match, employers will be required to hire ERTC “advisors” to file an “asset management plan.” In the process, the adviser must certify that they have engaged qualified staff to handle the assets of the employee.

Employer Matching Requirements For 2019

For 2019, employers who file an asset management plan for an employee will need to comply with the following ERTC requirements:

  • The reporting employer must have direct control over the IRA or 529 account.
  • The assets must be of an “eligible IRA or 529 retirement account” subject to ERTC.
  • The assets should not be owned by another individual.
  • Employers must report the contribution by the end of each year.
  • The asset management plan must be filed by the end of 2019.
Second Step: Employee’s Initial Asset Exemption

According to the 2018 ERTC proposal released in January 2018:

For 2019, the initial IRA or 529 asset exempt amount will be $120,000 ($80,000 for the employee).

The basic IRS filing requirement remains unchanged:

  • No employer contribution is required for employers that have the first dollar of the employee’s 401(k) or IRA, or had a 2018 taxable distribution for those contributing to IRA or 401(k).
  • No employer contribution is required for those having an eligible distribution in 2018.
  • For those reporting a 2018 taxable distribution and not meeting the “preferential treatment” requirement below, the initial asset exemption amounts are $180,000 ($120,000 for the employee).
  • The 2018 preferential treatment provision required employers to contribute $480,000 ($480,000 for the employee) to ensure a $2,000 lump sum benefit to the employee when the amount was maximized.

Employer Matching Requirement for 2019

Employers can choose to provide an additional $6,000 incentive to their employee for charitable giving. Even if the IRS does not deny the plan for 2018, this will be the first contribution by the employer to an ERTC-eligible individual in 2018.

A charitable contribution of $6,000 will be required to achieve the $2,000 tax deduction that is not reflected in the 2017 Form 1040, according to the 2018 ERTC proposal. The additional $6,000 contribution must be a part of a plan that allows a taxable distribution in 2019.

In 2019, the spouse of the employee will not be able to claim the $2,000 charitable deduction under the preferential treatment provisions. Thus, for those who are eligible to claim a deduction in 2018 but not in 2019, they can plan to contribute an additional $6,000 in 2019.

The tax consequences will depend on the type of the tax year:

  • Uncertified distribution, in the year in which the contribution is made, is generally deductible.
  • A qualified distribution, in the year in which the contribution is made, is generally not deductible.

For those individuals who claim a charitable deduction in 2018, and are not eligible for a deduction in 2019, the 2018 charitable deduction could be carried forward indefinitely. This has the potential to significantly reduce a tax liability in the future.

Third Step: Nonqualified Distribution for ERTC Eligibility

For those taxpayers who wish to make a nonqualified distribution in 2019, the annual ERTC filing requirements will differ from the current year. No additional yearly filing requirement is required.

The nonqualified distribution must be made in 2019 if:

  • The qualified distribution in 2017 was not qualified and was qualified in 2018.
  • The nonqualified distribution was made before April 1, 2019, but in excess of the initial ERTC exemption amount, but was made after April 1, 2019, in excess of the initial ERTC exemption amount.

Note: The ERTC tax law provided for a lump sum distribution in 2018 if the nonqualified distribution made in 2017 was not qualified. The filing requirement for 2019 could be either $1,000 or $1,000 plus a one-half of 1% withholding tax (whichever is greater). The one-half of 1% withholding tax rule could be a part of the proposal released today. However, it is likely to be omitted in the final proposal.

In 2019, the withdrawal of the initial ERTC exemption will allow the nonqualified distribution to be made.

The Nonqualified Distribution Rules for 2019

Exclusion of the initial ERTC exemption is phased out. For those receiving an initial nonqualified distribution, any additional nonqualified distribution in 2019 (other than the initial nonqualified distribution) is subject to the tax withholding rules described above. Any additional nonqualified distributions are taxable at ordinary income rates.

For those receiving an additional nonqualified distribution, the amount of the nonqualified distribution does not reduce the nonqualified distribution amount for the year that is 2018. Therefore, if the nonqualified distribution is a gift, the additional nonqualified distribution can be taxable. The gift tax exemption amount for 2018, therefore, would be the initial nonqualified distribution exemption and will be $6,000, subject to the withholding tax rules.

Nonqualified distributions can be made for any purpose except an eligible charity or a qualified charity for a qualified individual. There is no contribution limit to the nonqualified distribution. For more information on the rules for nonqualified distributions, please refer to Publication 585, “IRS Tax Guide – Special Rules for Qualified Charitable Distributions.”

Reduction of Limit for Nonqualified Distributions

In general, there is no limit on the total amount of nonqualified distributions. However, the contribution limits to the Qualified Charitable Distribution (QCD) program will be decreased from $100,000 to $75,000. For qualified charity distributions that do not meet the prior QCD threshold of $100,000, there is no limit on the total amount of nonqualified distributions, and the contributor can aggregate up to the prior QCD level.

If more than one nonqualified distribution is made during the year, each one can be treated as a separate qualified distribution (an aggregate distribution), subject to the limits on the total amount of qualified distributions (the limits on the aggregate distributions).

If a taxpayer wishes to make a nonqualified distribution in a single year, the nonqualified distribution can be made before April 1, 2019, and the exclusion is phased out. If the nonqualified distribution was made before April 1, 2019, however, the nonqualified distribution will be treated as part of the initial nonqualified distribution, subject to the provisions described above.

The filing requirement for nonqualified distributions for tax year 2018 will remain $1,000. However, the nonqualified distribution will be treated as an additional qualified distribution for tax year 2018. If the nonqualified distribution exceeds the $75,000/$100,000 aggregate limit for a tax year, the excess amount is treated as a separate nonqualified distribution, subject to the rules described above.

Any nonqualified distributions paid by qualified charities to individuals in excess of the aggregate amount that was allowed under the prior rules and prior exemption provisions for individual taxpayers are treated as an additional nonqualified distribution and taxable as ordinary income to the individual and treated as a qualified distribution to the qualified charity.

This distribution will be treated as a separate nonqualified distribution for tax years 2018 through 2020. In 2020, the individual must file a tax return to claim the additional nonqualified distribution. Any additional nonqualified distributions after that point are treated as part of the initial nonqualified distribution, subject to the rules described above.

Fourth Step: ERC Will Increase

The Qualified Charitable Distribution (QCD) program reduces the investment tax deduction on the full contribution to QCD by 1% for each $1,000 that is contributed. For example, an individual who made a contribution of $100,000 to a qualified charity could claim a deduction of $50,000. If the contribution was made in a single year and the total of the contribution is $200,000, the deduction for the $50,000 of contribution would be reduced by $12,500, resulting in a $50,000 deductible charitable contribution of $100,000.

The maximum taxable amount that can be received as a distribution will not be reduced by the investment tax deduction. If the net contribution is greater than the limitation (this amount could be as much as $105,000 in 2018), the remaining balance can be converted to an individual retirement account (IRA) or qualified college savings plan (QSP), or other qualified plan (s).

The additional allowable amount of nonqualified distribution is available for the next four calendar years after the contribution. For example, the contribution must be made by April 1, 2018, and the additional amount is available for the year 2017, 2018, 2019, and 2019.

There is no minimum amount to contribute. All distribution payments made within the calendar year are treated as part of the QCD contribution for the calendar year in which they are made. The annual limit of $100,000 per tax year is the maximum amount that can be contributed, or given to the qualified charity.

In order to be qualified for a QCD contribution, the donation must meet the following criteria:

  1. The contribution must be made by December 31 of the year in which the contribution is made, and the contribution must be for the year in which the contribution is made.
  2. The donation must be for a qualified charitable organization.
  3. The contribution is nonqualified charitable distribution (NQCD), and must be made on or after January 1, 2016.
  4. The contribution is not a gift in exchange for anything of value.
  5. The contribution is not a contribution made in exchange for money, property, securities, or any other consideration.
  6. The donation is not made as a way of avoiding U.S. income taxes.
  7. The contribution is made in connection with another qualified charitable contribution (QCG) or as an original installment payment for a qualified charitable contribution.
  8. The contribution is a not a prohibited 1031 exchange and includes an amount to be received by the contributor on or after January 1, 2016, in connection with the making of the QCD.
  9. The contribution is made from a qualified retirement plan, defined contribution plan, or qualified education plan.
  10. The contribution is made to the qualified charity as part of an election by the contributor, as provided under IRS. 12 § 451€
ERC Changes Can Apply To This Year’s Tax Return

This change can apply to a year-end distribution made in 2015. Because the benefits from the change are cumulative for future years, the affected distribution may be included as part of a charitable remainder trust or qualified charitable distribution for the 2017 tax year if the contribution date was before January 1, 2016. The taxpayer will report the QCD to the IRS as a qualified charitable distribution. This distribution is treated as it would have been in the prior calendar year if the conversion had occurred on December 31, 2015.

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