The President signed into law the CARES Act to provide tax relief, cash flow, and liquidity to businesses along with benefits to individuals. Learn how these changes will impact your business.
The President signed into law today the Coronavirus Aid, Relief and Economic Security Act (the CARES Act) to relieve economic impacts of the novel coronavirus (COVID-19), approving a number of corporate tax changes that raise planning considerations. The legislative package also provides an estimated $2.2 trillion of assistance for individuals and businesses, including direct cash payments to most Americans and multi-billion dollar loans for certain businesses.
The CARES Act includes numerous tax changes that grant tax relief and provide cash flow and liquidity to businesses. The majority of the provisions will accelerate and magnify corporate refunds for overpayments in prior years.
New Employee Retention Tax Credit
New to the final text of the Act is a refundable, one-year only credit against an employer’s 6.2 percent share of Social Security payroll taxes. Section 2301 provides that the credit will be equal to 50 percent of the qualified wages paid to each employee for an eligible quarter, capped at $10,000 of qualified wages to each employee for the duration of 2020. Eligible employers are those that carry on a trade or business during calendar year 2020 and that, with respect to a given calendar quarter, either fully or partially suspended the operation of that trade or business during the calendar quarter due to orders from an appropriate governmental authority limiting commerce, travel or group meetings (for commercial, social, religious, or other purposes) due to the COVID-19. Taxpayers may also qualify as an eligible employer if they have a trade or business during calendar year 2020 that suffers a significant decline in gross receipts, such that their gross receipts for a calendar quarter in 2020 are less than 50 percent of its gross receipts for the same calendar quarter in 2019. If a business qualifies under the gross receipts test, then it will remain qualified until it has a quarter where its gross receipts exceed 80 percent of its gross receipts for the same calendar quarter in 2019. In all cases, qualified wages will include qualified health plan expenses allocable to the wages, including amounts paid to maintain group health plans.
The definition of qualified wages hinges on the average number of full-time employees (as defined by section 4980H of the Internal Revenue Code (the “Code”)) employed by the eligible employer during 2019. For employers with more than 100 such employees, qualified wages include wages paid to an employee ONLY for the time that the employee is not providing services due to either A) a full or partial suspension of operations by order of a governmental authority or B) a significant decline in gross receipts. For employers with 100 or fewer such employees, qualified wages include wages paid to all employees, including wages paid to employees that continue to work.
Expanding Usage of Net Operating Losses
One of the more notable provisions expands the usage of net operating losses (NOLs). This expansion can provide significant immediate cash flow to certain taxpayers by relaxing limitations on taxpayers that were put in place as part of the 2017 Tax Cuts and Jobs Act (TCJA). Beginning in 2018 under the TCJA, NOLs were able to be carried forward for an indefinite period of time but were not allowed to be carried back to prior tax years. A carryback would be especially valuable to a corporate taxpayer because the applicable tax rate in tax years prior to 2018 was 35 percent (instead of the 21 percent corporate rate that applied in tax years 2018 forward). Additionally, the TCJA limited the use of NOLs to an amount that was 80 percent of taxable income, determined without regard to the NOL deduction itself.
Section 2303 of the Act provides that NOLs arising in a tax year beginning in 2018, 2019 or 2020 can be carried back five years. Unfortunately, this carryback does not apply to real estate investment trusts. For all other taxpayers, NOLs can be carried back to as far as tax year 2013, a year in which the corporate tax rate was 35 percent. It also temporarily removes the taxable income limitation, allowing an NOL to fully offset corporate-level income for years 2018, 2019 and 2020. Importantly, the 80 percent limitation is permanently eliminated for losses generated prior to 2018 and carried forward to future years. Corporations that have NOLs arising in 2018 or 2019 should be able to claim large refunds, and those that forecast an NOL for 2020 can expect additional refunds from NOLs generated.
The Act provides that if the taxpayer can carryback an NOL to a year with section 965 income, the taxpayer will be treated as having made the section 965(n) election, which excludes section 965 income from determining the amount of NOL for that year. This election was put in place to allow a taxpayer with an NOL in the section 965 year to take the foreign tax credits in such year and preserve the NOL for a future year. Alternatively, a taxpayer may elect to exclude from the carryback period any year to which section 965 applies.
In the case of a corporate taxpayer that generates foreign derived intangible income (FDII), the Act did not modify the application of NOLs to such income. That is, when calculating a taxpayer’s NOL for the years 2018 and forward the Section 250 deduction is inapplicable. Similarly, the Act has not modified the method in which NOLs interact with the calculation of the base erosion and anti-abuse tax (the BEAT). Specifically, the rules limiting the use of NOLs to calculate taxable income for BEAT purposes and the rules applicable to adding back certain NOLs to calculate modified taxable income remain applicable.
Modified Limitation of Losses for Pass-Through Entities and Individuals
The Act allows non-corporate taxpayers to fully utilize their excess business losses by temporarily – and retroactively – turning off section 461(l) for tax years beginning after December 31, 2017 and before January 1, 2021. The TCJA’s enactment of section 461(l) disallowed deductions for “excess business losses,“ which were defined as the excess of the taxpayer’s deductions over their aggregate gross income plus $250,000 ($500,000 if married filing jointly). These excess losses were converted to NOL carryovers under section 172, which often did not allow for efficient loss utilization. Note that the loss limitation applies to partnerships and S corporations at the partner or shareholder level.
Section 2304’s retroactive halt on section 461(l) will allow taxpayers that had losses limited in 2018 or 2019 to file an amended return to claim a refund. The Act also provides that any deductions, gross income or gains attributable to a trade or business of performing services as an employee shall be disregarded when computing excess business losses, effectively legislating that wages will not be considered business income – an issue that the IRS and the Joint Committee on Taxation had disagreed upon.
The Act increases the amount of interest expense businesses are allowed to deduct under section 163(j). This will allow businesses to incur more debt enabling them to pay employees and maintain cash flow during the pandemic without incurring a limitation on the amount of interest deducted. Specifically, for tax years 2019 and 2020, section 163(j) is modified to allow taxpayers to deduct 50 percent, as opposed to 30 percent, of an amount that approximates the taxpayer’s EBITDA. Specifically, section 163(j) allows a deduction for interest expense for the years 2019 and 2020 to the extent the expense does not exceed 50 percent of the taxpayer’s EBITDA, business interest, and certain floor plan financing interest. Additionally, the Act provides a special rule for partners of partnerships that were allocated excess business interest for tax year 2019. This could be especially beneficial to private equity and venture capital fund investors who were allocated excess business interest in tax year 2019. In such case, 50 percent of the 2019 allocated excess business interest income would not be subject to Code Section 163(j) limitations. Finally, recognizing that the amount of EBITDA in the year 2020 may be little or non-existent due to the COVID-19 global pandemic, the Act allows taxpayers to use their 2019 tax year EBITDA to determine the 50 percent interest deduction limitation. Presumably, a taxpayer’s 2019 EBITDA would be significantly greater than its 2020 EBITDA so that more interest expense would be deductible.
Modification to Qualified Improvement Property
Section 2307 of the Act corrects the so-called “retail glitch,“ allowing restaurants, retail shops and hotels the ability to immediately deduct costs associated with their qualified improvement property (QIP). The TCJA intended to allow these businesses immediate write-offs for costs associated with their QIP; instead, the final text mistakenly failed to classify such property as having a 15-year recovery period, causing companies to depreciate their improvement costs on a 39-year depreciation schedule.
The Act includes technical corrections that clarify that QIP is classified as 15-year property under the modified accelerated cost recovery system (20-year property for alternative depreciation system) and eligible for 100 percent bonus depreciation. In addition, this Section will take effect as though it were originally enacted in the TCJA. As a result, subject to certain requirements, businesses can immediately amend their 2018 and 2019 tax returns to claim the one-time QIP deductions that were disallowed for their 2018 and 2019 tax years.
Delayed Payment of Employer Payroll Tax and Self-Employment Tax
Section 2302 of the Act allows deferral of an employer’s and a self-employed individual’s payment of the employer share of the social security tax they otherwise are responsible for paying to the federal government with respect to their employees or self-employment activities. Employers are generally responsible for paying a 6.2 percent social security tax on employee wages. The deferral period lasts from the date of the enactment of the Act until December 31, 2020. The provision requires that the deferred social security tax be paid over the following two years, with half of the amount required to be paid by December 31, 2021 and the other half by December 31, 2022. Provided these taxes are paid by these deadlines, the employer will be treated as having made timely payments. Importantly, the social security tax trust funds will be held harmless under this provision.
Section 2305 allows corporations to elect to immediately claim the entirety of their outstanding alternative minimum tax (AMT) credits, a portion of which would not have otherwise been available until 2021. The Act also temporarily suspends the excise tax applied on alcohol used to produce hand sanitizer.
The Act also includes a number of individual income tax provisions. Among others, the Act waives early withdrawal penalties for COVID-19 related distributions from qualified retirement accounts, removes the required minimum distribution rules for certain defined contribution plans and IRAs, allows above-the-line deductions for up to $300 of charitable contributions, and entirely removes the charitable contribution limitations for individuals that itemize.
In addition to the tax relief provisions, the Act includes specific economic relief for businesses, offering $377 billion in federally guaranteed loans to small businesses to cover their debt obligations and guaranteeing $500 billion in loans and loan guarantees for at-risk industries, including airlines and cargo carriers.
The Act also includes relief measures for individuals. It authorizes the Internal Revenue Service to issue checks of as much as $1,200 per person ($2,400 for joint-filers). Payments would be phased in for low-income taxpayers and phased out for individuals with adjusted gross income over $75,000 ($150,000 for joint filers). It also provides for an additional $500 per child. In addition, Senate Democrats successfully negotiated for key unemployment provisions, offering an additional 13 weeks of federally sponsored benefits and extending payments to freelancers and gig workers.
The final text of the Act does not address several key provisions that Senate Republicans had initially proposed, including the restoration of certain downward attribution rules under Section 958(b)(4) that had been removed by the TCJA. If that technical correction had been included, it would have significantly decreased the number of companies that are treated as controlled foreign corporations for U.S. tax purposes, generally reducing the effective tax rate for multinationals based in the U.S. Separately, although Republican’s initial proposal had called for the delay of certain corporate and individual estimated tax payments, the IRS has since issued Notice 2020-18, which obviates the need for that provision.