COVID-19 Response: Tax Update - Using CARES to Conserve or Generate Cash, and Other Changes to Federal Tax Law
Washington, D.C. (March 31, 2020) - Signed into law by President Trump on March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES) (Public Law No. 116-36) amends numerous provisions of federal tax law affecting both businesses and individuals. Many of the changes aim to help taxpayers conserve or generate cash, either prospectively or by amending prior years’ tax returns. Here is our initial take on the changes and the opportunities they present.
Given the speed with which CARES was drafted, the Act’s language raises even more questions than usual for new legislation. We have flagged some but undoubtedly not all the interpretive questions the answers to which taxpayers will crave in interpretations from the IRS and possibly even future legislation.
Section numbers in the headings below refer to sections of CARES.
Section 1106: Small Business Loan Forgiveness
An eligible borrower of a covered loan guaranteed under the Small Business Act (SBA Loan) is eligible for forgiveness of the SBA Loan in an amount equal to the following costs incurred and payments made during the “covered period”: payroll costs, interest payments on “covered mortgage” payments (not principal payments), “covered rent” payments, and “covered utility payments.” The “covered period” means the 8-week period beginning on the SBA loan origination date. Taxpayers should note that the “covered period,” as currently stated, is for eight weeks and not defined to match the loan term. Note there is a prohibition on forgiveness without required documentation submitted to the lender.
Unlike income from discharge of indebtedness generally, amounts that are forgiven are not included in the borrower’s taxable income.
Technical Observation: In general, gross income for federal income tax purposes includes income from the discharge of indebtedness (COD). Internal Revenue Code (IRC) Section 61(a)(11). Section 108 of the IRC, however, excludes from gross income various categories of COD. CARES Section 1106 does not reference or specifically amend IRC Section 108. Instead, CARES Section 1106(i) states that any eligible amount from a qualifying forgiveness which otherwise would be includible in gross income shall be excluded.
Sections 2102-2115: Expanded Unemployment Insurance
CARES temporarily expands unemployment insurance for workers in various ways including amounts available to workers through state-operated unemployment insurance programs. For example, qualifying recipients can receive, on top of amounts payable by their state’s program, an additional $600 per week for up to four months, fully funded by the federal government. The extra funds may be paid as a separate check or together with the traditional unemployment check provided by the state. Additionally, recipients who were previously nearing the end of their unemployment can apply for a 13-week extension with their state unemployment agency.
Qualifying recipients are also expanded to include workers such as self-employed individuals, freelancers, gig workers, and independent contractors, most of whom have not traditionally been eligible for unemployment benefits.
Technical Observation: Amounts a worker receives through unemployment insurance traditionally must be included in the worker’s gross income and are thus subject to Federal income tax. CARES does not exempt its enhanced payments from this general rule.
Tax-exempt organizations are deemed to satisfy these conditions. The credit may be taken with respect to the first $10,000 of compensation, including group health benefits, paid to each qualified employee from March 13 through December 31, 2020. However, the scope of qualified wages depends on the employer’s size:
- Employers having more than 100 full-time employees: qualified wages consist of compensation paid to employees when they are not providing services on account of COVID-19 related circumstances.
- Employers having 100 or fewer full-time employees: all employee wages qualify for the credit whether the employer is open for business or subject to a shutdown order.
Employees can elect out of deferring employment taxes for any calendar quarter.
If an employer takes out a payroll protection loan under Section 7(a) of the Small Business Act, the retention credit will no longer be available for that business. In other words, under CARES an employer must choose between taking a payroll protection loan or employee retention credits.
Section 2201: Recovery Rebates for Individuals 2020
Individuals that are compliant in filing their tax returns and are not claimed as dependents by another person will receive a rebate from the IRS. The amount of the rebate depends on the taxpayer’s (1) adjusted gross income (AGI), (2) what type of tax filer the taxpayer is, and (3) whether the taxpayer has children. Taxpayers making $75,000 ($150,000 married filing jointly) or less will receive the full amount of the rebate, $1,200 ($2,400 married filing jointly). Additionally, taxpayers will receive $500 per child claimable as a dependent. The rebate declines by $5 for each $100 of AGI exceeding:
- $150,000 for joint returns
- $112,500 for heads of household filers and
- $75,000 for all other filers
To determine the amount of rebate payable, the IRS will use a taxpayer’s federal income tax return for 2019, if on file. If the taxpayer has not filed his or her 2019 return, the IRS will use the 2018 federal income tax return. For federal tax purposes, the rebates will be characterized as refundable credits against liability for federal income tax for 2020. The rebates are payable only to “eligible individuals” and are not includible in gross income.
For purposes of this rebate, “eligible individuals” do not include:
- Nonresident alien individuals
- Any individual claimable as a dependent by someone else
- Trusts and estates
Technical Observation: Importing existing rules on “advance refunding” of tax credits, CARES basically treats these rebates as advances of tax credits allowed for tax year 2020. If the amount of the rebate is less than the credit allowable for 2020, then the taxpayer can claim the balance of the credit when filing the 2020 return. If the rebate ends up being greater than the credit allowable, then the taxpayer will not have to repay the excess because the credit for 2020 cannot be reduced below zero.
Section 2202: Special Rules for Use of Retirement Funds
Ordinarily, if a beneficiary of a qualified retirement plan such as a 401(k) or IRA prematurely withdraws funds from the plan, the beneficiary is subject to both federal income tax and a 10% early withdrawal penalty for the year in which the funds are withdrawn. However, if the recipient has attained the age of 59 1/2 prior to the early withdrawal, the 10% penalty does not apply.
CARES mitigates these consequences for up to $100,000 of coronavirus-related distributions that a qualified plan distributes during 2020:
- No early withdrawal penalty
- Recipient can pay income tax on the withdrawal ratably over three years (unless the recipient elects to pay all the income tax on the withdrawal in the year received)
- Within three years of having withdrawn them, the recipient can recontribute the withdrawn funds to an eligible retirement plan without regard to that year’s cap on contributions.
These relaxed rules apply only to coronavirus-related distributions not exceeding $100,000, defined as distributions made to an individual in any of three situations:
- Diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention;
- Spouse or dependent diagnosed with COVID-19 by such a test; or
- Experiences adverse financial consequences as a result of being quarantined, furloughed, laid off, having work hours reduced, being unable to work due to lack of child care because of COVID-19, closing or reducing hours of a business owned or operated by the individual due to COVID-19, or other factors as determined by the Treasury (presumably in guidance issued by the IRS).
If a taxpayer who received a coronavirus-related distribution recontributes the distribution to another qualified retirement plan within three years of having received it, then the individual will not be subject to income tax on the distribution. The taxpayer may recontribute the distribution to another plan in one or more installments. For purposes of this rule, CARES basically treats the reinvestment as a rollover distribution and trustee to trustee transfer within 60 days of the distribution. In general, rollover distributions reinvested in a trustee to trustee transfer within 60 days are not subject to income tax.
Technical Observation: These rules on distributions and reinvestments raise various technical questions. Assume, for example, that an individual receives in 2020 a coronavirus-related distribution of $100,000. The individual does not elect to include the entire $100,000 in taxable income in 2020, and accordingly, the individual reports 1/3 ($33,333) in income for 2020 and 1/3 ($33,333) in 2021. In 2022, the individual recontributes the $100,000 to a qualified plan. How will the taxpayer in effect reverse the amounts reported as income in 2020 and 2021?
CARES also temporarily liberalizes restrictions on taking nontaxable loans from qualified retirement plans.
Section 2203: Temporary Waiver of Minimum Distribution Rules
In general, once a beneficiary of a qualified retirement plan has attained a stated age (typically age 72) (or 70 1/2 if the taxpayer turned 70 1/2 before January 1, 2020), the individual in order to avoid a penalty tax annually must take required minimum distributions (RMDs) from all qualified plans (401(k)s, IRAs, etc.) For calendar year 2020, however, CARES suspends requirements to take RMDs.
Section 2204: Partial Above the Line Deduction for 2020 Charitable Contributions
In general, only individuals who itemize income tax deductions (i.e., take “below the line” or deductions from AGI) may deduct contributions to charitable organizations. Individuals who take the standard deduction cannot deduct contributions. For 2020, however, individuals who do not elect to itemize may deduct up to $300 of contributions. Only contributions made in cash qualify.
Section 2205: Liberalized Limitations on Charitable Contributions for 2020
In general, both individuals and corporations face limitations on charitable contributions they currently may deduct. Contributions exceeding these limitations carry over indefinitely and subsequently may be deducted subject to the same limitations.
For qualified contributions made in 2020, these limitations are relaxed:
- Individuals: Instead of being limited to 50% of AGI, may be deducted up to AGI
- Corporations: Instead of being limited to 10% of taxable income, may be deducted up to 25% of taxable income.
A “qualified contribution” must be made in cash, and the taxpayer must elect to treat it as such under procedures the IRS presumably will provide. Contributions exceeding these relaxed limitations will carry over.
Technical Observation: These relaxed limitations are not available for contributions to (a) supporting organizations (as defined in IRC Section 509(a)(3)) or (b) for the establishment of a new, or the maintenance of an existing, donor advised fund (as defined in IRC Section 4966(d)(2)).
Technical Observation: Under CARES ordering rules, qualified contributions are “stacked” behind other allowable contributions. Qualified contributions thus are allowed up to the taxpayer’s contribution base reduced by other allowable charitable deductions.
Additionally, for 2020, the limitation on deducting contributions of food inventory is increased from 15% to 25% of the applicable limitation, which depends on the type of taxpayer (see IRC Section 170(e)(3)(C)).
Section 2206: Exclusion from Gross Income of Certain Employer Payments of Student Loans
Under CARES, an employer may contribute up to $5,250 (principal or interest) toward repayment of an employee’s student loans, and the contribution is excluded from the employee’s gross income. The employer can pay either the employee or the lender. However, the cap of $5,250 applies in the aggregate to both this new benefit and other educational assistance (such as tuition, fees, and books) not taxable to employees under the tax law before this amendment. This expanded benefit applies to student loans that an employer repays between the date of CARES’ enactment and January 1, 2021.
Technical Observation: An employee may not deduct under IRC Section 221 interest on a loan excluded from gross income under CARES.
Section 2301: Employee Retention Credit
An eligible employer may qualify to take a refundable payroll tax credit equaling 50% of wages paid to employees during the COVID-19 crisis. The credit is available to employers suffering either of two adverse effects of the crisis for a calendar quarter:
- Operations were fully or partially suspended on account of a COVID-19-related government shut-down order, or
- Gross receipts declined by more than 50% when compared to the same quarter in the prior year.
The credit is "refundable" meaning that it can be taken even if it more than zeroes out the employer’s tax liability and may generate an overpayment of tax creating a refund which the employer can claim from the IRS.
Technical Observation: The credit is equal to 50% of the “qualified wages” paid to EACH employee for the quarter until December 31, 2020. The credit will be provided to eligible businesses quarterly to offset their 6.2% share of OASDI payroll taxes for each quarter until the business’ receipts exceed 80% of what they were for the same quarter in the prior year. The credit is applied toward qualified wages, including any “qualified health plan expenses”. However, the credit may offset only an employer’s liability for federal employment taxes, not income taxes.
Technical Observation: Wages on which employee retention credits may be taken also do not include wages with respect to which an employer may take credits under the Families First Coronavirus Response Act for providing paid leave and extended family and medical leave. These credits reduce the amounts of CARES retention credits.
Section 2302: Delay of Paying Employer Payroll Taxes
To help make payroll, employers may defer paying applicable employment taxes otherwise payable during 2020. Applicable taxes consist of an employer’s share of OASDI (6.2%) and 50% of a self-employed individual’s OASDI (50% of 12.4% or 6.2%). Deferred amounts must be paid over the following two years, with one-half of the deferred amount paid by December 31, 2021, and the remaining amounts paid by December 31, 2022. This deferral is not available for the Hospital Insurance component (1.45%) of Social Security taxes.
Employers that have had forgiven a payroll protection loan (as enhanced by CARES) cannot defer payroll taxes under this provision.
Technical Observation: Employers choosing to defer will be able to receive an immediate credit against the deferred payroll taxes by applying for either the emergency medical leave credit, sick leave credit, or new employee retention credit.
Section 2303: Modifications for Net Operating Losses
CARES temporarily expands in two ways corporate taxpayers ability to deduct net operating losses (NOLs):
- For 2020, the usual limitation based on taxable income will not apply;
- NOLs arising in 2018, 2019, and 2020 can be carried back up to five years
Under current law, the deduction of NOLs is limited to the lesser of the available NOL carryforward or 80% of the taxpayer’s pre-NOL deduction taxable income. NOLs may only be carried forward and not carried back.
CARES suspends the referenced 80% limitation for taxable years beginning before January 1, 2021 and allows NOLs to be fully offset against taxable income and carried back for taxable years beginning after December 31, 2017 but prior to January 1, 2021 to each of the five taxable years proceeding the taxable year in which the NOL arose. During this temporary suspension period, corporations will be able to use NOLs incurred when corporate income has been subject to a 21% federal corporate tax to offset income previously taxed at 35% even to the extent of zeroing out that prior year’s income and creating a loss.
The availability of the full five-year NOL carryback may be impacted by short tax years due to accounting changes and M&A transactions. M&A transaction documents will need to be reviewed to determine the ability to amend returns and benefit from carried back NOLs.
The impact of certain tax attributes (i.e., IRC Sections 199, 179, 250 and 170(b)), which are calculated based upon corporate taxable income, will also need to be considered before taking the full carryback of NOLs as those provisions may have unintended consequences. There are special NOL carryback rules for real estate investment trusts and life insurance companies and special rules related to the interaction between IRC Section 965 (deemed repatriation tax) and NOL carrybacks.
Technical Observation: For 2018 fiscal taxable years, the carryback claim will be deemed timely filed if it is filed no later than 120 days from the enactment of CARES.
Section 2304: Modified Limitation on Deducting Business Losses of Noncorporate Taxpayers
In general, noncorporate taxpayers may not deduct excess business losses. An excess business loss means the amount by which business deductions exceed business income or gains plus $250,000 ($500,000 for married taxpayers filing jointly). Currently applicable starting in 2018, this limitation has been postponed by CARES to take effect starting in 2021.
Refund Opportunity: This postponed effective date of the limitation applies retroactively to taxable years beginning after December 31, 2017. Taxpayers who did not deduct excess business losses in prior years apparently can deduct them by amending affected income tax returns, potentially generating refundable tax overpayments.
Technical Observation: CARES also makes various “technical” amendments of the limitation and excess business losses. These amendments narrow the limitation’s scope.
Section 2305: Acceleration of Corporate AMT Credits
The Tax Cuts and Jobs Acts of 2017 repealed the alternative minimum tax (AMT) on corporations after 2017. Prospectively, however, the 2017 Act allowed corporations refundable AMT credits. These credits may be taken after 2017 to the extent that the corporation’s hypothetical AMT exceeds the corporation’s regular tax liability. The 2017 Act allowed corporations to take AMT credits over several years from 2018 through 2021.
CARES accelerates remaining AMT credits. Corporations may choose to take them entirely in 2020 instead of through 2021.
Better yet, under CARES, a corporation may elect to take the entire refundable credit in 2018.
Refund Opportunity: A corporation that had been taking refundable AMT credits over the originally prescribed number of years instead may elect to take the entire refundable credit in 2018. The taxpayer may make this election by filing an application for a tentative refund with the IRS. The application must be filed with the IRS before December 31, 2020.
Section 2306: Modified Limitation on Deducting Business Interest
Before CARES, any amount of business interest expense exceeding any business interest income was generally allowable as a deduction from that year’s taxable income to the extent of 30% of taxable income for that same tax year. Under CARES, this limitation is increased from 30% to 50% of taxable income for tax years beginning in 2019 and 2020.
CARES further allows that in determining the taxable-income deduction limitation for 2020, a taxpayer has the option to substitute its taxable income from 2019 for its 2020 taxable income. This option could benefit a taxpayer who enjoyed a more profitable year in 2019 as compared to 2020.
Taxpayers have an “Election Out” option for the 50% business interest limitation and can remain at the 30% limitation. Whether a taxpayer chooses to take advantage of these options will likely be informed by how many NOLs would be generated and if this is advantageous.
Partners in partnerships are allowed to elect the increase in the business interest deduction limitation but only for 2020 (and not for 2019). For partners that do not elect out of the increased limitation, 50% of their accrued business interest from 2019 is deemed to accrue in 2020 and then is not subject to any limitation in 2020.
Section 2307: Write-offs of Qualified Improvement Property
Correcting an error in the Tax Cuts and Jobs Act of 2017, CARES clarifies that bonus depreciation may be taken for “qualified improvement property” such as tenant improvements. The entire cost of the improvements may be deducted (“bonused”) in the year paid or incurred rather than having to be depreciated over the life of the building to which the improvements were made.
Refund Opportunity: This correction applies retroactively to qualified improvement property placed in service after December 31, 2017. Taxpayers who did not take bonus deprecation on qualifying property before this correction apparently can take it starting in 2018 by amending affected income tax returns, potentially generating refundable tax overpayments.
Lewis Brisbois has formed a COVID-19 Attorney Response Team to help your business with the myriad legal issues arising from the outbreak. Visit our COVID-19 Response Resource Center to find an attorney in your area.
Michael J. Grace, Partner
Morgan B. Gray, Associate
John J. Heber, Partner
Sara Jane Holland, Partner
David Kern, Partner