On March 27, 2020, President Trump signed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) providing significant relief to those impacted by the pandemic. Below is a summary of the major tax provisions within the Act.
1. SBA 7(a) Forgivable Loan Expanded (Payroll Protection Program)
The CARES Act expands the existing SBA 7(a) loan program, allocating $349 billion to this forgivable business loan program. The maximum loan amount is 2.5 times average monthly payroll. For businesses and not-for-profits with less than 500 employees, and for self-employed schedule C individuals, you are eligible if you are:
- A business with fewer than 500 employees; this includes full- and part-time employees and SBA affiliation rules apply.
- A small business that otherwise meets the SBA’s size standard.
- A 501(c)(3) with fewer than 500 employees.
- An individual who operates as a sole proprietor.
- An individual who operates as an independent contractor.
- An individual who is self-employed who regularly carries on any trade or business.
- A Tribal business concern that meets the SBA size standard.
- A 501(c)(19) veterans organization that meets the SBA size standard.
There are a couple special rules that also may make you eligible:
- If you are in the accommodation and food services sector (NAICS 72), the 500-employee rule is applied on a per physical location basis.
- If you are in the accommodation and food services sector (NAICS 72), operating as a franchise or receive financial assistance from an approved Small Business Investment Company, the normal affiliation rules do not apply.
- Lenders will ask borrowers for certification that proceeds will be used to retain workers and maintain payroll, or to make mortgage, rent or utility payments.
- Loan is equal to or the lesser of 2.5 times average monthly payroll or $10 million.
- Payroll includes salary and wages, severance, healthcare costs and retirement contributions.
- Limited to $100,000 per employee in calculating the average monthly payroll (there are special rules for seasonal or startups).
- Proceeds can be used for payroll, interest on mortgage obligations, rent and utilities.
- Loan will be forgiven if you maintain employee count and wages or eliminate reductions by June 30, 2020.
- Forgiveness is not taxable; support will be needed at the time of application for forgiveness that proceeds were spent on qualifying costs.
OUR TAKE >> This program is designed to get much needed cash into the hands of business owners to make it through the next two and half months. The intent of the program is that businesses will be able to use this cash to retain employees and cover other eligible costs while the market is essentially shut down. The forgivable nature of this loan program will likely result in available funds going fast, so taxpayers should be having discussions with their advisors and bankers ahead of time.
>> Read IRS Clarifies Employer Payroll Deferral Rules for Paycheck Protection Program Offered in CARES Act
2. Recovery Rebate Credit and Advanced Payment of Credit
Eligible individuals are entitled a credit of $1,200 ($2,400 for eligible individuals filing a joint return) plus $500 per qualifying child on the taxpayer’s 2020 return. The credit is reduced by 5% of the taxpayer’s adjusted gross income that exceeds $150,000 (joint return), $112,500 (head of household) and $75,000 (all other taxpayers). Key aspects of this credit include:
- An eligible individual is any individual other than 1) nonresident alien, 2) a dependent of another individual, and 3) an estate or trust.
- A qualifying child is a child under the age of 17 who can be claimed as a dependent.
- Taxpayers may be entitled to an advanced payment of this credit based on their 2019 return (2018 if a taxpayer’s 2019 return has not been filed). If a return was not filed for either 2018 or 2019, the Treasury may use information obtained from the Social Security Administration.
- If a taxpayer’s advanced payment exceeds the recovery rebate credit calculated on the taxpayer’s 2020 return, the taxpayer will NOT be required to pay back the excess. However, if a taxpayer’s advanced payment is less than the recovery rebate credit calculated on the taxpayer’s 2020 return, they will be entitled to use the additional credit on their 2020 return.
OUR TAKE >> This provision is intended to transfer cash to taxpayers who need the financial assistance based on economic impact from the coronavirus outbreak. If you were an ineligible individual for 2018 but will be an eligible individual for 2019 (for example, if you qualified as a dependent in 2018 but will no longer be a dependent for 2019), you should file your 2019 return as soon as possible to ensure you will be entitled to an advanced payment. Alternatively, if you have not filed your 2019 return and would qualify as an eligible individual based on your 2018 return, but not your 2019 return, you may want to consider delaying filing your 2019 return.
3. Early Distribution Penalty for Retirement Plans Waived
Distributions from an eligible retirement plan will not be subject to the 10% additional penalty for qualified coronavirus-related distributions. Qualified coronavirus-distributions include those from an eligible retirement plan made on or after January 1, 2020, and before December 31, 2020, to an individual who 1) was diagnosed with COVID-19, 2) had a spouse or dependent diagnosed with COVID-19 or 3) experienced adverse financial consequences due to the virus, such as due to being quarantined, furloughed or unable to work due to lack of child care due to the virus, among others. Qualified coronavirus-related distributions may not exceed $100,000. Taxpayers may recognize the income related to coronavirus-related distributions ratably over three years beginning in the taxable year of the distribution. Additionally, taxpayers may recontribute the amount of qualified coronavirus-related distributions within three years of receipt without being taxed on the original distribution.
OUR TAKE >> The penalty-free aspect and potentially tax-free aspect (assuming the distribution is repaid within three years) provides qualified individuals who have temporary cash flow needs with a significant planning opportunity. However, taxpayers should be mindful, and work closely with their financial planning advisors, any time they are withdrawing funds from their retirement account to understand the impact it will have on future needs.
4. Limitations on Loans from Qualified Plans Temporarily Increased; Existing Loans Deferred
Qualified loan limitations have been increased, for certain qualified individuals, from the lesser of $50,000 and 50% of the present value of the participant’s accrued benefit up to the lesser of $100,000 or 100% of the present value of the participant’s accrued benefit for loans made during the 180-day period beginning on March 27, 2020.
Repayment of existing qualified plan loans is deferred one year for loans coming due during the period beginning on March 27, 2020, and ending December 31, 2020.
OUR TAKE >> If cash needs are longer term, taking a loan from a qualified plan may be a better strategy than taking a distribution. The qualified loan provisions allow for repayment over a period of five years or greater.
5. Suspension of Required Minimum Distributions
For the calendar year 2020, required minimum distributions are suspended for defined contribution plans, including 401(k) plans, 457(b) plans and IRAs. This suspension applies to any distribution required in 2020, including distributions required in 2020 related to the 2019 calendar year that were not made before January 1, 2020.
OUR TAKE >> Taxpayers not in need of cash may wish to defer their 2020 required minimum distribution until 2021 to keep the funds invested and allow for a potential market recovery. Required minimum distributions in any calendar year can be taken as a lump sum distribution as the end of each calendar year; therefore, funds not withdrawn in 2020 can remain invested until December, 2021, when the next required minimum distribution is required.
6. Enhanced Charitable Deduction Opportunities
An individual who is not claiming itemized deductions may take an above-the-line deduction for qualified charitable contributions up to $300. Qualified charitable contributions are cash contributions made to qualified charities, but excludes private foundations and donor advised funds. For 2020, the percentage limitation on qualified contributions for individuals who itemize is suspended. For 2020, the percentage limitation on qualified contributions by a corporation and the deduction limitation on food inventory is increased to 25%.
OUR TAKE >> Taxpayers should keep the above items in mind when determining their charitable contributions for 2020.
7. Net Operating Loss Rules Rolled Back
The Cares Act makes significant changes to the net operating loss (NOL) rules, including technical corrections to provisions added by the Tax Cuts and Jobs Act (TCJA). These changes include:
- Five-year carryback of NOLs for tax years beginning in 2018, 2019 or 2020. Taxpayers may elect to waive the carryback period and instead carry the NOL forward indefinitely.
- Temporary repeal of the taxable income limitation. For losses arising in a tax year beginning after December 31, 2017, the TCJA limited the use of the loss to 80% of the taxpayer’s taxable income. However, the CARES Act repeals this limitation for tax years beginning before January 1, 2021. Although losses arising in a taxable year beginning in 2018, 2019 or 2020 are not subject to the 80% for tax years beginning prior to January 1, 2021, any such losses carried into a tax year beginning in 2021 will be subject to the 80% limitation. The TCJA prohibited fiscal year taxpayers from carrying back NOLs for tax years ending after December 31, 2017. However, the CARES Act changed the date to tax years beginning after December 31, 2017. This change allows fiscal year taxpayers to carry back an NOL generated in a tax year beginning in 2017 and ending in 2018.
OUR TAKE >> When determining whether or not to carryback an NOL, proper consideration should be given to the amount and character of the income reported in the carryback years. Keep in mind that the maximum tax rate for both corporations and individuals was lowered as part of the TCJA. However, a taxpayer may wish to forego the carryback period if the income was taxed at preferential rates, such as long-term capital gains or qualified dividends, or because the taxpayer was in a low tax bracket in the carryback years.
8. Excess Business Loss Limitation Delayed
The Act delays the effective date of Section 461(l) to tax years beginning after December 31, 2020. Section 461(l) capped the amount of trade or business losses a taxpayer could deduct to $250,000 ($500,000 for a joint return). Any trade or business losses disallowed under Section 461(l) is treated as an NOL. Furthermore, the Act clarifies:
- Excess losses are determined without regard to any deduction allowed under Section 172 for NOLs or Section 199A for qualified business income;
- Excess losses are determined without regard to any deductions, income or gains attributable to any trade or business of performing services as an employee; and
- Net losses from the sale of capital assets (whether business or non-business) will not be taken into account in determining excess business losses under section 461(l), and business capital gains will be included only to the lesser of net business capital gains or net capital gain income.
OUR TAKE >> Taxpayers who were subject to the 461(l) limitations in 2018 can file an amended return to create a tax refund and/or an NOL that could be carried back five years. If a taxpayer has already filed their 2019 return, they could file a superseded return instead of an amended return.
9. C Corporations AMT Credit Carryforward Changed
Corporations can recover refundable AMT credits in 2018 and 2019. The refundable amount is 50% for tax years beginning in 2018 and 100% for tax years beginning in 2019. Alternatively, corporations can elect to recover 100% of the refundable credit for tax years beginning in 2018. Taxpayers making this election can file Form 1139 (Corporate Application for Tentative Refund) to claim the credit.
OUR TAKE >> When deciding whether to claim the remainder of the credit on a taxpayer’s 2019 return or file an application for a tentative refund, consider the amount of the remaining credit and when the taxpayer will file their 2019 return.
10. Business Interest Limitation Increased
For taxpayers other than partnerships, the Act increases the business interest expense limitation from 30% to 50% of adjusted taxable income for tax years beginning in 2019 and 2020. For partnerships, the limitation remains at 30% for 2019 but increases to 50% for 2020. However, 50% of any excess interest allocated to a partner for the partnership’s 2019 tax year is treated as business interest expense by the partner in 2020 that is not subject to section 163(j). The remainder of the excess interest allocated to a partner for the partnerships 2019 tax year remains subject to the normal 163(j) rules applicable to partners in a partnership. Additionally, a taxpayer, including a partnership, can elect for their taxable year beginning in 2020 to use their 2019 adjusted taxable income to calculate their 163(j) limitation.
OUR TAKE >> Taxpayers may not only be able to increase the amount of business interest deductions due to the changes in the CARES Act but final regulations under sec. 163(j) are expected to be issued in the near future. Although taxpayers will not be required to follow the final regulations until 2020, if the regulations are more favorable then the previously issued proposed regulations it may be an advantage for the taxpayer to apply the final regulations on their 2019 return.
11. Bonus Depreciation Allowed on Qualified Leasehold Improvements
The Act fixes a much talked about error in the TCJA regarding Qualified Improvement Property. Qualified improvement property was intended to have a 15-year recovery period (20 years under the alternative depreciation system) and be eligible for bonus depreciation; however, due to a drafting error, qualified improvement property had a 39-year recovery period (40 years under the alternative depreciation system) and was not eligible for bonus depreciation. Not only does the CARES Act correct the recovery period and bonus eligibility of qualified improvement property, it also makes the correction retroactive back to the enactment of TCJA.
OUR TAKE >> Most taxpayers affected by this change will be required to file either an amended return or a change of accounting method. All taxpayers will be able to implement this change by filing a change of accounting method with their 2019 return (2020 if the taxpayer has already filed their 2019 return). Alternatively, some taxpayers may be able to file an amended return; however, this option is currently not available to all taxpayers and may not be available for all tax years that could be affected.
12. Employee Retention Credit
The CARES Act allows for a payroll tax credit for eligible employers equal to 50% of the qualified wages, limited to $10,000 per employee for all calendar quarters, paid by the employer after March 12, 2020, and before January, 1, 2021, if: 1) operations were fully or partially suspended in any calendar quarter by a federal, state or local government order due to the COVID-19 virus or 2) the employer experienced a substantial decline in gross receipts during any calendar quarter beginning in the first calendar quarter of 2020. Which employees’ wages are considered qualified wages for purposes of this credit depends upon the average number of employees of the employer during 2019. Additionally, wages included in the calculation of the credit allowed for emergency paid sick leave and family leave are not qualified wages for purposes of this credit, and an employee is not considered an employee for purposes of this credit if the employer is receiving a work opportunity credit with respect to the employee. An eligible employer who receives a covered loan under SBA 7(a) is not eligible for this credit.
OUR TAKE >> Employers, even those that otherwise would meet the qualifications for this credit, may find it difficult to use the credit given the substantial downturn the business must experience to qualify while still continuing to pay wages to the employees who are not working. In addition, in many circumstances the employee may be economically better off remaining on unemployment, taking into account the additional federal benefits.
13. Deposit and Payment of Employer Share of Social Security Taxes Delayed
Employers and self-employed taxpayers can defer their share of Social Security tax for deposits and payments due from March 27, 2020, through December 31, 2020. The deferred taxes must be paid over two years with half due by December 31, 2021, and the remaining due by December 31, 2022. This deferral does not apply to any taxpayer who has had indebtedness forgiven under the Act with respect to an SBA 7(a) loan.
OUR TAKE >> This deferral can provide added cash flow for eligible taxpayers regardless of a taxpayer’s size. An open question exists for borrowers of 7(a) funds with a potential forgiveness in the future. Since the deferral is prohibited only with respect to taxpayers who realize a deferral, there is a period as long as 10 weeks after the issuance of a loan where the taxpayer could be in limbo. The questions are: can a recipient of a 7(a) loan continue to defer payroll taxes during the 10 weeks before the forgiveness occurs, and what happens to amounts deferred prior to the issuance of the 7(a) loan proceeds? The CARES Act does not address these situations nor the repayment of deferrals and potential waivers of penalty and interest.
14. Changes Made to the Families First Coronavirus Response Act
The CARES Act amends portions of the Emergency Paid Sick Leave and Expanded FMLA provisions, which were added by the Families First Coronavirus Response Act. The Cares Act:
- Limits the maximum amount an employer is required to pay an employee under the emergency paid sick leave ($511 per day capped at $5,110 or $200 per day capped at $2,000 depending upon circumstances for which the wages are paid) and family leave ($200 per day capped at $10,000) provision to the maximum credit available to the employer for such payments;
- Allows employers to receive an advance of payroll credits related to emergency paid sick leave and family leave; and
- Expands the definition of eligible employee for purposes of the family leave provisions to include an employee who was laid off not earlier than March 1, 2020, and had worked for the employer for at least 30 of the last 60 calendar days prior to being laid off, and was rehired by the employer.
OUR TAKE >> Since the CARES Act caps the amount that must be paid to an employee under these provisions to the maximum credit amount available, an employer will likely suffer little to no economic outlay with respect to these provisions. Therefore, employers may want to consider reinstating certain employees who would be eligible for the benefits of these provisions immediately upon reinstatement. This could be an effective strategy for employees the employer wants to retain, even though the current situation due to Coronavirus may prevent them from returning to work immediately.
The CARES Act offers a lot of information for taxpayers to digest. Taxpayers should work closely with tax advisors to navigate any potential relief for their business.
Contact Tony Bakale at firstname.lastname@example.org, Robert Venables at email@example.com or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.