The federal government took another action in response to the continuing COVID-19 pandemic with the enactment of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. This bill passed the Senate on March 25th, and on March 27, it was passed by the House of Representatives and signed into law by President Trump. The CARES Act is substantial legislation that includes many provisions to support healthcare efforts and provide economic stimulus. It also includes a significant number of changes to federal tax laws to support both businesses and individuals.
The CARES Act follows several recent actions by the federal government to combat the pandemic. Following President Trump’s declaration of a national emergency, the Department of Treasury took action to extend certain tax filing and payment due dates from April 15 to July 15. Moreover, the Families First Coronavirus Response Act, Pub. L. 116-127, was enacted on March 18, which expanded paid sick leave and family leave programs for certain employers while also providing payroll tax credits to such employers.
What does this mean?
Overall, the tax changes allow businesses and individuals to claim additional tax deductions, utilize tax losses more quickly, and obtain tax credits with the goal of getting cash in the hands of taxpayers. Several of these changes modify rules that were implemented by the Tax Cuts and Jobs Act (TCJA) in late 2017. The CARES Act largely impacts the 2019 and 2020 tax years, but certain provisions impact years prior to 2019. Accordingly, the timing of when taxpayers realize these tax benefits will depend on the changes being applied and the manner in which they’re claimed.
The changes made by the CARES Act directly impact the federal income tax responsibilities of taxpayers. However, there are also state and local tax implications depending on the response of those governments. In some cases, the new federal rules may be adopted. In other cases, it will be necessary to apply different rules. Moreover, states that ultimately choose to follow the CARES Act may be delayed in taking the necessary steps given the disruption of the COVID-19 pandemic.
Other items that were and weren’t included
This discussion focuses on the federal income tax provisions of the CARES Act. However, there are many other provisions that will impact businesses and individuals across the country. One provision that has gotten significant attention is the “Paycheck Protection Program,” which provides forgivable loans to certain businesses. (See this alert for details of that program.) Visit the Plante Moran COVID-19 Resource Center for access to many other details of the CARES Act and other resources.
Several items that were originally on the table as Congress negotiated the CARES Act weren’t ultimately included in the enacted bill. Specifically, the CARES Act doesn’t include provisions providing broader tax filing and payment relief. The IRS extended those due dates through Notice 2020-18, and no further legislative action was taken by Congress. Moreover, no specific provisions were included to modify international tax rules originally enacted under the TCJA.
Business tax relief
The CARES Act includes numerous business tax provisions. These changes may provide businesses with opportunities to reduce future taxes, as well as to claim deductions in 2019 and previous years. Businesses will need to adjust their unfiled 2019 tax returns, while also considering opportunities to amend any previously filed tax returns for both 2018 and 2019. Additionally, the new loss carryback provisions may create tax refund opportunities going as far back as 2013. The following items are among the most important business tax provisions in the CARES Act:
Employer Tax Credits for Employee Retention
Certain employers may claim a new refundable employee retention credit. To qualify, the employer must meet either one of two requirements: (1) the operation of the employer’s business must be partially or fully suspended due to government orders, which limit commerce, travel, or group meetings due to COVID-19, or (2) the gross receipts of the business have declined for a quarter to less than 50% of the gross receipts from the same quarter in the prior year. If a business qualifies under the gross receipts test, it remains qualified until the quarter after the quarter for which gross receipts are more than 80% of the gross receipts for the same quarter in the prior year. These tests also apply to Section 501(c)(3) entities. Businesses that obtained certain government loans authorized by the CARES Act are not eligible for the credit.
The credit is a refundable payroll tax credit equal to 50% of eligible wages, including healthcare expenses, paid to employees. Eligible wages are limited to $10,000, leading to a maximum credit of $5,000 per employee. For employers with 100 or fewer employees, wages of all employees are eligible for the credit as long as the employer meets at least one of the two eligibility requirements listed above. For employers with more than 100 employees, only wages for, with respect to employees who didn’t provide services as a result of either eligibility event above, are eligible for the credit. Only wages paid after March 12, 2020 qualify. Wages included in the employee retention credit are not allowed to be included in certain other employment-related credit.
The IRS has issued guidance on similar credits that permit an employer to retain any federal payroll taxes or withholdings up to the amount of the credit in order to gain immediate access to cash. It’s anticipated that similar guidance will be issued for this credit. These employer tax credits should also be evaluated in conjunction with other credit opportunities that were created by the Families First Coronavirus Response Act.
Businesses relying on the gross receipts test will have to be extremely cautious because they will not necessarily know their gross receipts until after each quarter is closed and will need to pay extra attention to their quarterly gross receipts in order to determine when they may become eligible — and when such eligibility will end. This may include making adjustments to reconcile book-to-tax differences in gross receipts on a quarterly basis. However, the CARES Act directs the IRS to waive penalties for failure to deposit payroll taxes if the failure was due to the reasonable anticipation of the employee retention credit.
Deferral of employer payroll tax and self-employment taxes
The CARES Act allows all employers to defer the deposit of the employer’s 6.2% Social Security tax for the remainder of the year with respect to any amounts not yet deposited as of March 27, 2020. Fifty percent of such deferred taxes are due on Dec. 31, 2021, with the remainder due on Dec. 31, 2022. Similar deferral is permitted for the equivalent share of self-employment tax for self-employed individuals. In that case, estimated taxes for the 2020 tax year are computed without regard to that portion of the self-employment tax.
Employers should work closely with their payroll tax providers to determine eligible deferral amounts. Employers should also keep in mind that this is, in effect, a 33-month interest-free loan that will have to be repaid and that individual employees of a business can be directly liable for any payroll taxes that aren’t eventually deposited by the applicable due dates.
Qualified improvement property — technical correction
Under the TCJA, certain property was made ineligible for both 100% bonus depreciation and a 15-year recovery period despite an apparent intention to provide such benefits. Impacted property included qualified leasehold improvement property, qualified retail improvement property, and qualified restaurant property. As a result, such property has generally been depreciated over a much longer 39-year recovery period and was not eligible for 100% bonus depreciation.
Fortunately, the CARES Act provides a long-awaited technical correction for qualified improvement property. Specifically, such property is now eligible for both 100% bonus depreciation and a 15-year recovery period if bonus depreciation isn’t claimed. This correction is also retroactive to the enactment of the TCJA, so it will apply to 2017 and subsequent years. Taxpayers should work with their tax advisors to determine whether opportunities exist to claim bonus depreciation for all impacted years, whether on original or amended returns or through the filing of a Form 3115. Utilizing 100% bonus depreciation on qualified improvement property will often generate sizable deductions, which may create net operating losses. As discussed further below, the CARES Act does make such losses more valuable due to new loss carryback rules.
Increased business interest expense limitation
The TCJA imposed a new business interest expense limitation under Sec. 163(j) beginning in 2018. Businesses subject to that limitation have only been able to deduct annual business interest expense in an amount equal to the sum of: (1) business interest income; (2) 30% of adjusted taxable income (ATI); and (3) floor plan financing interest. Special rules were created for certain small businesses that are below gross receipts thresholds ($26 million for 2019 and 2020) and specific industries, such as real estate businesses, farms, and utility companies.
The CARES Act generally relaxes business interest expense deductions limitations in 2019 and 2020. This is completed by increasing the second component of the limitation from 30% of ATI to 50% of ATI for those years. This increase, however, doesn’t apply to partnerships in 2019. Instead partnerships will apply the limitation using 30% of ATI for 2019, and any corresponding excess business interest expense (EBIE) is subject to a special rule at the partner level. Namely, the partner will be able to deduct 50% of such EBIE in 2020, and the remaining 50% of EBIE will be subject to the normal carryforward rules. A partner may elect out of that special rule relating to EBIE allocated by the partnership in 2019. Partnerships will be eligible to utilize the increased limitation based on 50% of ATI in 2020.
In addition, taxpayers may elect to use their ATI from 2019 on their 2020 tax returns for purposes of determining the amount of deductible business interest expense. This will allow businesses that were more profitable during 2019 than 2020 to further increase their business interest expense deductions in 2020. This provision is welcome news for businesses facing financial uncertainty as the COVID-19 pandemic continues to impact business operations in 2020. Final and proposed regulations under Sec. 163(j) are expected to be issued shortly which businesses might be able to apply to the 2019 tax year. Businesses will have to evaluate whether the application of these regulations to their 2019 tax year could increase ATI for 2019 which could then be utilized in 2020 as well.
Overall, these changes will benefit businesses and will allow for more business interest expense deductions, especially when combined with the upcoming regulations.
Utilization of net operating losses
Net operating loss (NOL) rules are changing once again. The TCJA made several adjustments to the treatment of NOLs created after enactment of that legislation. In the first case, it eliminated the ability to carryback NOLs to prior years but allowed for unlimited future carryforwards. Additionally, the TCJA limited the use of NOLs incurred in 2018 or later years to 80% of taxable income.
The CARES Act make two significant changes to the treatment of NOLs that will allow for faster utilization of such losses by both businesses and individuals. Specifically, NOLs created in 2018, 2019, or 2020 are now carried back to the five years preceding the year of such loss. The 80% limitation on the use of NOLs has also been removed for tax years before 2021.
One narrower change was also made with respect to fiscal year corporations with NOLs in their first tax year ending during 2018. The elimination of NOL carrybacks by the TCJA was enacted in the middle of those corporation’s fiscal year and prevented them from carrying back NOLs from that year, even though calendar year corporations were able to carryback NOLs for their 2018 tax year. This was not intended by Congress, and the CARES Act corrected this. Therefore, fiscal year corporations with NOLs in their first fiscal year ending in 2018 must now carryback those NOLs rather than carry them forward.
Businesses should work with their tax professionals to carefully review opportunities to carryback NOLs on amended returns where it’s advantageous to do so. Careful planning should be undertaken to make this determination. In general, it’s advantageous to carryback NOLs but there will be interactions with other tax provisions that could mitigate some of all those benefits. This may include the qualified business income deduction, global intangible low taxed income, base erosion anti-abuse tax, and other provisions. It’s also possible that procedures will be released that provide for expedited tax refunds. If a business wouldn’t benefit from carrying back an NOL, it’s likely that relief will be provided to permit the taxpayer to forgo the carryback.
Changes for excess business losses from pass-through and businesses reported on Schedules C, E, and F
The TCJA implemented a limitation on the ability of individuals to utilize business losses to offset nonbusiness income. Specifically, NOLs could only offset $250,000 of nonbusiness income for a single individual or $500,000 if married filing jointly. The resulting excess business losses were then treated as NOLs carrying-forward to the next tax year.
The CARES Act suspends the application of this loss limitation until 2021 and makes other technical corrections. Any taxpayer that was subject to this limitation for its 2018 or 2019 tax year will be required to amend that tax return in order to claim the excess business losses and make any other corresponding adjustments. Taken together with the NOL rules described above, this provision will provide individual taxpayers with a much greater ability to utilize business losses and obtain tax refunds.
Corporate charitable contributions
The CARES Act increased the charitable contribution limitation for corporations. Previously, corporations could only deduct charitable contributions up to 10% of their taxable income. That is now increased to 25% for 2020. As discussed in greater detail below, it similarly increased the charitable contribution limitation for individuals that’s based on adjusted gross income.
Corporate AMT credits
The alternative minimum tax (AMT) for corporations was eliminated for tax years after 2017 under the TCJA. Corporations were allowed to claim 50% of any unused AMT credit carryforwards as a refundable credit for 2018, 2019, and 2020, with any excess being fully refundable in 2021. The CARES Act amends this rule to allow for any excess credits to be fully refundable in 2019. In addition, corporations can elect to claim the full AMT credit refund in 2018. Like other aspects of the CARES Act, this change provides corporations with faster access to a tax attribute and a potential need to amend the 2018 tax return.
Individual tax relief
Specific changes were made to provide benefits to individual taxpayers. However, several provisions impacting the determination of business income also impact individual taxpayers that own pass-through businesses.
One aspect of the CARES Act that has gotten significant attention is the creation of a direct payment program for individuals. Individual taxpayers are eligible to receive $1,200, married couples who file jointly are eligible to receive $2,400, and parents are eligible to receive an additional $500 for each of their children under the age of 17. Such payments are also subject to an income-based phaseout. Taxpayers with the following adjusted gross income are completely phased out of this benefit: single filers with $99,000, head of household filers with $136,500, and joint filers with $198,000. The phaseout limits are increased by $10,000 for each eligible child.
The IRS will make the payments based on taxpayers’ 2018 adjusted gross income, filing status, and eligible children. If the taxpayer has already filed their 2019 return, that information will be used instead. These recovery rebates are treated as advance refunds of credits against a taxpayer’s 2020 taxes, and the credit will be recalculated on 2020 federal income tax returns. If the taxpayer is entitled to a larger credit based on 2020 tax information, they will claim that additional credit on the 2020 federal income tax return. If they are entitled to a smaller credit, it appears that they can retain that amount. Taxpayers with no income or whose income is derived from certain government programs — such as Social Security benefits — and do not have a tax return filing requirement will still be eligible for the rebate.
Similar to other disaster-related situations, the CARES Act provides relief to individuals with respect to certain retirement accounts. First, required minimum distributions from qualified plans are waived during 2020 irrespective of whether the individual has been directly impacted by COVID-19. In addition, the CARES Act provides relief to individuals that wish to take distributions from certain retirement accounts. Specifically, the early distribution penalty of 10% on early distributions from qualified retirement accounts is waived for amounts up to $100,000 for COVID-19-related purposes. Any income that’s attributable to an early distribution in these circumstances will be subject to tax over a three-year period, and the taxpayer will be allowed to recontribute the distributed funds to an eligible retirement plan within three years. Such recontributions will not be limited by normal yearly contribution limits.
A distribution will be considered for “coronavirus related purposes” if it’s a distribution made during the 2020 calendar year to an individual:
- Who is diagnosed with COVID-19 pursuant to a CDC-certified test.
- Whose spouse or dependent is diagnosed with COVID-19.
- Who experiences adverse financial consequences as a result of being quarantined, furloughed, laid off, reduced working hours, being unable to work due to the lack of childcare because of COVID-19 reasons, having to close or minimize hours of a business owned by the individual because of COVID-19, or other factors that are determined by the Secretary of the Treasury.
For charitable contributions, the CARES Act creates an above-the-line deduction of up to $300 for cash charitable contributions made by taxpayers who do not claim itemized deductions. Such contributions can generally be made to charitable organizations but exclude private foundations and donor-advised funds. The TCJA increased the standard deduction and thereby reduced the number of taxpayers that claim itemized deductions such as charitable contributions. This change restores the ability of taxpayers claiming the standard deduction to obtain a limited tax benefit for charitable contributions.
The CARES Act also increases the limitations on deductions for charitable contributions made by corporations and individuals who itemize. Generally, an individual taxpayer cannot claim charitable contribution deductions in excess of 60% of such taxpayer’s adjusted gross income. The CARES Act suspends that limitation for the 2020 calendar year, allowing individuals to claim unlimited charitable contribution deductions.
Employer-paid student loans
The CARES Act allows employers to provide tax-free student loan repayment benefits to its employees. Specifically, employers are permitted to contribute amounts up to $5,250 toward an employee’s student loans per year, with such amounts being excluded from the employee’s taxable income. The capped amount of $5,250 is combined with any other tax-free educational assistance that the employer already provided, such as tuition, fees, books, and more. This provision will apply to any student loan payment that’s made by an employer directly to an employee or on an employee’s behalf beginning on March 28, 2020, and ending on Dec. 31, 2020. This only applies with respect to student loans related to the education of the employee and not to loans held by the employee related to the education of any other person.