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The CARES Act: Tax implications for transactions and private-equity-owned portfolio companies

April 13, 2020 / 15 min read

The CARES Act has several provisions that will benefit private equity firms. We break down exactly what you need to know, including the impact on transactions and portfolio companies.

The federal government recently enacted the Coronavirus Aid, Relief, and Economic Security (CARES) Act as part of its ongoing effort to help businesses and individuals weather the economic storm caused by COVID-19. The new law focuses on helping businesses keep more cash on hand by allowing them to utilize tax losses more quickly, claim additional tax deductions, earn new tax credits, and defer tax payments. The CARES Act changes have their biggest impact in the 2019 and 2020 tax years, but certain provisions could modify tax returns for several additional prior years.

Private equity firms should focus their CARES Act implementation efforts in two areas:

  1. Making sure that portfolio companies take full advantage of the assistance that the CARES Act tax changes offer, and
  2. Managing the impact of tax adjustments in past, present, and future years on the transactions.

Here’s a look at how some of the key provisions affect portfolio company tax liabilities and transactions.

Utilization of net operating losses (NOLs)

The CARES Act accelerates the use of NOLs by:

  1. Allowing taxpayers to carry NOLs created in 2018, 2019, or 2020 back to the five years preceding the loss year.
  2. Removing the 80% limitation on the use of NOLs for tax years before 2021.

Portfolio company impact

Transaction impact

Increased business expense limitations

The Tax Cuts and Jobs Act of 2017 (TCJA) imposed a limit on the business interest expense beginning in 2018. The CARES Act generally increases the TCJA limitation from 30% of ATI (adjusted taxable income) to 50% of ATI for 2019 and 2020.

This increase will not 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. Affected partners will be able to deduct 50% of such EBIE in 2020. 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.

Portfolio company impact

Transaction impact

Qualified improvement property (technical correction)

The CARES Act fixed a drafting error in the bonus depreciation provisions of the TCJA. Qualified improvement property is now eligible for both 100% bonus depreciation and a 15-year recovery period if bonus depreciation isn’t claimed. The TCJA failed to include qualified leasehold improvement property, qualified retail improvement property, and qualified restaurant property among the assets eligible for bonus depreciation, despite an apparent intention to do so. As a result, this property has generally been depreciated over a much longer 39-year recovery period without the benefit of bonus depreciation since the TCJA became law. This correction is also retroactive to the enactment of the TCJA.

Portfolio company impact

Transaction impact

Deferral of employer payroll tax and self-employment taxes

The CARES Act allows certain employers to defer the deposit of the employer’s portion of the 6.2% Social Security tax for the remainder of the 2020 calendar year. The deferral applies to any amounts not yet deposited as of March 27, 2020. 50% of the deferred taxes are due by Dec. 31, 2021, while the remainder must be paid by Dec. 31, 2022. If a company reporting on a calendar-year tax basis takes advantage of the full deferral period and does not pay any of the deferred portion of the payroll taxes until sometime after Sept. 15, 2021, the company will not be able to deduct the payroll taxes until the time of payment.

Portfolio company impact

Transaction impact

Employer tax credits for employee retention

The CARES Act created a refundable payroll tax credit designed to help employers continue to pay employees when operations were curtailed or halted by COVID-19 restrictions. The credit is equal to 50% of eligible wages, including healthcare expenses, paid to employees. Eligible wages are limited to $10,000 per employee, leading to a maximum credit of $5,000 per employee. For employers with more than 100 employees, only wages that are paid to employees who didn’t provide services as a result of either eligibility event described below are eligible for the credit. Qualified wages are limited to those paid after March 12, 2020. Wages included in the employee retention credit aren’t allowed to be included in certain other employment-related credits. In addition, taxpayers taking advantage of a covered loan under section 7(a) of the Small Business Act such as the Payment Protection Program are not eligible for this credit.

To be eligible for the credit, an employer must be either:

  1. Carrying on a trade or business during 2020, or
  2. A section 501(c) organization are entitled to the credit.

In addition, the eligible entity must be affected by COVID-19, which can be demonstrated in one of two ways:

  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 in the quarter must have declined to less than 50% of the gross receipts from the same quarter in the prior year.

An entity whose eligibility is based on a full or partial suspension of operations will remain eligible only until it’s no longer suspended. The definition of “partially suspended” is not provided in the CARES Act. The IRS has issued frequently asked questions providing that the term includes circumstances where “the operation can still continue to operate but not at its normal capacity.” Given the broad reach of many state orders that have been issued, it’s possible that most businesses would qualify as partially suspended under future guidance.

For the gross receipts test, a business remains eligible through the quarter in which gross receipts exceed 80% of the gross receipts from the same quarter in the prior year (but in no cases can this extend beyond Dec. 31, 2020). Quarterly gross receipts are not something that most businesses are ordinarily required to measure for income tax purposes. Additional accounting and tax procedures may be required to determine the amount of gross receipts in the relevant quarters of both 2019 and 2020. Further, an entity won’t know whether it will fall below the 50% threshold until the quarter is complete, so it may have to delay the application of the credit unless it also qualifies as fully or partially suspended during the quarter.

Cash flow from the credit

The retention credit is a refundable payroll tax credit. An employer is permitted to retain payroll taxes and withholdings up to the amount of the credit in order to keep cash on hand when wages are paid. An employer is permitted to retain any amounts that would otherwise be due to the federal government, including:

The retained amounts can be related to any wages paid for the period and do not need to relate to the qualified wages.

To the extent that there are not enough withholdings to cover the full amount of the credit, the employer can either (1) wait until the end of the quarter and request a cash refund with its quarterly payroll tax return or (2) file Form 7200 to obtain an advance refund for the credit. Form 7200 can be filed as late as the end of the month following the end of the quarter, but can also be filed multiple times during the quarter in order to obtain refunds more contemporaneously with when the qualified wages are paid. The IRS has indicated that it expects to process refund claims within about 2 weeks, but specific details have not yet been provided.

The IRS has issued Notice 2020-22 providing that an employer will not be subject to any failure to deposit penalties with respect to payroll taxes retained in an amount equal to the anticipated credit. It isn’t clear how this penalty relief will apply in situations where an employer miscalculates the available credit or where it loses its eligibility at a later date.

In any case, the credit is reported and reconciled on each quarterly payroll tax filing. The IRS has indicated that reporting for the credit will begin with the second quarter payroll tax filings, so it’s not yet clear how the credit will be reported for wages paid form March 12, 2020 through March 31, 2020.

Portfolio company impact

Transaction impact

Changes for excess business losses from pass-through and businesses reported on Schedules C, E, and F

The CARES Act suspends the application of this loss limitation until 2021 and makes other technical corrections.

Portfolio company impact

Corporate AMT credits

The alternative minimum tax (AMT) for corporations was eliminated for tax years after 2017 under the TCJA. Corporations could 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 and allows any excess credits to be fully refundable in 2019. In addition, corporations can elect to claim the full AMT credit refund in 2018.

Portfolio company impact

Transaction impact

Understanding the full impact of the CARES Act

The changes made by the CARES Act stretch beyond just the tax function. Provisions in the new law will affect labor relations and human resources rules in ways that may still affect the value of a target going forward. For answers to specific questions about the impact of these changes on your business, please contact your Plante Moran advisor. 

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