The landmark 335-page Coronavirus Aid, Relief, and Economic Security Act (CARES Act), signed into law on March 27, 2020, is an estimated $2+ trillion package primarily devoted to providing economic relief and stimulus for individuals and businesses. The CARES Act follows only nine days after the enactment of the Families First Coronavirus Response Act (FFCRA), which provides relief by expanding mandatory paid leave for many employees impacted directly or indirectly by COVID-19, while offering partially refundable payroll tax credits to self-employed individuals and those employers obligated to provide paid leave by the act. The CARES Act contains numerous changes and updates to current federal tax law, many of which are highlighted below.
Business Interest Deductions
The CARES Act modifies Section 163 of the Internal Revenue Code, which was itself substantially altered by the Tax Cuts and Jobs Act of 2017 (TCJA). Section 163(j), as modified by the TCJA, limits the amount of business interest expense that may be deducted in any given tax year to an amount generally equivalent to 30% of the taxpayer’s “adjusted taxable income” (ATI) for the year in excess of its business interest income. There is a special rule for consolidated filers. The CARES Act increases the ATI limitation for C corporations to 50%, thus allowing a greater amount of business interest to be deducted in a year, for tax years beginning in 2019 or 2020. For partnerships, the 50% limitation only applies to the tax year beginning in 2020. A special election permits a taxpayer to use its 2019 ATI in lieu of 2020 ATI when applying the 50% interest expense limitation for 2020, which may be very useful considering that many businesses will likely have substantially lower ATI in 2020 than in 2019 due to this year’s economic downturn.
Deductibility of Net Operating Losses
The TCJA tightened Code Section 172 by, among other things, imposing two substantial restrictions on the ability of a corporate taxpayer to utilize its net operating losses (NOLs). NOLs generally cannot be carried back to any prior taxable years, and NOLs can only be used to offset 80% of current taxable income instead of 100%. The CARES Act loosens Section 172 so that taxpayers may use NOLs to offset 100% of current taxable income, although the 80% limitation is reinstated for tax years beginning in 2021. The CARES Act also allows taxpayers to carry back NOLs to offset prior years’ income for up to five years, but this carry back allowance only applies to NOLs incurred in the 2018, 2019, or 2020 tax years. As under the TCJA, NOLs can be carried forward indefinitely. Not only does this create additional cash flow, it allows potential tax rate arbitrage, i.e., qualifying taxpayers may offset losses incurred in a 21% tax rate environment against what might have been a 35% tax liability in pre-TCJA years.
In addition to NOL relief for C corporations, the CARES Act gives a welcome break regarding loss deductibility to non-corporate taxpayers (i.e., passthrough entities such as S corporations and partnerships, as well as sole proprietors) with “active” owners. The TCJA added Code Section 461(l), which limits the deductibility at the owner level of certain losses (excess business losses) attributable to trades or businesses of noncorporate taxpayers to $250,000 annually ($500,000 for joint filers). The CARES Act temporarily waives Section 461(l) so that excess business losses are allowed (retroactively) for taxable years beginning on or after January 1, 2018, and extending through 2020.
Employee Retention Credit
The CARES Act allows certain employers impacted by the COVID-19 pandemic to receive a 50% credit on “qualified wages” (up to $10,000 of wages per employee) against their 6.2% share of the FICA employment tax liability for each quarter, with any excess credits being eligible for refunds. To qualify, an employer must have had either (i) its business operations fully or partially suspended in 2020 due to a governmental order (such as a shutdown order), or (ii) a “significant decline in gross receipts” during 2020 (i.e., beginning with the quarter when its gross receipts are less than 50% of its gross receipts for the same quarter in the prior year, and ending with the quarter when its gross receipts exceed 80% of its gross receipts for the same calendar quarter in the prior year). The credit applies to wages paid after March 12, 2020, and before January 1, 2021, and must be reduced by any employment tax credits claimed under the FFCRA. Tax-exempt organizations qualifying under Code Section 501(c)(3) also qualify.
Wages paid to all employees qualify for the credit, unless the business has more than 100 employees. In the latter case, only wages the employer pays to employees who are not providing services due to the suspension of the business or the substantial decrease in gross receipts are eligible for the credit.
Payroll Tax Deferral
Employers and self-employed individuals may elect to defer payment of the employer’s share (6.2% of employee wages) of Social Security/FICA payroll taxes that would have otherwise been owed for the period March 27 through December 31, 2020. Half of the deferred taxes must be paid by December 31, 2021, and the remaining 50% must be paid by December 31, 2022. Any estimated tax payments owed during the deferral period would also exclude the payroll taxes that are being deferred. This is essentially an interest-free loan from the government to all employers.
Corporate AMT Credit Acceleration
The TCJA repealed the corporate alternative minimum tax (AMT) and allowed corporations to fully offset their “regular” income tax liability with AMT credits. Any remaining AMT credits became refundable incrementally from 2018 through 2021. The CARES Act allows corporations to accelerate any remaining unused AMT credits and claim a refund for the entire amount, retroactively beginning in 2018.
“Recovery Rebate” Payments to Individuals
The CARES Act provides for expedited direct payments (supposedly within weeks) of as much as $1,200 to individuals, with an additional $500 for each qualifying child, which are treated as advance refunds of a 2020 tax credit. These “recovery rebates” are phased-out for taxpayers with adjusted gross income over $75,000 ($150,000 for joint filers), with complete phase-out for taxpayers with adjusted gross incomes exceeding $99,000 ($198,000 for joint filers). Generally, the adjusted gross income determinations will be made by the IRS based on the taxpayer’s 2019 tax return if filed, or in the alternative, their 2018 return. No refund request is needed.
Charitable Deduction Limitations
The Internal Revenue Code includes limitations on the amount of charitable contributions that can be deducted in any given tax year, based on an individual’s adjusted gross income and a corporation’s taxable income. The CARES Act loosens the limitations for 2020. For individuals, the 50% of adjusted gross income limitation is increased to 100%, and for corporations, the 10% of taxable income limitation is increased to 25%. The CARES Act also creates an above-the-line deduction for 2020 of up to $300 for individuals who make cash charitable contributions in 2020, if the individual chooses not to itemize their deductions.
Distributions from Retirement Plans
The CARES Act allows distributions to be made from qualified retirement plans without being subject to the 10% early withdrawal penalty, up to $100,000 (i.e., the 10% penalty still applies to any early withdrawals in excess of $100,000). The distributions must cover certain expenses related to COVID-19 or reduced working hours or business closure in order to qualify for the penalty waiver. The CARES Act allows the distribution to be treated as a loan and repaid over three years or, at the taxpayer-recipient’s election, any income inclusion resulting from the early withdrawal can be spread over three years. The amendment also waives the required minimum distribution (RMD) rules for certain defined contribution plans and IRAs in 2020.
Other Tax Relief Provided by the CARES Act
- Certain payments made by an employer in 2020 to or on behalf of an employee in order to pay off or reduce that employee’s educational loans will be tax-free to the employee ($5,250 limit on the exclusion).
- The “retail glitch” is finally fixed. Certain “qualified improvement property” will be eligible for bonus depreciation or a shorter (usually 15 years) recovery period, effective retroactively to the enactment date of the TCJA. Thus, qualifying taxpayers who made the qualifying improvements can amend their federal (and perhaps state) tax returns to claim refunds for the costs of the qualified improvement property placed in service after December 31, 2017, that were being depreciated over 39 years.
- Federal aviation excise taxes are temporarily repealed through the end of 2020.
Congress and the administration are working on at least one additional stimulus package, stimulus four, and it is expected to include corrections and clarifications to the CARES Act and previous stimulus efforts, as well as additional relief and stimulus efforts. Bradley is actively monitoring and engaging with Congress and the administration on these issues.