This client alert summarizes recent federal tax changes that are intended to provide relief to businesses and individuals impacted by the coronavirus (“COVID-19”) epidemic, including changes effected under recent IRS announcements, The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), and the Families First Coronavirus Response Act (the “FFCR Act”). The recent announcements and the Acts delay certain deadlines related to the filing of returns and the payment of taxes and amend various provisions of the Internal Revenue Code of 1986 (the “Code”) to provide federal tax benefits to businesses and individuals struggling during this difficult time. The CARES Act also includes certain long-awaited technical corrections to provisions added to the Code under the Tax Cuts and Jobs Act of 2017 (the “TCJA”). This alert focuses on how businesses and individuals can benefit from the federal income tax implications of the recent changes and discusses how such changes will affect businesses and individuals going forward.
While the tax benefits discussed below are intended to provide relief to businesses and individuals struggling due to COVID-19, all businesses and individuals can utilize such benefits, except where otherwise noted.
Delay of Tax Returns and Tax Payments to July 15
The IRS has announced a three-month delay to July 15, 2020 in filing tax returns for 2019 and for paying taxes for 2019 and 2020 estimated taxes due April 15, 2020. However, the second installment of estimated income and self-employment taxes for 2020 remains due June 15, 2020. These filing and payment extensions were covered in a previous Greenberg Glusker client alert.
Immediate Payment and Refundable Credit
The CARES Act provides a refundable credit in 2020 of $1,200 if single and $2,400 if married filing jointly, plus $500 for each child under the age of 17. The credit is phased out by 5% of adjusted gross income above $75,000 if single and $150,000 if married filing jointly. The IRS has announced that it will be sending advance checks to taxpayers for this credit based on their last reported adjusted gross income.
100% Credit for Mandatory Sick/Absent Paid Leave Under the FFCR Act
The FFCR Act requires certain employers to provide minimum amounts of paid sick/absent leave to employees due to COVID-19 (which is covered in prior client alerts here and here). To cover the cost of this requirement, the employer is entitled to an immediate credit against such employer’s social security tax liability in the amount of 100% of all such additional sick/absent leave pay. Any excess credit is refundable.
A similar credit against all federal taxes will be available for self-employed persons that would have qualified for the new mandatory sick/absent leave pay if they were employees. In particular, people who are self-employed will be eligible for a tax credit for up to two weeks of sick pay at either 100% or 67%, depending on the cause of such person’s sick leave, of their average daily self-employment income and ten weeks of family leave pay at 67% of their average daily self-employment income.
Wages taken into account for purposes of the paid sick leave credit will be limited to $511 or $200 per day, depending on the cause of the sick leave, and the maximum tax credit per employee is either $5,110 or $2,000, again depending on the cause of the sick leave. Wages taken into account for purposes of the paid family leave credit will be limited to $200 per day, and the maximum family leave tax credit per employee is $10,000.
Modification of Net Operating Losses
Prior to the enactment of the TCJA, a business could generally elect to carryback its net operating losses (“NOLs”) up to 2 years or carryforward such NOLs up to 20 years. The TCJA eliminated the option to carryback NOLs (except in very limited circumstances) and allowed NOLs to be carried forward indefinitely. In addition, the TCJA limited the NOL carryforwards and carrybacks that could be used by a business in any taxable year to 80% of its taxable income, determined prior to the application of the NOLs (the 80% Limitation).
The CARES Act modifies the rules relating to NOLs for taxable years beginning in 2018, 2019 and 2020. The new rules (i) allow NOLs incurred in 2018, 2019 and 2020 to be carried back up to 5 years preceding the year of the tax loss and carried forward for an indefinite period, (ii) repeal the 80% Limitation for taxable years beginning before January 1, 2021, and (iii) provide that NOL carryforwards arising from taxable years beginning before 2018 are not subject to the 80% Limitation when carried forward to tax years beginning in 2021 and beyond.
However, a Real Estate Investment Trust (“REIT”) cannot carry back NOLs, and NOLs generated during non-REIT years cannot be carried back to REIT years. In addition, NOLs cannot be used to offset income of certain foreign subsidiaries that is deemed to be repatriated under Section 965 of the Code. However, when calculating the five-year NOL carryback period, a taxpayer can exclude any year in which it has this so-called “Section 965 income,” thereby effectively allowing the taxpayer to carry its NOLs back even farther.
These changes can result in businesses receiving cash refunds now by using NOLs from 2018 and 2019 that were required to be carried forward under the TCJA rules. In addition to this timing benefit, there is an absolute tax benefit to corporations that can offset net income from taxable years prior to 2018 as a result of the change to the corporate income tax rate, from 35% to 21%, effected under the TCJA. For example, a $100 NOL that can now be carried back to a pre-TCJA year under the new rules is worth $35 (assuming there was enough net income that year to use the full amount of the NOL), as opposed to being worth a maximum of $21 if used in a post-TCJA year.
Further, businesses that have engaged in M&A activity since the enactment of the TCJA and either bought or sold a business that had NOLs should review the purchase agreement to establish rights and obligations with respect to claiming and allocating NOL carrybacks. For example, a seller may have the right to receive any tax refund from pre-closing periods but may not have the right to obligate the buyer to carryback NOLs and claim the available refunds. In such circumstances, a buyer may be incentivized to waive the NOL carryback and elect to apply the NOL to post-closing taxable years. NOL utilization strategies will vary depending on the purchase agreement language, and we are available to discuss any proposed strategy.
Modification on Limitation of Business Interest
Under the TCJA, business interest expenses have been limited to 30% of a taxpayer’s so-called “adjusted taxable income” (as defined in Code Section 163(j)(8)) (the “Business Interest Limitation”). The CARES Act increased the limitation from 30% to 50% for taxable years beginning in 2019 (except for partnerships, discussed below) and 2020. In addition, the CARES Act allows taxpayers to elect to use their adjusted taxable income from 2019 for purposes of calculating their Business Interest Limitation for 2020. This election will benefit any business whose 2020 adjusted taxable income is reduced due to COVID-19.
For partnerships, the Business Interest Limitation is determined at the partnership level, and the increase in the limitation percentage only applies to taxable years beginning in 2020. Excess business interest (i.e. interest that cannot be deducted because of the Business Interest Limitation) is allocated to the partners and is suspended at the partner level until it is “released” under the Business Interest Limitation rules. The CARES Act provides that partners can deduct 50% of the excess business interest allocated to them in 2019 on their 2020 tax return without being subject to the Business Interest Limitation rules. The remaining 50% will continue to be subject to the Business Interest Limitation rules.
Modification of Limitation on Losses for Taxpayers Other Than Corporations
For taxable years starting after December 31, 2017, the TCJA prevented non-corporate taxpayers from deducting more than $250,000 ($500,000 for joint filers) of net business losses against other sources of income (the “Business Loss Limitation Rule”). The CARES Act retroactively repeals the Business Loss Limitation Rule for the 2018, 2019 and 2020 taxable years. The CARES Act also provides some technical clarifications regarding the calculation of the losses that will be suspended under the Business Loss Limitation Rule going forward. Significantly, the CARES Act provides that any income attributable to a trade or business of performing services as an employee is not business income for purposes of applying the Business Loss Limitation Rule starting in 2021.
Modification of Credit for Prior Year Minimum Tax Liability of Corporations
The TCJA repealed the alternative minimum tax for corporate taxpayers the (“Corporate AMT”) for tax years beginning after December 31, 2017. However, taxpayers that were subject to the Corporate AMT in tax years beginning prior to December 31, 2017 may still have unused minimum tax credits (within the meaning of Code Section 53(b)). Under the TCJA, unused minimum tax credits could be used in tax years beginning in 2018, 2019 and 2020 by a taxpayer to offset regular tax liability, and 50% of the excess of such credits over the taxpayers’ regular tax liability was refundable. In 2021, any unused minimum tax credit remaining would be fully refundable to such taxpayer.
The CARES Act modifies the rules from the TCJA to provide that 100% of any unused minimum tax credits are immediately refundable to corporate taxpayers. Such credits can be claimed on the taxpayer’s 2018 or 2019 tax return.
Technical Amendments Regarding Qualified Improvement Property
As a result of a drafting error, the TCJA inadvertently left out “qualified improvement property” (generally, internal improvements to nonresidential real property) as 15-year depreciable property under Code Section 168(e). As a result, qualified improvement property placed into service after December 31, 2017, has not been eligible for bonus depreciation under Code Section 168(k). In the final regulations promulgated under Code Section 168(k), Treasury acknowledged that the exclusion of such qualified improvement property from Code Section 168(e) was contrary to the congressional intent as evidenced by the legislative history, but that a legislative change must be enacted to fix the issue.
The CARES Act provided the long-awaited technical correction to the classification of qualified improvement property as 15-year depreciable property under Code Section 168(e). This means that qualified improvement property placed into service after December 31, 2017, is now eligible for bonus depreciation under Code Section 168(k). The technical correction also applies retroactively to tax years beginning in 2018 and 2019.
Although the technical correction may allow many businesses to accelerate their depreciation of qualified improvement property, a business that has elected to be treated as an “electing real property trade or business” (as defined in Code Section 163(j)(7)(B)), which exempts it from the Business Interest Limitation, will not be impacted because it cannot take advantage of bonus depreciation under 168(k) with respect to qualified improvement property.
Employee Retention Credit
The Employee Retention Credit provides an “eligible employer” with a refundable tax credit that can be used to offset such employer’s social security tax liability. An employer is an “eligible employer” with respect to any calendar quarter if (i) it is carrying on a trade or business that has been fully or partially suspended because of government (federal, state or local) orders (“Suspension Order”) limiting commerce, travel or group meetings due to COVID-19 during such calendar quarter or (ii) the employer has experienced a decline of at least 50% in gross receipts as compared to those in the same quarter in the prior year due to the pandemic.
The amount of the tax credit is equal to 50% of “qualified wages” paid to each employee by the eligible employer. For a business that has greater than 100 full-time employees, “qualified wages” are wages paid to employees that are not providing services due to a Suspension Order or because the employer is experiencing a period of significant decline in gross receipts. For a business that has 100 or fewer full-time employees, “qualified wages” include all wages paid to employees during any applicable calendar quarter. The foregoing notwithstanding, “qualified wages” do not include (i) wages taken into account in determining payroll credits allowable under Sections 7001 (relating to paid sick leave) and 7003 (relating to paid family leave) of the Families First Coronavirus Response Act (discussed above) and (ii) wages paid to certain related parties of the employer.
“Qualified wages” taken into account for purposes of calculating the amount of an eligible employer’s Employee Retention Credit are limited to $10,000 per employee for all calendar quarters. This effectively limits the amount of the credit to $5,000 per employee. Further, the Employee Retention Credit is only available with respect to wages paid to employees after March 12, 2020, and before January 1, 2021. Any excess portion of the Employee Retention Credit that is not used to offset an eligible employer’s social security tax liability is refundable.
An employer is ineligible for the Employee Retention Credit if such employer receives a “covered loan” under the Small Business Administration Paycheck Protection Program.
Delay of Payment of Employer Payroll Taxes
Payment of the employer portion of social security taxes for periods beginning on March 27, 2020, and ending before January 1, 2021, may be deferred. Half of any such deferred payments will be due by December 31, 2021, and the other half will be due by December 31, 2022. A comparable rule is provided for self-employment tax with respect to persons who are self-employed.
Employers will be unable to defer payments of social security taxes if they have had any indebtedness forgiven under the Paycheck Protection Program.
Distributions and Loans from Retirement Plans
If an individual (or the individual’s spouse or dependent) is diagnosed with COVID-19 or the individual experiences adverse financial consequences as a result of the COVID-19 crisis, the CARES Act permits special disbursements and loans of up to $100,000 from 401k and other qualified retirement plans, waiving the normal 10% early withdrawal penalty. Any withdrawal amount required to be included in gross income may be spread out over a three-year period for purposes of the regular income tax. Additionally, any amounts withdrawn from qualified retirement plans for COVID-19 expenses may be recontributed to the qualified retirement plan over the subsequent three-year period. Finally, the CARES Act also suspends the requirement of 2020 required minimum distributions from qualified retirement plans.
Pursuant to existing Section 139 (which applies to payments made after a National Disaster, which now includes COVID-19), if an employer reimburses employees for reasonable personal expenses due to COVID-19, the payment is deductible to the employer and non-taxable to the employee. However, this section does not apply to payments in lieu of compensation.
Discharge of SBA Loans
The CARES Act provides for the discharge of certain Small Business Administration loans that are used to pay for certain employee and overhead costs (the details of which are beyond the scope of this article). To avoid a double tax benefit, the employer is not entitled to a deduction for the expenses paid for with the discharged loan.
The foregoing is a summary of the tax provisions in recent legislation that we think will most likely have an impact on businesses, and it is not intended to be an exhaustive list of changes to the Code. The applicability of the rules discussed above will depend on facts and circumstances specific to each taxpayer.