Following nearly a week of intense negotiations, the Senate passed the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act” or the “Act”) on March 25, and the House passed the Act and the President signed the Act into law on March 27 (the “date of enactment”). The CARES Act contains numerous substantive and technical changes to the Internal Revenue Code, designed to provide relief to taxpayers affected by the coronavirus and taxpayers generally. We summarize the tax provisions of the Act in this Report.
The CARES Act provides more than $2 trillion in financial assistance to combat the economic consequences of the coronavirus. This is the largest economic stimulus in U.S. history, dwarfing that of the $800 billion stimulus package that Congress passed in response to the 2008 financial crisis.
The Act includes $350 billion in aid to small businesses, $500 billion in corporate aid, direct one-time payments of up to $1,200 per adult and $500 per child, $100 billion in grants to hospitals, and numerous tax relief provisions, discussed further below.
Direct Payments to Taxpayers
The CARES Act provides for direct payments to the vast majority of Americans, with an estimated 90% being eligible for full or partial stimulus payments. Under the Act, single Americans would be eligible to receive up to $1,200 with married couples being eligible for twice that amount, or $2,400. These payments are available to persons who have no income and who receive income which is not subject to taxation. Parent’s with qualifying children would be eligible to receive an additional $500 per child. The payments begin to phase out for individuals with incomes of $75,000, with the rebate amount being reduced by $5 for each $100 that a taxpayer’s income exceeds the phaseout threshold. These amounts are completely phased out for individuals with incomes over $99,000, heads of household earning more than $146,500, and joint filers with incomes above $198,000. The IRS will use a taxpayer’s adjusted gross income from their 2019 tax return, if filed, to apply the phase out. If 2019 returns have not been filed, 2018 returns will be used. For those who did not file a tax return in 2018 or 2019 because they did not have enough income to be taxable, the IRS will look to Social Security statements, if applicable.
The Act will provide payments under these provisions through December 31, 2020. The payments can be delivered electronically to an account where a taxpayer has authorized the deposit of a tax refund on or after January 1, 2018. The Act requires that notice of any payment under this provision be sent to the taxpayer within 15 days of sending the payment.
Penalty Waiver for Early Withdrawals from Qualified Retirement Accounts
The 10% penalty tax imposed by the IRS on certain early withdrawals from qualified retirement accounts is waived for qualifying distributions of up to $100,000 (determined on an aggregated basis for a controlled group of employers). In addition, the distributed amount is taxed ratably over a three-year period rather than being taxed on the full amount in the year of the distribution. Further, taxpayers are allowed to recontribute such funds to an eligible retirement account at any time within three years of the distribution, which is treated as an eligible rollover distribution, and avoid both the penalty and the ordinary income tax on the distribution. “Qualifying distributions” are withdrawals made on or after January 1, 2020 and before December 31, 2020 for certain COVID-19 related reasons. Consistent with the rule for qualifying distributions, the limitation on plan loans to participants affected by COVID-19 is increased from $50,000 to $100,000, and the repayment rules are relaxed.
The Act also waives the required minimum distribution (RMD) rules for certain defined contribution plans for calendar year 2020, allowing taxpayers to “skip” the RMD for 2020 without penalty. Presumably the RMD waiver is intended to allow taxpayers impacted by the decline in the securities market to preserve their retirement account balances without a forced RMD calculated based on their December 31, 2019 account balance, at the top of the market. For additional information on the impact of the CARES Act on employee benefit plans, see the Nelson Mullins Comp and Benefits Brief: CARES ACT– Impact on Tax-Qualified Retirement Plans.
Modification of Limitations on Charitable Contributions
The CARES Act significantly benefits individuals and corporations who make cash contributions to qualified charitable organizations during 2020. Individuals are normally not allowed to deduct cash contributions to charitable organizations in an amount that exceeds 60% of their contribution base (increased from 50% to 60% under the Tax Cuts and Jobs Act of 2017 (“TCJA”) through 2025), which is based on adjusted gross income (AGI). The new provision suspends the 60% limit for 2020 and permits deduction of amounts up to 100% of the taxpayer’s contribution base. Similarly, the 10% of taxable income limit for charitable contributions by corporations is increased to 25%.
The relaxed deduction rules do not apply to contributions to supporting organizations and donor advised funds, presumably because the contributed amounts would not immediately provide relief to those affected by COVID-19. The income limitation on the deduction for contributions of food inventory in 2020 is also increased from 15% to 25%.
In addition, the Act allows individuals to deduct up to $300 for contributions made to certain qualifying charities. This deduction is applied “above-the-line” and therefore allows taxpayers to use the deduction even when they take the standard deduction. If a taxpayer itemizes their deductions (rather than using the standard deduction), any such charitable contribution is deducted “below-the-line” as it normally would be, subject to the increased limitations discussed above.
Employee Retention Credit
The Act also creates a refundable credit against the 6.2% Social Security tax on employee wages. Eligibility for the credit is restricted to employers whose business operations (i) were fully or partially suspended during any quarter of 2020 due to orders from a government authority resulting from COVID-19 or (ii) remained open in 2020 but during any quarter had gross receipts that were less than 50% of the gross receipts from the corresponding quarter in 2019. Under the second of the preceding conditions, the employer would be entitled to a credit for each quarter until their business operations produce gross receipts that exceed 80% of gross receipts from the corresponding 2019 quarter.
The credit will be calculated quarterly and will be in an amount equal to 50% of the qualified wages paid to each employee after March 12, 2020 and before January 1, 2021 up to $10,000 per employee. For businesses with more than 100 employees, qualified wages are limited to wages paid to employees while business operations were shut down (described in (i) above). For businesses with less than 100 employees, qualified wages include wages paid to employees during a shut down as well as wages paid to employees during a year-over-year decline (discussed in (ii) above). Any wages paid pursuant to the mandated paid sick leave and paid family leave under the CARES Act are not considered when determining qualified wages.
Employers are ineligible for the credit if they receive a loan under the SBA Paycheck Protection Program for 7(a) loans established under the CARES Act. Employers also cannot use the credit for wages for which they receive a credit under the work opportunity tax credit or a paid leave credit. Additionally wages taken into account for the paid leave credit established under prior COVID-19 response legislation cannot be used to claim the employee retention credit. The employee retention credit does not apply to federal, state or local government employers.
Delay of Filing and Tax Payments for Corporations and Individuals
Under the Act, corporations and Individuals may delay their Q1 estimated tax payments until July 15, 2020. With respect to the extension of the due dates for tax returns otherwise due on April 15, 2020, see the Nelson Mullins Tax Report: Treasury Extends Deadline for Filing and Payment of 2019 Income Tax Returns.
Employer Payroll Taxes
Employers are responsible for paying 6.2% Social Security tax on employee wages. The payment of these employment taxes for the period beginning on the date of enactment of the CARES Act and ending on December 31, 2020 will be deferred. Fifty percent of such payments will be due by December 31, 2021 with the remaining amounts due December 31, 2022. This deferral will not apply to employers with small business loan debt that is forgiven under the CARES Act. Additionally, for self-employed individuals, the measure would defer 50% of their Social Security tax payments.
Net Operating Losses
The CARES Act reverses the “revenue raising” provisions of the TCJA which eliminated carrybacks of net operating losses (“NOLs”) and limited the use of NOL carryforwards to 80% of taxable income. The new provision allows business taxpayers to aggregate NOLs from tax years 2018, 2019, and 2020 and carry them back up to five years. Notably, the five-year carryback would allow corporations to apply losses to years in which the corporate tax rate was 35%, which has the effect of increasing the value of NOLs carried back. Additionally, the provision temporarily removes the 80% taxable income limitation, allowing NOLs to fully offset taxable income for tax years beginning before January 1, 2021. As a practical matter, NOL carrybacks that arise during a taxable year are generally calculated at the close of a company’s taxable year meaning that the relief this provision provides with respect to 2020 NOLs will be delayed until the end of the tax year and the filing of the 2020 tax returns with the carryback adjustments. Special rules apply to NOLs incurred by REITs and life insurance companies and with respect to the availability of credits for prior year alternative minimum tax liability of corporations.
For U.S. corporations with foreign-source and foreign-derived income, including those owning 10% or more of the shares of non-U.S. corporations that are treated as controlled foreign corporations (“CFCs”), the carryback provisions of the Act must be analyzed in light of the global intangible low-taxed income (“GILTI”) and foreign-derived intangible income (“FDII”) provisions enacted by the TCJA. In certain circumstances, this interplay of these provisions may vitiate the tax benefits of the new NOL carryback provisions
GILTI was enacted by the TCJA to spur U.S. multinationals to repatriate their intangible assets, such as patents and intellectual property, from low-tax jurisdictions by taxing the “under-taxed” earnings on these assets. GILTI operates by immediately taxing earnings from intangible assets in certain low tax jurisdictions. Earnings subject to this tax allow corporations to deduct 50% of the GILTI and claim a foreign tax credit for 80% of foreign taxes paid or accrued on GILTI. The aim thus was to impose a GILTI-related tax only where the income realized by the CFC was not subject to at least a 13.125% tax by its “low-tax” jurisdiction.
In contrast, the FDII provisions were enacted as an inducement for U.S. corporations to retain (or move) their intangible assets in (or to) the U.S., while licensing them to non-U.S. persons. To achieve this aim, the TCJA extended a similar 37.5% deduction (also under section 250 of the Code) of their “deemed intangible income” that is foreign derived.
This interplay arises when the sum of GILTI and FDII (determined without regard to the section 250 deductions) exceeds the taxable income of the U.S. corporation. In that event, there is a “carve-back” of the amount of Section 250 deductions. Thus, for example, a U.S. corporation, by reason of a NOL carryback, could lose the benefit of its section 250 deductions (which are not subject to carryback or carry forward).
Therefore, it appears that a U.S. corporation with GILTI or FDII will be faced with the choice either of carrying back NOLs (for example, to 2018 or 2019) and effectively forfeiting section 250 deductions or carrying forward those NOLs to offset (expected) U.S. income, which is currently taxed at the lower corporate rate (21%).
The CARES Act also provides Treasury with regulatory authority to modify the application of limitations on NOLs and other tax attributes under section 382.
Limitation on Business Loss Rules for Non-corporate Taxpayers
The CARES Act modifies the rules enacted by the TCJA, which imposed a limitation on the amount of business losses an individual could use to offset their income. Such limitations capped loss deductions at $250,000 for individuals and $500,000 for joint filers. Any losses above those limits were treated as net operating losses and subject to income and carryback limitations. The Act removes these loss limitations for taxpayers other than corporations for tax years beginning after December 31, 2017 and before January 1, 2021 and allows taxpayers to file amended returns to claim losses in 2018 and 2019, if applicable.
Expedited Credit for Prior Year Minimum Tax Liability for Corporations
The TCJA repealed the corporate alternative minimum tax (“AMT”). As part of this repeal, corporations who were previously subject to the tax received refundable credits which were made available over several years ending in 2021. The Act repeals the 2021 timeline and allows eligible companies to apply for an immediate refund of AMT amounts that would otherwise be deferred under the TCJA.
Limitation on Business Interest
The TCJA limited the amount of deductible business interest expense to 30% of the taxpayer’s adjustable taxable income (“ATI”) for the tax year. The Act relaxes this amount and enables taxpayers to elect to increase the section 163(j) limitation from 30% to 50% for any taxable year beginning in 2019 or 2020. Additionally, for tax years beginning in 2020, businesses may use their 2019 ATI to calculate the interest expense limitation which will likely be higher due to the economic downturn. While partnerships are still subject to the 30% limitation for 2019. The Act provides that 50% of any interest deductions that are suspended by the 30% income limitation in 2019 can be applied or “freed up” in 2020 without regard to any income limitations. The remaining 50% will continue to be subject to the normal section 163(j) limitations. Many businesses are likely to benefit from the revised limitations due to the sudden economic downturn and grim short-term forecasts. However, real estate businesses that elected out of the section 163(j) limitations and as a result were required to transition to longer depreciation methods for their assets, will likely not benefit from the new provisions. Additionally, some taxpayers, including taxpayers subject to the BEAT, may elect not to increase their 163(j) limitation in order to utilize their excess interest expense to offset income in future years.
Expensing of Qualified Improvement Property
The TCJA allowed full (100%) expensing of cost of depreciable tangible assets, such as machinery and equipment through 2022, then phased out the provision over the subsequent five years through 2026. For property with longer production periods, the phase out of the provision extended through 2027. The Conference Report for the TCJA described an intention to treat “qualified improvement property,” which generally include any improvements to the interior portion of nonresidential real property that do not enlarge the building or improve its internal structural framework (other than elevators or escalators), as 15-year property, which would in turn render it eligible for the 100% expensing. However, language of Section 168(k) as incorporated in the TCJA failed to achieve that intended result.
The CARES Act includes a technical correction to the TCJA and enables businesses to immediately deduct costs associated with improving facilities or “qualified improvement property” as opposed to depreciating those improvements over 39 years. The Act makes this correction retroactive to January 1, 2018 (allowing companies to file amended returns for 2018 or 2019 when beneficial). Congress expects that this change will incentivize businesses to invest in improvements despite difficult financial conditions. Notably, the newly corrected 100% deduction for qualified improvement property may generate net operating losses that are now, pursuant to the Act, permitted to be carried back for up to five years.
Exclusion of Cancellation of Debt (“COD”) Income for Employer Payment of Employee Student Loan Debt
The Act provides that an employer can pay up to $5,250 of an employee’s student loan debt in 2020 without such payment being includible in the income of the employee. Any such employer paid amounts would count towards the limit on employer-provided education assistance that can be excluded from income. Interest attributable to the portion of student loan debt paid by an employer will not be deductible to the employee.
Temporary Exception from Excise Tax for Alcohol Used to Produce Hand Sanitizer
For the 2020 calendar year the Act waives the federal excise tax on any distilled spirits produced and distributed in a manner consistent with guidance issued by the Food and Drug Administration.
The numerous substantive tax law changes in the CARES Act will impact most businesses and individuals.