Authored by: Anthony R. Boggs, Aresh Homayoun, John Harden, and Ryan Gorman
On March 27, 2020, President Trump signed H.R. 748: the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) into law. The CARES Act is considered Phase Three in the COVID-19 legislative relief effort and provides $2 trillion of economic relief for individuals and businesses, with the headline being the recovery rebate that will immediately put cash in the hands of most Americans. The CARES Act includes important tax provisions that should provide substantial relief for businesses, including walking back some of the business-related tax provisions enacted under the Tax Cuts and Jobs Act of 2017 (TCJA) that were less taxpayer friendly.
This article reviews the tax updates under the CARES Act. See other MMM Guidance on the CARES Act and other tax relief related to COVID-19 here, including guidance on (i) the impact of the CARES Act on tax-qualified retirement plans, (ii) refundable tax credits under the Families First Coronavirus Response Act and (iii) delayed tax payments and filings due to IRS.
Recovery Rebates for Individuals
Individuals, other than nonresident aliens and individuals who may be claimed as a dependent on another individual’s federal income tax return, are provided immediate relief in the form of rebate checks for up to $1,200 ($2,400 for couples married filing jointly), plus an additional $500 for each qualifying child of the taxpayer (i.e., a child and certain other individuals who may be claimed by the taxpayer as a dependent). This one-time rebate phases out based on a taxpayer’s 2019 adjusted gross income (2018 adjusted gross income if a 2019 tax return has not yet been filed), beginning at $75,000 for individual filers and $150,000 for couples married filing jointly, and is completely phased out at $99,000 and $198,000, respectively.
For the vast majority of individuals, no action on their part will be required to receive a rebate check, as the IRS will obtain necessary information using the taxpayer’s 2019 tax return (or 2018 tax return if the taxpayer’s 2019 tax return has not been filed).
Use of Retirement Funds
The CARES Act waives the 10% early withdrawal penalty for coronavirus-related distributions of up to $100,000 from eligible retirement plans (including 401(k) plans, 403(b) plans, governmental 457(b) plans and individual retirement plans/IRAs) made on or after January 1, 2020 and before December 31, 2020. The taxable income attributable to such distributions would be subject to tax ratably over three years beginning in the year of the distribution unless otherwise elected by the participant, and the taxpayer may recontribute all or a portion of the distributed funds (and avoid income taxation with respect to such recontributed amounts) to an eligible retirement plan within three years beginning on the day after the date of the distribution without regard to that year’s cap on retirement plan contributions.
A coronavirus-related distribution for these purposes is limited to a distribution to an individual: (1) who is diagnosed with SARS-CoV-2 or COVID-19 by a test approved by the CDC, (2) whose spouse or dependent is diagnosed with SARS-CoV-2 or COVID-19, or (3) who experiences adverse financial consequences as a result of being quarantined, furloughed, laid off, having work hours reduced due to such virus or disease, being unable to work for reasons related to the virus or disease (including due to lack of child care), closing or reducing hours of operation of a business owned or operated by the individual due to the virus or disease, or other factors determined by the Treasury (a Qualified Individual).
Loans from Qualified Employer Plans
The limit on the amount of a loan from a qualified employer plan to a Qualified Individual (that will not be treated as a taxable distribution from the plan if repaid) is increased from (1) the lesser of $50,000 or 50% of the participant’s vested account balance to (2) the lesser or $100,000 or 100% of the participant’s vested account balance. This limit increase applies only with respect to loans made during the 180-day period beginning on March 27, 2020.
In the case of a Qualified Individual with an existing loan from a qualified employer plan with a due date that occurs during the period beginning March 27, 2020 and ending December 31, 2020, such due date is extended for one year.
Minimum Distributions from Retirement Accounts
The CARES Act waives the required minimum distribution rules for certain defined contribution plans (401(k), 403(b), and governmental 457(b) plans) and individual retirement plans/IRAs for calendar year 2020, thereby providing relief to individuals who would otherwise be required to withdraw funds from such retirement accounts during the economic downturn.
The CARES Act encourages cash contributions to charitable organizations in 2020 by permitting individuals who do not elect to itemize deductions to deduct up to $300 of cash contributions.
In addition, the CARES Act modifies the limitations on deductions for cash contributions to charitable organizations by individuals who itemize deductions, as well as corporations. For individuals, the 50% of adjusted gross income limitation applicable to cash contributions is suspended for 2020. For corporations, the 10% limitation applicable to cash contributions is increased to 25% of taxable income for 2020.
The CARES Act enables employers to provide a student loan repayment benefit to employees on a tax-free basis. More specifically, until January 1, 2021, an employer may contribute up to $5,250 annually toward an employee’s outstanding student loans, with such payment excluded from the employee’s income.
Net Operating Losses (NOLs) and Excess Business Losses
The TCJA limited the use of NOLs generated in tax years beginning after December 31, 2017 to 80% of taxable income and disallowed any carryback of NOLs for tax years ending after December 31, 2017.
The CARES Act (i) removes the 80% use limitation on post-TCJA NOL carryovers or carrybacks that may be deducted in tax years beginning prior to January 1, 2021, so taxpayers may use NOLs to offset 100% of taxable income in such tax years and (ii) allows NOLs generated in tax years beginning in 2018, 2019 and 2020 to be carried back for up to five tax years.
The five-year carryback has the potential to provide substantial tax benefits as it allows corporations to use losses to offset taxable income for tax years prior to the TCJA when the corporate tax rate was 35%, thereby providing critical cash flow and liquidity during the current health crisis. The CARES Act does not allow taxpayers to carryback NOLs to offset any taxable income related to the one-time transition tax on accumulated foreign earnings imposed by the TCJA under Section 965. However, taxpayers can elect to exclude any tax years with income from Section 965 from the taxpayer’s carryback period. Further, special rules apply to REITs (e.g., REITs cannot carry back NOLs to prior REIT tax years), as well as life insurance companies, which relevant taxpayers should review.
For non-corporate taxpayers, the TCJA provided a limitation on the ability to use business losses in excess of $250,000 ($500,000 joint return) (Excess Business Losses) against non-business income. Excess Business Losses could only be carried over to subsequent tax years. The CARES Act provides benefits for non-corporate taxpayers (e.g., individuals operating a business directly or through S corporations or entities taxes as partnerships) by eliminating the limitation on Excess Business Losses for tax years beginning after December 31, 2017, but before January 1, 2021.
Business Interest Expense
As a result of the TCJA, businesses could only deduct net business interest expense (i.e., business interest expense in excess of business interest income) in an amount equal to 30% of their adjusted taxable income (i.e., EBITDA for tax purposes).
The CARES Act provides that for any tax year beginning in 2019 or 2020, the 30% limitation is increased to 50% (except for the 2019 tax year of partnerships, as discussed in more detail below). Further, for tax years beginning in 2020, taxpayers can elect to use their adjusted taxable income for 2019 for purposes of determining their deductible business interest expense, which will likely be higher given the 2020 economic downturn.
For the 2019 tax year, a partnership’s net business interest expense deduction remains limited to 30% of the partnership’s adjusted taxable income; however, if a partner is allocated excess business interest expense, (i) 50% of such amount shall be available for such partner to deduct in its first tax year beginning in 2020 and (ii) the other 50% of such amount is treated as excess business interest expense and carried forward under the standard Section 163(j) rules.
Employee Retention Credit for Employers Subject to Closure Due to COVID-19
The CARES Act provides eligible employers with a refundable payroll tax credit against applicable employment taxes on 50% of qualified wages (including qualified health plan expenses paid to each employee). The amount of qualified wages that may be taken into account for purposes of the credit cannot exceed $10,000 per employee. Therefore, an eligible employer may receive up to $5,000 of payroll tax credits for each employee.
Eligible employers are those that were carrying on a trade or business during calendar year 2020 and (i) had to fully or partially suspend operations in a calendar quarter during calendar year 2020 due to orders from an appropriate governmental authority limiting commerce, travel or group meetings due to COVID-19 or (ii) had gross receipts for such calendar quarter that are less than 50% of gross receipts for the same calendar quarter in the prior year. An employer no longer qualifies for the credit under clause (ii) of the preceding sentence once gross receipts for a subsequent calendar quarter reach 80% of the gross receipts for the same calendar quarter in the prior year.
Qualified wages are (i) for employers with greater than 100 employees, wages paid to employees who are not providing services due to COVID-19 and (ii) for employers with 100 or fewer employees, any wages paid.
The credit is not available for employers receiving small business interruption loans under the CARES Act.
Delay Payment of Employer Payroll Tax
Employers are generally responsible for paying a 6.2% social security tax (i.e., the employer’s portion) on employee wages for the period beginning March 27, 2020 and ending December 31, 2020. The CARES Act allows employers to delay the payment of 50% of such taxes until December 31, 2021, and the remaining 50% until December 31, 2022. Similar rules apply with respect to the delay of the payment of 50% of social security taxes payable with respect to self-employment income.
These rules do not apply to any taxpayer that has had certain indebtedness forgiven under the CARES Act.
Alternative Minimum Tax (AMT) Refundable Credit
The TCJA repealed the corporate AMT, but spread the refundable portion of the credit over four years, ending in 2021.The CARES Act provides corporate taxpayers with an election to take the entire portion of the refundable credit in 2018, thereby obtaining additional cash flow during the health crisis.
Small Business Loan Forgiveness
The CARES Act includes a loan forgiveness program for small businesses. Any cancellation of indebtedness income under this program would be excluded from income and would not result in a loss of any tax attributes.
Emergency Relief to Eligible Businesses
The CARES Act authorizes the Department of Treasury to make loans, loan guarantees and other investments in support of eligible businesses, States and municipalities that do not, in the aggregate, exceed $500 billion.
Any such loans or guarantees shall be treated as debt for income tax purposes and any investment in equity made pursuant to this section of the CARES Act shall not cause an “ownership change” as defined in Section 382 for any applicable corporations.
Technical Corrections / Clarifications
In addition to providing taxpayers with immediate liquidity relief to help compact economic pressures resulting from COVID-19, the CARES Act also added some technical corrections and clarifications to the TCJA.
Retail Glitch Correction
The TCJA modified the depreciable life of qualified improvement property (i.e., improvements to the interior of a nonresidential real property made after the building was placed into service) so that it was 39 years and as a result, such improvement expenses were not eligible for immediate expensing as bonus depreciation.
The CARES Act corrects the depreciable life for qualified improvement property to be 15 years (from 39 years) so that it can be immediately expensed as bonus depreciation. This correction is effective retroactively and applies to property placed in service after September 27, 2017.
The CARES Act corrects the applicability date of the NOL carryback rule under the TCJA so that it applies for tax years beginning after December 31, 2017. Fiscal year taxpayers with tax years beginning in 2017 and ending in 2018 can now carryback NOLs generated in such tax year. Impacted taxpayers may request a tentative refund under Section 6411 for a period of 120 days from March 27, 2020.
For purposes of determining the taxable income against which the 80% use limit is applied for any tax year beginning after December 31, 2020, the CARES Act clarifies that (i) pre-TCJA NOLs are taken into account (and are not subject to the use limitation) and (ii) the Section 199A deduction (Qualified Business Income Deduction) and the Section 250 deduction (for GILTI and FDII) are not taken into account.
Excess Business Losses
The CARES Act clarifies that Excess Business Losses that are carried forward are treated as NOLs for the taxpayer and Excess Business Losses are determined without regard to (i) the Qualified Business Income Deduction and any NOLs or (ii) any deductions, gross income or gains attributable to any trade or business of performing services as an employee.
If you have any questions about this legal update, please do not hesitate to reach out to any of your contact(s) at Morris, Manning & Martin, LLP.