This post was updated April 6.
On March 27, 2020, President Trump signed into law the $2.2 trillion Coronavirus Aid, Relief, and Economic Security (“CARES”) Act (H.R. 748). The CARES Act is the third stimulus package enacted amid the COVID-19 public health emergency, and while not the Act’s primary focus, it contains significant business tax relief. In a previous post, we provided an overview of the entire Act. This post covers the business tax changes and additions.
The key business tax provisions include:
- The creation of an employee retention credit of up to 50% of the first $10,000 paid to each employee;
- For taxable years 2018, 2019, and 2020, net operating loss carryovers (“NOLs”) are no longer subject to an 80% cap based on taxable income, and NOLS from 2018, 2019, and 2020 can be carried back five years;
- For taxable years prior to January 1, 2021, the excess business loss limitation that applies to noncorporate taxpayers is repealed;
- For taxable years beginning in 2019 or 2020, the interest expense limitation is increased to 50%, and taxpayers can use their 2019 adjusted taxable income for purposes of the 2020 calculation;
- A technical correction to the depreciation treatment of qualified improvement property;
- Unused corporate AMT credits through 2021 are accelerated for current full use and refundable for tax years 2018 and 2019;
- Employer-side Social Security payroll tax payments may be delayed until January 1, 2021, with the first half due December 31, 2021 and the remainder due December 31, 2022;
- An exclusion from income for certain loan forgiveness on loans taken out pursuant to other provisions of the CARES Act.
Employee Retention Credit
Effective for wages paid between March 13, 2020, and before January 1, 2021, the CARES Act allows for a refundable credit against Social Security taxes for each calendar quarter equal to 50% of the qualified wages paid to each employee. Employers may only take up to $10,000 of qualified wages into account for each employee for all calendar quarters, and the credit may be applied to the first $10,000 of compensation (including health benefits) paid to an eligible employee. This means that an eligible employer may receive a credit of up to $5,000 per employee, and there is no cap on the number of employees an employer may include in calculating the amount of the total aggregated credit. If the amount of an employer’s combined employee credits exceeds its quarterly employment taxes (as reduced by other credits), the excess will be treated as a refundable overpayment.
An “eligible employer” with respect to a calendar quarter, is an employer that had been carrying on a trade or business during the 2020 calendar year and (i) has operations that were fully or partially suspended during such calendar quarter due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings because of COVID-19, or (ii) has a significant decline in gross receipts for such calendar quarter. A significant decline begins with the quarter in which the gross receipts for the quarter were less than 50% of those in the same quarter in the prior calendar year. The decline ends with the quarter in which gross receipts are greater than 80% of the gross receipts for the same quarter in the prior calendar year.
For employers with more than 100 full-time employees, qualified wages are wages paid to employees currently retained even though not providing services for such employers due to either of the COVID-19-related reasons listed above. For employers with less than 100 employees, all wages paid to their retained employees are qualified wages even if the employees are currently still providing services for such employers. Qualified wages may not exceed the amount an employee would have received for working an equivalent amount of time during the 30 days prior a specified period affected by COV1D-19.
The credit is reduced by any credits taken by employers for qualified veterans and research expenditures for small businesses. Additionally, the amount of qualified wages for which an eligible employer may claim the Employee Retention Credit does not include the amount of qualified sick and family leave wages for which the employer received tax credits under the Families First Coronavirus Response Act (FFCRA).
There are other limitations that apply to certain employers. Specifically, any eligible employers that receive a covered loan under the Paycheck Protection Program of the CARES Act are not eligible for this credit. Further, if an employer is allowed a Work Opportunity Tax Credit with respect to an employee, then that employee is not included for purposes of this credit for any period with respect to the employer. Keeping in mind that the Paycheck Protection Program is only available for business with fewer than 500 employees, the Employee Retention Credit is therefore available to larger employers who meet the distressed business criteria listed above. Employers qualifying for both the Paycheck Protection Program and the Employee Retention Credit will have to determine which of the two is more advantageous for its particular business. Eligible employers may elect out of the credit for any calendar quarter.
Further, just as with the credits for paid family and sick leave under the FFCRA, these credits do not apply to certain United States government or State government employers. The credit does, however, apply to tax-exempt organizations described under section 501(c) of the Code, which covers everything from charities to business leagues to social clubs to credit unions, etc. Any of these tax-exempt employers is deemed to be an eligible employer with respect to all of its operations (notwithstanding that such operations may not be a trade or business), and the same exclusion for participation in the Paycheck Protection Program applies.
Relaxation of Net Operating Loss Rules
The Tax Cuts and Jobs Act (“TJCA”) only just recently changed the net operating loss (“NOL”) rules. For taxable years ending after December 31, 2017, NOLs were allowed to be carried forward indefinitely but could offset only 80% of a taxpayer’s taxable income (a change from 100%) and could no longer be carried back to prior years (previously a two-year carryback was allowed).
The CARES Act now provides that, for tax years beginning before January 1, 2021, the 80% taxable income limit does not apply, which means corporate and noncorporate taxpayers are allowed to use NOLs to fully offset taxable income. It also clarifies how the 80% limitation is to be applied when it goes back into effect for any taxable year beginning after December 31, 2020.
The CARES Act also provides that NOLs arising in a taxable year beginning after December 31, 2017 and before January 1, 2021 are to be treated automatically as a carryback to each of the five preceding taxable years, unless the taxpayer elects out of the carryback. The carryback therefore operates on an all-or-nothing basis, meaning taxpayers may not choose to carry NOLs back to one particular year within the five-year carryback period. An NOL arising in a tax year beginning in 2018, 2019, or 2020 must be carried back to the earliest year within the five-year carryback period in which there is taxable income, as early as 2013, 2014, and 2015, respectively. Considering the pre-2018 corporate tax rate was 35% (versus 21% now) and the top individual rate was 39.6% (versus 37% now), this carryback could be extremely valuable to certain taxpayers.
A taxpayer must make the election to forgo these NOL carrybacks for 2018, 2019, and 2020 at least by the filing deadline for one’s 2020 income tax return (including extensions). The decision to elect out is, however, allowed to be made for each year. This means that a taxpayer may opt out of the 2018 carryback without limiting its decision for 2019 and 2020. The IRS will likely release guidance advising taxpayers how to request refunds for NOL carrybacks or elect out of the automatic carryback. No refund can be claimed until the return for the tax year in which the NOL arises has been filed. For most taxpayers, the 2018 income tax return has been filed, meaning they may request a refund for a year to which a 2018 NOL is carried (the earliest of five prior years with taxable income). This can be done by filing an amended return or by filing a request for tentative refund. Taxpayers who have already filed for 2019 may do the same to make use of any NOLs for that year. No NOL may be carried back from 2020 until the tax year closes.
Remembering that you cannot pick and choose the year(s) to which an NOL is carried back, taxpayers should consider the opportunity to use an NOL to reduce or clear an underpayment of tax for a year within the five-year carryback range.
Special rules apply to real estate investment trusts (REITS) and life insurance companies. A REIT is not allowed to carry back any NOL, nor may an NOL be carried back to any year in which a taxpayer was formerly a REIT.
Suspended Excess Business Loss Rules
For years before January 1, 2021, the CARES Act repeals the excess business loss limitation that applies to noncorporate taxpayers (individual’s, partnerships, or S corporations) after the passive loss rules, and which disallows the use of a business loss in excess of $250,000, or $500,000 for joint filers against nonbusiness income, and treats such loss as an NOL carryover to the next tax year. This means noncorporate taxpayers with business losses arising in 2018, 2019, and 2020 can enjoy the five-year carryback without regard to the excess business loss rules. If you had a business loss that was limited in 2018 or 2019 under the excess business loss rules, then you may be able to obtain a refund by filing an amended tax return.
Increased Business Interest Expense Limitation
Current law generally limits taxpayers’ deduction for a business interest expense to the sum of business interest income and 30% of adjusted taxable income. For most taxpayers, the CARES Act increases this 30% limit up to 50% of a taxpayer’s adjusted taxable income for tax years 2019 and 2020. A taxpayer may elect to not apply this increased limitation, but once the election is made, it can only be revoked by the Secretary of the Department of Treasury.
Special rules apply for partnerships. For partners in a partnership, the increase to 50% applies only to taxable years beginning in 2020 (therefore, excluding 2019), but a partner can carry over to 2020 any business interest that was disallowed in 2019 and deduct 50% of that amount, with the remaining 50% subject to the otherwise applicable rules. The CARES Act also allows any taxpayer to elect to use its 2019 adjusted taxable income instead of its 2020 adjusted taxable income when computing the business interest limitation for 2020. This will increase the amount of business interest expense most taxpayers are able to deduct, assuming their income was higher in 2019.
Technical Correction for Qualified Improvement Property
The TCJA mistakenly defined the term “qualified improvement property” in a way that prevented such property from being eligible for the intended 100% bonus depreciation. Qualified improvement property is generally defined as any improvement to an interior of a nonresidential building that is placed in service post-improvement, following the original date on which the building was placed in service. The CARES Act makes a technical amendment to Code section 168(e)(3)(E) correcting a drafting error by including qualified improvement property as “15-year property” instead of the mistaken recovery period of 39 years. This amendment applies retroactively to property placed in service after December 31, 2017. This provision is meant to not only increase a business’s cash flow by allowing them to amend a prior year’s return, but it is also meant to incentivize them to continue to invest in improvements during this public health emergency.
The IRS is expected to release guidance as to how taxpayers may claim the greater depreciation deduction through automatic accounting method change procedures. In the meantime, taxpayers may have the option of amending previously filed returns to retroactively claim any missed deductions.
Credit for Corporate Alternative Minimum Tax
Prior to the TCJA, the amount of alternative minimum tax (“AMT”) paid by a corporation was allowed as a credit in a subsequent taxable year. The TCJA repealed the AMT for corporations for taxable years beginning after December 31, 2017, but allowed corporations to treat 50% of any unused AMT credit as refundable in 2018, 2019, 2020, and 100% as refundable in 2021. The CARES Act accelerates this timeline, making the AMT credit 100% refundable for taxable years beginning in 2018 and 2019. Accordingly, the new law provides relief to corporate taxpayers with non-refunded AMT credits in 2018, who should be able to amend their 2018 returns (assuming they have been previously filed) and be refunded for those amounts.
Delay of Employer-Side Social Security Payroll Tax Payments
The employer’s portion of Social Security taxes for the period from enactment (March 27, 2020) up to January 1, 2021 will not be due until December 31, 2021, when half of the deferred amount is due, and December 31, 2022, when the other half is due. Similar rules allow deferral of 50% of the corresponding Federal self-employment taxes.
Federal withholding taxes, Medicare taxes and withholding, and employee social security withholding are not eligible for the deferral.
All employers are eligible for the deferral other than those who have loans forgiven under the CARES Act’s Paycheck Protection Program. However, there is some tension in the timing of potential loan forgiveness and at least the first payroll tax payment deadline. This means an employer could apply for a loan under the Paycheck Protection Program and not receive a loan until after the first payroll tax payment is due. In this situation, an employer is allowed to defer payroll tax payments until the employer subsequently receives loan forgiveness, because deferral is not disallowed until an employer has actually had loan amounts forgiven. We expect the IRS to release guidance as to how it plans to handle this situation. It may be that the IRS will not expect payment of any payroll taxes deferred prior to loan forgiveness until the first due date (December 31, 2021), or it may provide for a sooner claw back of any deferred payments.
Payroll tax deferral can be used in conjunction with the Employee Retention Credit, so long as the credit does not result in a refund to the employer.
Certain Loan Forgiveness Excluded from Income
The CARES Act allows certain small business loan forgiveness necessary to maintain payroll or pay mortgages, rent, or utilities incurred or paid by the borrower during the 8-week period beginning on the loan origination date. If a business applied for and received a $10,000 advance under the Economic Injury Disaster Loan provisions before transferring into the Paycheck Protection Program, such advance will be deducted from the total loan forgiveness amount. Any portion of the loan that is forgiven pursuant to the Act is excluded from taxable income.
There are numerous tax provisions in the CARES Act that could be beneficial to a business, including multiple opportunities to amend a prior year’s return to increase liquidity. Please do not hesitate to call us if we can assist you in taking advantage of any part of this legislation.