THE CORONAVIRUS AID, RELIEF AND ECONOMIC SECURITY ACT (“CARES Act”)
The CARES Act provides an immediate and substantial federal government response to the ongoing Coronavirus pandemic in a variety of contexts. What follows is a high level summary of certain tax and other relief that we expect to result from the passage of the CARES Act, provided that it passes in its most recent form without substantive changes.
- Unprecedented allocation of federal government cash to various federal agencies for COVID-19 related issues
- Immediate cash payments to taxpayers of $1200 (single)/$2400 (married) plus $500 per child
- Injection of substantial liquidity via small business loans for payroll and other expenses, with favorable terms, forgiveness and other benefits
- Reduction in useful life of Qualified Improvement Property can generate increased deductions and potentially NOLs that be used to generate refunds and/or reduce tax
- Relaxing of qualified retirement plan distribution rules provide access to liquidity without penalty and deferral of a portion of accrued income taxes
- Increased deductibility of charitable contributions
- Excludes from income of employee qualified education expenses and student loans paid by employer up to $5,250
- Tax credits for employers affected by coronavirus
- Deferral of filing and payment deadlines for estimated taxes and income taxes
- Substantial modifications to NOL rules create opportunities to generate refunds/reduce taxes
- Relaxing of interest deductibility limitations
I. Individual Taxpayer Rebates
a. U.S. Government cuts checks to individual taxpayers.
b. $1,200 for single taxpayers and $2,400 for married taxpayers filing jointly, in addition to $500 for each child under the age of 17.
c. Refunds phased out at higher adjusted gross income (“AGI”) levels. If AGI > $75,000 (for single taxpayers) or $150,000 (for married taxpayers filing jointly), then the refund is phased out at $5.00 for every $100.00 by which the taxpayer’s AGI exceeds those thresholds. In other words, the refund is completely phased out at an AGI of $99,000 for a single taxpayer with no children and $198,000 for married taxpayers with no children. For taxpayers with children, the AGI threshold would be increased until the phase out eliminates the additional per child refunds.
d. Note that the refund, while computed based on recent tax or Social Security related income reported by the taxpayer, is treated as an advance payment of a tax credit that the taxpayer will compute on his or her 2020 income tax return. This means that the payment will be determined based on 2020 tax information and will be compared to the payment that was actually received by the taxpayer.
i. If the payment actually made is > the amount to which the taxpayer was entitled based on 2020, it is not clear under the CARES Act what happens – income recognition is not expressly required under the CARES Act nor is there apparently any requirement for the taxpayer to repay the excess amount received.
ii. If the payment actually made is < the amount to which the taxpayer is entitled based on 2020 data, the difference will apply as a credit to the taxpayer’s 2020 tax liability.
II. Small Business Loans – Paycheck Protection Loans
a. U.S. Government makes available to lenders to lend to small businesses (those that employ < 500 employees, inclusive of sole proprietors and nonprofits) approximately $350B in so-called “paycheck protection loans” under Section 7 of the Small Business Act during the period from February 15, 2020 through June 30, 2020.
b. Loans are 100% guaranteed by the U.S. Government, meaning that lenders will be incentivized to make them to borrowers, and no borrower collateral is required. Loans can be provided directly by the SBA or via banks or other lenders who participate in the SBA program, with current SBA lenders already authorized to make and approve these loans being automatically eligible to participate.
c. Loan amount limitations are the lesser of (x) average total monthly payroll costs for the 1 year period ending on the date the loan is made, multiplied by 2.5, and (y) $10M. Note that there is a different calculation for so-called seasonal employers.
i. “Payroll costs” for these purposes consist of wages, commissions, salaries or similar compensation, whether to an employee or an independent contractor, tips or equivalent, vacation, parental, family, medical or sick leave, dismissal or separation allowances, retirement benefits, state and local taxes assessed on employee compensation, and group health care costs including health care insurance premiums paid.
ii. “Payroll costs” do not include individual employee compensation > $100,000 per annum, payroll taxes, compensation of employees with a principal residence outside the U.S. or qualified sick leave or family medical leave for which the taxpayer is otherwise allowed a credit under the Coronavirus Relief Act passed last week.
d. Permitted loans have a maximum maturity of 10 years and interest rate not to exceed 4%.
e. Loan proceeds can be made to fund payroll, mortgage payments, rent, utilities and other debt service requirements provided that the debts were incurred prior to the applicable time period.
f. Eliminates standard loan related fees under Section 7 and eliminates personal guaranty requirement for the business owner.
g. Fast tracks eligibility determinations and broadens eligibility of businesses.
i. Requires lender to determine if the business was operational on February 15, 2020 and had employees with respect to which it paid salaries and payroll taxes or independent contractors paid for services. Minimal other eligibility requirements.
ii. Note that borrowers obtaining Section 7(b) loans for purposes of funding payroll and providing payroll support are not eligible for these loans.
h. Requires lenders under Section 7(a) to provide complete deferment relief for impacted borrowers for a period up to, but not in excess of, 1 year.
i. Provides for potential forgiveness, on a tax-free basis, of a portion of the “paycheck protection loans.” Note that this forgiveness is limited where the employer reduces its workforce during the 8 week period following the making of the loan and where certain salary reductions are made.
i. Loan forgiveness is reduced by a percentage equal to (average # of full-time equivalent employees per month employed during the covered period / average # of full time equivalent employees per month employed March 1, 2019 through June 30, 2019) – 1.
1. Average number of employees is determined by calculating the average number of employees for each pay period falling within a month.
2. Accordingly, if the employer had an average of 10 full-time equivalent employees per month from March 1, 2020 through June 30, 2020 and 20 full-time equivalent employees per month from March 1, 2019 through June 30, 2019, the forgiveness would be reduced by (10/20 – 1) = 0.5 – 1 = 50% reduction in the loan forgiveness amount.
ii. Loan forgiveness also reduced by any reduction > 25% of compensation in the most recent full quarter in which the employee was compensated (i) in an amount < $33,333 from March 1, 2019 through June 30, 2019, or (ii) less than or equal to $100,000 on an annualized basis during 2019. Note that this reduction does not apply to tipped employees.
iii. Where the business has already laid off employees or reduced salaries due to coronavirus, the borrower can re-hire the employees and/or increase wages without being penalized.
1. Re-hires and increase would need to be made by June 30, 2020.
III. Small Business Loans – Emergency Government Disaster Loans & Loan Subsidies
a. Expands Economic Injury Disaster Loans under Section 7(b) of the Small Business Act (“EIDL Loans”) to make sole proprietors and ESOPs eligible, in addition to businesses with < 500 employees.
b. Eliminates personal guaranty requirement from business owner for loans made before December 31, 2020 in amount < $200,000.
c. Provides for government paid principal and interest on loan for the 1st 6 months for which payments are due.
d. Creates emergency grant up to $10,000 to maintain payroll to eligible borrowers, with repayment being waived even if the borrower is not able to obtain a Section 7(b) loan. These advances are to be disbursed within 10 days of the application of an eligible borrower.
e. For small business loans made under Section 7(a) of the Small Business Act, Title V of the Small Business Act and for loans made by an intermediary under Section 7(m) loans or grants, the government pays the principal, interest and fees owed for those loans in regular servicing status that were made before enactment of the CARES Act and within 6 months from the date of enactment.
i. Contemplates relief of borrower’s obligation to repay the amount paid by the government and avoids requirement for banks to increase reserves to account for the payments.
ii. Note that these subsidies do not apply to payroll protection loans and/or EIDL loans, discussed above, given that these loans are addressed under the provisions of the CARES Act applicable to those loans.
IV. Tax Relief.
a. Fixing Technical Glitch Relating to QIP.
i. In the 2017 Tax Cuts and Jobs Act, Congress attempted to accelerate depreciation on so-called “qualified improvement property” (“QIP”). QIP generally consists of improvements made to the interior portion of a nonresidential building after the building was placed in service. The period over which QIP was to be depreciated was intended to be reduced from 39 years to 15 years, coupled with 100% bonus depreciation for assets with a life of 20 years or less. Unfortunately, Congress forgot to reduce the depreciation period for QIP to 15 years, meaning it remained at 39 years and 100% bonus depreciation was not available to taxpayers.
ii. The CARES Act fixes this technical glitch, reducing the depreciation period for QIP to 15 years and, importantly, making this change retroactive to January 1, 2018. Accordingly, eligible taxpayers should be able to amend previously filed returns and gain the benefit of accelerated depreciation for the 2018 and 2019 tax years.
iii. The amended returns may generate net operating losses, which can be carried back for up to 5 years to generate refunds of excess taxes previously paid.
b. Use of Retirement Funds for Coronavirus Costs.
i. Allows taxpayers to take a “coronavirus related distribution” from a qualified retirement plan during 2020, in an amount up to $100,000, free of the 10% penalty on early distributions.
ii. Limited to taxpayers diagnosed with SRS-COV-2 or COVID-19, with the diagnosis confirmed by a test approved by the CDC, whose spouse or dependent is so diagnosed, or who experiences adverse financial consequences as a result of being quarantined, furloughed or laid off, having work hours reduced, or being unable to work due to lack of child care.
- Note that “adverse financial consequences” is not defined and seemingly would apply to nearly every taxpayer.
iii. Eliminates the 10% penalty, but not the income tax on accrued gains. Nevertheless, the CARES Act allows the taxpayer to spread the income, and pay the associated tax, over a 3 year period beginning with 2020. The CARES Act also provides the taxpayer with the ability to repay the distribution within 3 years of receiving it and thereby avoid any income recognition at all.
iv. Increases from $50,000 to $100,000 the limitation on retirement plan loans for the 180 day period following enactment of the CARES Act.
v. Eliminates required minimum distribution requirement for taxpayers for 2020 year only.
c Charitable Contributions
i. For taxpayers who do not itemize deductions, the CARES Act permits an up to $300 “above-the-line” deduction for cash contributions to charitable organizations. This will permit taxpayers using the standard deduction to deduct up to that amount of cash contributions, in addition to the standard deduction.
ii. For taxpayers who itemize, the CARES Act temporarily eliminates the limits on charitable donations for 2020. This means that instead of the 60% of AGI limitation on such deductions, a taxpayer can deduct up to 100% of AGI for 2020. In addition, excess deductions for 2020 can be carried over to the next 5 years.
iii. For corporate donors, the limit is increased from 10% of adjusted taxable income to 25% of adjusted taxable income.
d. Exclusion from Income of Employer Paid Employee Student Loan Debt
i. Permits employer to pay up to $5,250 in 2020 of an employee’s student loan obligation. Instead of treating these payments as wages paid by the employer and received by the employee (and therefore included in income and subject to income and payroll taxes), these amounts are not treated as wages and/or income to the employee. The employer deducts the amount paid, up to the annual limitation, and the employee’s student loans are paid free of income tax.
ii. Modifies Section 127 of the Internal Revenue Code of 1986, as amended, which permits an employer to pay up to $5,250 of for qualified education expenses of an employee on a tax-free basis (for instance, for an advanced degree).
iii. This appears to now be a combined limit, meaning the student loan payments and qualified education expenses can be aggregated. Nevertheless, the aggregate limit remains at $5,250.
iv. Prohibits the employee’s deduction of student loan interest to the extent repayment was made by the employer.
v. Note that this potentially creates a win-win for employers and employees – deduction for employers and exclusion from income of employees.
e. Employee Retention Credits
i. Provides a 1 year credit against the employer’s share of Social Security payroll taxes for those businesses forced to suspend or close operations due to coronavirus, provided that the business continues to pay its employees during the shut-down.
- Testing is based on gross receipts for the quarter and the credit is calculated quarterly.
ii. Credit amount is 50% of the “qualified wages” paid to each employee during the applicable calendar quarter. That term includes qualified health plan expenses, such as amounts paid to maintain a group health plan.
iii. Prohibits “stacking” of benefits under the loan related provisions of the CARES Act.
iv. Credit is refundable if it exceeds the liability for payroll taxes.
f. Deferral of Employer Payroll Tax and Self-Employment Tax
i. Permits the employer’s share of Social Security payroll taxes that would otherwise be due from the date of enactment of the CARES Act through December 31, 2020, to be paid 50% on December 31, 2021 and 50% on December 31, 2022.
ii. Self-employed taxpayer can likewise defer paying 50% of his or her self-employment tax until December 31, 2021 (1/2 of the 50% deferred) and December 31, 2022 (the remainder of the deferred amount).
iii. This creates an immediate credit for the employer share of Social Security taxes in 2020 (by virtue of the credits created under other provisions of the CARES Act, discussed elsewhere in this summary), coupled with deferred payment of that tax until the end of 2021 and 2022, respectively.
iv. Note that the deferral of payment is not permitted for those who take out payroll protection loans that are forgiven under the above-referenced loan forgiveness programs established under the CARES Act.
g. Modifications to the NOL Rules
i. Temporarily modifies changes to the rules governing net operating losses (“NOLs”) implemented in the 2017 Tax Cuts and Jobs Act (“TCJA”).
ii. 2018, 2019 and 2020 NOLs can now be carried back 5 years or carried forward indefinitely to offset taxable income in the years to which the NOLs are carried back or carried forward.
iii. Losses carried to 2019 and 2020 can be utilized to offset up to 100% of taxable income in those years, as opposed to the 80% limitation set forth in the TCJA.
h. Interest Limitation Rule Modifications.
i. Changes the ability of a business to deduct interest expense from 30% of adjusted taxable income to 50% of adjusted taxable income for 2019 and 2020, while also permitting the calculation of the 2020 limitation based on 2019 adjusted taxable income.
ii. Accordingly, for those businesses generating taxable income in 2019, while generating losses in 2020, this provision would enable the generation of a bigger NOL in 2020. The NOL could then be carried back to 2019 to recover taxes paid in that year.
iii. For entities classified as partnerships for tax purposes, the 50% of adjusted taxable income limitation does not apply at the partnership level. However, disallowed interest is allocated to the partners and for 2020 50% of the disallowed interest is deductible, with the other 50% suspended until such time as the partnership allocated taxable income to the partner.
***This article is intended to be educational and is provided for your convenience. It does not constitute legal advice and it does not establish an attorney-client relationship between any reader and our law firm.