On March 27, 2020, President Trump signed H.R. 748, the Coronavirus Aid, Relief and Economic Security Act (Public Law No: 116-136, the “CARES Act” or the “Act”). The CARES Act makes significant changes to the taxation of individuals and businesses in the form of a number of relief provisions designed to mitigate the negative economic consequences of the novel coronavirus or “COVID-19” pandemic. The Act also makes technical corrections to prior relief legislation, the Families First Coronavirus Response Act (PL 116–127, H.R. 6201), and corrects one of the most significant errors in the Tax Cuts and Jobs Act (P.L. 115-97, the “TCJA”). Due to the unusual speed of the legislative process, the CARES Act may contain technical issues or drafting errors that may have to be addressed in future legislation.
This blog post summarizes several of the most significant tax and accounting changes for businesses and individuals. A separate blog post containing a more detailed review of the employment tax and employee benefits changes is also forthcoming. The Kean Miller Tax Group will post additional updates as the situation develops.
In addition to the tax changes, the CARES Act contains provisions designed to provide relief to small businesses, large businesses, and changes designed to support the U.S. health care system. Additional guidance on these provisions is forthcoming. All of Kean Miller’s guidance related to the Coronavirus pandemic is located here.
Business Tax Changes
Section 1106 – Loan Forgiveness –The CARES Act permits the U.S. Small Business Administration (the “SBA”) to make loans to certain small business under the Paycheck Protection Program, discussed in more detail here. Section 1106 of the Act provides a mechanism under which certain indebtedness related to these loans can be forgiven. Unless an exception applies, Internal Revenue Code (“IRC”) Section 61 requires a taxpayer to include cancellation of indebtedness income in its taxable income. Section 1106 creates an exception to IRC Section 61 and provides that loan forgiven under the Act shall be excluded from a taxpayer’s taxable income for purposes of the Internal Revenue Code. It should be noted that the Act is silent on whether a borrower’s tax attributes will be reduced under IRC Section 108 in the amount of the forgiven debt. Additional guidance may be necessary to clarify this issue.
Section 2205 – Modification of Limitations on Charitable Contributions for Businesses – The CARES Act amends IRC Section 170 to increase the cap on charitable contribution deductions for corporations for “qualified contributions” and provides for the carryover of any excess contributions. The Act defines “qualified contributions” as contributions of cash during the 2020 calendar year to charitable organizations other than most private foundations (other than certain private operating foundations and certain special types of private foundations), supporting organizations or donor advised funds and for which the taxpayer makes an election to have the new law apply. For partnerships and S Corporations, the election is made at the partner or shareholder level.
For corporations, the Act allows a corporation to deduct qualified contributions to the extent they do not exceed 25% (increased from 15%) of the corporation’s taxable income reduced by the amount of other charitable contributions allowed.
The Act increases the percentage limitation on contributions of food inventory from 15% to 25%. For any taxpayer other than a C corporation, the limit will be 25% of the taxpayer’s aggregate net income for such taxable year from all trades or businesses from which such contributions were made for such year. In the case of a C corporation, the limit will be 25% of the taxable income of the C corporation.
Section 2301 – Employee Retention Credit for Employers Subject to Closure Due to COVID-19 – The CARES Act provides an employee retention credit to employers, based on wages (and a proportionate amount of qualified health plan expenses) paid to employees. The credit is limited to 50% of wages paid after March 12, 2020 and before January 1, 2021 and cannot exceed $10,000 per employee. An eligible employer is a nongovernmental employer that carried on a trade or business during 2020 and that meets either of the following tests:
- Operation of the business was fully or partially suspended to due government orders limiting commerce, travel or group meetings due to COVID-19; or
- The business experienced a reduction in gross receipts (determined quarterly as compared with the prior year) of at least 50%, with the credit continuing until the gross receipts exceed 80% of prior year levels.
The credit applies to wages paid to employees by the employer, with respect to which the employee is not performing services (for an employer with over 100 employees in the prior year), to wages paid during the period of suspension (for employers with fewer than 100 employees and which are subject to suspension order), and to wages paid with respect to an employee in the calendar quarter during which the substantial reduction in gross receipts apply (for an employer with fewer than 100 employees and which had a 50% decline in gross receipts). Affiliated employers are considered a single employer for purposes of the 100 employee determination.
Self-employed persons may also claim the credit for their self-employment income. Wages credited under the Paid Sick Leave or Paid Family and Medical Leave provisions of the Families First Coronavirus Recovery Act are not included. Employers taking a small business interruption loan are not eligible for the credit. Tax exempt employers are eligible for the credit.
Wages credited under the Paid Sick Leave or Paid Family and Medical Leave provisions of the Families First Coronavirus Recovery Act are not included. Employers taking a small business interruption loan under the Paycheck Protection Program are not eligible for the credit. In addition, an employee for which the employer retention credit is taken is ineligible for purposes of the work opportunity tax credit in IRC Section 51.
The credit is claimed by the employer by reducing the employment taxes payable for all of its employees. If the credit exceeds the employment taxes, then the employer can claim a refund, which is payable by the Treasury Department under the refund rules for excess employment tax payments.
Section 2302 – Deferral of Payment of Employer Payroll Taxes – The Act also permits an employer to defer the payment of certain employer payroll taxes. Applicable payroll taxes include Social Security and Medicare as well as self-employment taxes. In the case of self-employment taxes only 50% of the self-employment taxes may be delayed. The payroll tax deferral period is the period from the date of enactment (March 27, 2020) to December 31, 2020. One-half of the taxes must be paid by December 31, 2021 and the remainder must be paid by December 31, 2022. The ability to defer payment of payroll taxes may not apply if the employer had indebtedness forgiven under the under the Paycheck Protection Program.
Section 2303 – Modifications for Net Operating Losses – The CARES Act makes two significant modifications to the net operating loss provisions in the Internal Revenue Code. First, the Act amends IRC Section 172(a) to temporarily repeal the taxable income limitation on the deduction for net operating losses. Second, the Act permits a 5-year carryback for net operating losses arising in a tax year beginning after December 31, 2017 and before January 1, 2021.
Under prior law, a taxpayer’s net operating loss deduction was limited to the lesser of an amount equal to the aggregate of the net operating loss carryovers to such year, plus the net operating loss carrybacks to such year or 80% of the taxpayer’s taxable income. The CARES Act suspends the 80% limitation for tax years beginning before January 1, 2021.
Under prior law, a net operating loss arising in a tax year ending after Dec. 31, 2017 could be carried forward indefinitely, but could not be carried back. (Note that, under prior law, a net operating loss that arose in a tax year ending before January 1,2018, could be carried back two years and carried forward 20 years). The CARES Act permits a 5-year carryback for net operating losses arising in a tax year beginning after December 31, 2017 and before January 1, 2021. This change is important because it could permit a taxpayer to carry net operating losses back to years before 2017, when the tax rate was 35%.
The CARES Act also makes some additional modifications and technical corrections to the tax laws related to net operating losses. The Act provides that the new 5-year carryback rule cannot be used to offset IRC Section 965 transition tax income. In addition, it contains an important technical correction to the TCJA that clarifies how a fiscal year filer should report a net operating loss for a tax year that includes December 31, 2017. Under the TCJA, it appeared that a taxpayer with a fiscal year that included December 31, 2017 was subject to the net operating loss carryback disallowance. The CARES Act corrects that language and clarifies that a taxpayer with a fiscal year that began before December 31, 2017 and ended after December 31, 2017 was permitted to carryback that year’s net operating loss.
The Act also provides that a net operating loss carryback claim for the 2018 tax year and certain fiscal years or short years will be considered timely filed if it is filed no later than 120 days after the enactment of the Act.
The net operating loss modifications may provide a refund opportunity for a taxpayer that incurred a net operating loss in its 2018 or 2019 tax years. It should also be noted that any taxpayer subject to the global intangible low-taxed income regime under the TCJA should carefully consider how carrying back net operating losses will impact their deduction under IRC Section 250. In addition, a taxpayer should consider the impact of carrying back net operating losses on its previously claimed foreign tax credits.
Section 2304 – Modification of Limitation on Losses for Taxpayers Other Than Corporations – The CARES Act temporarily repeals IRC Section 461(l), which prevented a non-corporate taxpayer (e.g., a partnership or sole proprietor) from deducting excess losses for a tax year beginning after December 31, 2017, and before January 1, 2026. Under the CARES Act, IRC Section 461(l) is effectively repealed for tax years beginning before December 31, 2020. The excess loss modifications may provide a refund opportunity for a taxpayer that incurred an excess loss in its 2018 or 2019 tax years.
By delaying the implementation of IRC Section 461(l) it appears the CARES Act permits a taxpayer other than a corporation, including a sole proprietor or non-corporate partner in a partnership, to elect to carry back net operating losses related to tax years beginning after December 31, 2017 and before December 31, 2020 for five years. Thus, depending on the taxpayer’s specific facts and circumstances, a taxpayer could use those net operating losses to offset tax previously paid when the top marginal tax rate was 39%. Additional bonus depreciation related to the technical correction made to fix the “retail glitch” (discussed below) could enhance the potential benefit of carrying back these net operating losses.
Section 2305 – Modification of Credit for Prior Year Minimum Tax Liability of Corporations – The CARES Act amends IRC Section 53 to accelerate the payment of alternative minimum tax credit refunds to corporate taxpayers.
Section 2306 – Modification of Limitation on Business Interest – The CARES Act amends IRC Section 163(j) to permit a taxpayer to elect to reduce the limitation on business interest deductions from 30% of a taxpayer’s adjusted taxable income to 50% of a taxpayer’s adjusted taxable income for any taxable year beginning in 2019 or 2020. In addition, for any tax year beginning in 2020, a taxpayer may elect to compute the limitation on business interest deductions based on their 2019 adjusted taxable income.
In addition, a partner in a partnership that is subject to the business interest expense limitation can treat 50% of an excess business interest expense allocated to the partner during 2019 as fully deductible in the 2020 tax year. The remaining 50% of the excess business interest expense would be subject to the rules under IRC Section 163(j) and as such is only deductible in a future year if the partner has excess taxable income or excess business interest income passed-through to the partner.
It should be noted that it is not clear whether the Treasury Department will issue guidance permitting certain real estate businesses that previously elected out of limitations on business interest deductions due to qualified improvement property being ineligible for bonus depreciation under IRC Section 168 (see below) to revoke their election.
Section 2307 – Technical Amendment Regarding Qualified Improvement Property – The CARES Act contains a technical correction to one of the most problematic sections of the TCJA, known as the “retail glitch”. The TCJA’s legislative history indicated that the drafters intended to make property classified as qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property eligible for 100% bonus depreciation under IRC Section 168. To accomplish this goal, for tax years beginning after December 31, 2017, the TCJA eliminated the 15-year MACRS property classification for that property and replaced it with single new classification, qualified improvement property. The retail glitch occurred because instead of assigning a cost recovery period of 20 years or less to the qualified improvement property, the TCJA assigned a 39-year cost recovery period, thereby making qualified improvement property ineligible for bonus depreciation.
The CARES Act corrects the retail glitch by amending IRC Section 168 and assigning a 20-year cost-recovery period to qualified improvement property. The amendment to IRC Section 168 is retroactive to the effective date of the relevant section of the TCJA, thereby creating a potential refund opportunity for certain taxpayers.
Employee Benefits Changes
As noted above, a separate blog post containing a more detailed review of the employment tax and employee benefits changes is forthcoming. Some of the more significant employment tax and employee benefits provisions are summarized below.
Section 2202 – Special Rules for Use of Retirement Funds – The CARES Act waives the ten percent early withdrawal penalty of IRC Section 72(t) for certain coronavirus related withdrawals of up to $100,000 from retirement plans and Individual Retirement Accounts. Any such withdrawals will be deemed to meet the permissible distribution requirements of IRC Section 401(k) as a hardship distribution and therefore are exempt from withholding and the trustee to trustee transfer rules. Further, any amounts withdrawn may be repaid to a qualified plan, an individual retirement account (“IRA”), or rollover-eligible vehicle at any time over a three-year period commencing on the date the distribution was received and do not have to be paid all at once. Withdrawals may be made by an individual who has been diagnosed with SARS-CoV-2 or COVID-19 as a result of taking a test approved by the Centers for Disease Control (CDC), a spouse or dependent who has been diagnosed by such a test, or even by an individual who has experienced adverse financial consequences as a result of being quarantined, furloughed, laid off, a reduction in working hours, or the inability to work for lack of child care. A retirement plan administrator may rely on a certification of qualification provided by the plan participant. If the recipient is unable to repay amounts withdrawn, tax on the distribution may be paid ratably over the three taxable years beginning with the taxable year in which the distribution was received.
In addition to liberalized withdrawal provisions, the CARES Act increases the dollar amount available for loans from qualified plans from $50,000 to $100,000 and also increases the percentage limitation on available loans from 50% to 100% of the present value of the plan participant’s benefit and provides other favorable provisions to facilitate taking loans from one’s retirement plan.
Sections 2203 – Temporary Waiver of Required Minimum Distribution Rules For Certain Retirement Plans and Accounts – The CARES Act provides for a one-year delay in the required minimum distributions (“RMDs”) otherwise due April 1, 2020, and other 2020 RMDs for defined contribution plans under IRC Sections 401(a), 403(a) and (b), as well as IRAs, and IRC Section 457 plans, but not defined benefit plans. The Act also provides for a special rollover rule for certain amounts subject to the RMD rules.
Section 3607 – Expansion of Department of Labor Authority to Postpone Certain Deadlines – The Act provides for extension of the date for making certain plan amendments and delays certain minimum funding contributions for qualified plans and gives the Secretary of Labor certain flexibility in extending deadlines as the result of the declaration of a “public health emergency” (which declaration was made on January 31st of this year).
Excise Tax Changes
Section 2308 – Temporary Exception From Excise Tax for Alcohol Used to Produce Hand Sanitizer – The CARES Act amends IRC Section 5214(a) to create an excise tax exemption for distilled spirits withdrawn from the bonded premises of any distilled spirits plant after December 31, 2019, and before January 1, 2021 for use in or contained in hand sanitizer produced and distributed in a manner consistent with any guidance issued by the Food and Drug Administration that is related the novel coronavirus pandemic. The amendment appears designed to ensure the nation’s distillers are able to produce hand sanitizer free of the alcohol excise tax.
“Distilled spirits” are, generally, ethyl alcohol, ethanol or spirits of wine in any form (including all dilutions and mixtures thereof from whatever source by whatever process produced). Liquor distillers pay a federal excise tax of up to $13.50 per proof gallon (of alcohol) on liquor and other products containing alcohol. Under the Act, distillers who have or will divert liquor-production operations to producing hand sanitizer will not be required to pay the federal excise tax generally imposed on the alcohol they use to produce liquor if the alcohol is used in hand sanitizer.
Section 4007 – Suspension of Certain Aviation Excise Taxes –
Transportation by Air – The CARES Act provides an excise tax holiday during which the excise taxes generally imposed by IRC Sections 4261 and 4271, on the cost of personal airfare and air transportation of property, respectively, shall not be imposed or due. The holiday period begins after the Act’s enactment – i.e., passage by both chambers of Congress and signed by the president – and ends at a date “before January 1, 2021.” Under the Act, without later legislation specifying an earlier date, the holiday will continue through December 31, 2020.
Personal air travel is normally subject to an excise tax of seven and one half (7.5%) percent on the amount of air fare. An additional amount of three ($3.00) dollars per domestic segment is also due. For the air transportation of property, an excise tax of six and one quarter (6.25%) percent is normally due on amounts paid to the transporter.
Use of Kerosene in Aircraft for Commercial Aviation – The excise tax holiday also extends to the excise taxes imposed on the purchase/use of kerosene in an aircraft for commercial aviation – i.e., air transportation of persons or property, for hire. Under IRC Section 4081, the excise tax on kerosene is levied at the rate of four and three tenths ($0.043) cents per gallon for commercial aviation. IRC Section 4041(c) provides an identical rate for commercial aviation. For purposes of the excise tax on kerosene, the Act provides that during the excise tax holiday period its use for commercial aviation shall be treated as a nontaxable use under IRC Section 6427(1).
Delay of Certain Accounting Rules
Section 4013 – Temporary Relief from Troubled Debt Restructurings – The CARES Act permits a financial institution to suspend the requirements under U.S. generally accepted accounting principles (“US GAAP”) for a loan modification related to the COVID-19 pandemic that would otherwise be categorized as a troubled debt restructuring and to suspend any determination of a loan modified as a result of the COVID-19 pandemic as being a troubled debt restructuring, including impairment for accounting purposes. Generally, a troubled debt restructuring occurs when a lender modifies a loan and grants concessions that it would not normally consider because of the debtor’s financial difficulties. In such a situation, US GAAP requires the lender to account for the impairment of the loan over time. The CARES Act, suspends those rules from March 1, 2020 through the earlier of December 31, 2020 or 60 days after the date the national emergency related to the COVID-19 pandemic is terminated.
Section 4014 – Optional Temporary Relief from Current Expected Credit Losses – In an unprecedented move by Congress, the CARES Act would delay the implementation of the Financial Accounting Standards Board’s current expected credit losses (“CECL”) standard (Accounting Standards Update No. 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments) which was scheduled to take effect for any entity required to file with the U.S. Securities and Exchange Commission for fiscal years beginning after Dec. 15, 2019 (note that for smaller SEC filers and other entities the effective date was for fiscal years beginning after December 15, 2022. The CECL standard was created in response to the 2008 financial crisis and would require an institution that issues credit, e.g., banks, credit unions and holding companies filing under US GAAP, to estimate credit loss reserves over the lifetime of a loan as opposed to the current incurred losses standard. The CARES Act would delay implementation of the CECL standard until the later of December 31, 2020 or the state on which the national emergency related to the COVID-19 pandemic is terminated.
Individual Income Tax Changes
Section 2201 – 2020 Recovery Rebates for Individuals – Section 2201 of the CARES Act amends the Internal Revenue Code to add a new section, IRC Section 6428. IRC Section 6428 creates a credit against an eligible individual’s 2020 income tax liability equal to the sum of $1,200 ($2,400 in the case of eligible individuals filing a joint return) plus a $500 credit for each qualifying dependent 16 years old or younger. That amount of the credit is phased out for single filers with an adjusted gross income (“AGI”) between $75,000 and $99,000, joint filers with an AGI between $150,000 and $198,000 and heads of household with an AGI between $112,500 and $146,500. An eligible individual includes every individual except a nonresident alien, a taxpayer who can be claimed on someone else’s return as a dependent, or an estate or trust.
The amount of an eligible individual’s credit is based on AGI reported on the individual’s 2019 income tax return, if already filed. If an eligible individual has not yet filed a 2019 return, the IRS will rely on information from the individual’s 2018 tax return or a Social Security Administration (Social Security Benefit Statement or Social Security Equivalent Benefit Statement) to determine eligibility.
The recovery rebate is technically a tax credit for the 2020 tax year that will be paid out, in advance, as soon as possible. The advance rebate amount will be later reconciled with the rebate based on 2020 income. This means that a taxpayer who receives a smaller advance rebate than they are eligible for based on 2020 income will receive the difference after filing a 2020 tax return, but overpayments of advance rebates due to higher income in 2020 will not be clawed back.
For the vast majority of Americans, no action is required to receive a rebate check. Payments are expected to be issued by the IRS through direct deposit and should be in an eligible recipient’s bank accounts within weeks. Individuals who have not previously provided direct deposit information to IRS may expect checks in the mail, which is likely to take longer. The IRS is expected to divert significant employee resources to administering this aspect of the CARES Act, with concomitant impact on other IRS services including audit and collection activity.
Section 2204 – Allowance of Partial Above-the-Line Deductions for Charitable Contributions – The CARES Act amends IRC 62 to create a new “above-the-line” charitable contribution deduction for “qualified contributions”. The Act defines “qualified contributions” as contributions of up to $300 cash in taxable years beginning in 2020 to charitable organizations other than most private foundations (other than certain private operating foundations and certain special types of private foundations), supporting organizations or donor advised funds. This above-the-line deduction applies to taxpayers who do not itemize deductions.
Section 2205 – Increased Charitable Contribution Limits for Individuals for 2020 Calendar Year – As noted above, Section 2205 of the CARES Act increases the cap on charitable contribution deductions for “qualified contributions” made by individuals. For individuals, the Act removes the percentage of adjusted gross income limitation and instead limits the deduction for charitable contributions to the individual’s adjusted gross income reduced by the amount of other charitable contributions allowed. This will benefit individuals who itemize deductions.
The CARES Act contains an unprecedented economic stimulus and the tax provisions are designed to facilitate getting cash to individuals and businesses as soon as possible. For certain self-employed individuals, e.g., sole proprietors and partners, previously taken tax positions or tax positions currently being evaluated may directly impact the amount of their potential Payroll Protection Program loan, including the amount eligible for forgiveness. Those taxpayers should re-evaluate those decisions in to take into account any potential impacts on the benefits offered by the Payroll Protection Program. In addition, taxpayers eligible for a Payroll Protection Program loan should carefully weigh the benefits of that program with the benefits of the employer retention tax credit and other tax changes contained in the CARES Act.
The CARES Act may also have substantial state and local tax implications, including the creation of additional refund opportunities related to previously filed returns or for 2019 returns that are currently being prepared. It is not clear at this time whether or to what extent states will conform to the provisions contained in the CARES Act. States like Louisiana, which use federal taxable income as a starting point for computing state taxable income, may be impacted by the CARES Act. In addition, taxpayers should consider that any amended federal returns filed as a result of the CARES Act may require the amendment of the related state tax returns.
It should also be noted that employers should review their employee benefits plans to determine whether the plans must be amended in light of the changes in the CARES Act. As noted above, a separate blog post containing a more detailed review of the employment tax and employee benefits changes is forthcoming.
For additional information, please contact the Kean Miller Tax Group: Jaye Calhoun at (504) 293-5936; Kevin Curry at (225) 382-3484; Jason Brown at (225) 389-3733; Angie Adolph at (225) 382-3437; J. Mark Miller at (318) 562-2701; Phyllis Sims at (225) 389-3717; Robert Schmidt at (225) 382-4621; or Willie Kolarik at (225) 382-3441.