The CARES Act: A Summary Overview of Federal Tax Changes Affecting Businesses
In response to the COVID-19 crisis, the United States, like many states and foreign governments, has reacted by easing tax burdens on businesses and individuals. On March 27, President Trump signed the Coronavirus Aid, Relief and Economic Security (“CARES”) Act.
The CARES Act changes affecting business are focused largely on providing liquidity on a short-term basis by temporarily and retroactively easing provisions that limit tax benefits for deductions and losses, by providing refundable credits to certain financially stressed employers who keep employees on the payroll, by delaying the due date for payment of certain taxes, and through one technical amendment to the 2017 Tax Cuts and Jobs Act (“TCJA”) that fixes an error that negatively impacted retailers. A summary overview of the CARES Act changes is provided below.
Employee Retention Credit for Employers Subject to Closure, Partial Suspension, or Significant Decline in Gross Receipts
Eligible employers may claim a credit against the Social Security portion of quarterly FICA taxes (with certain adjustments, “applicable employment taxes”) for 50% of qualified wages paid to each employee in a calendar quarter of 2020. Only wages paid after March 12, 2020 and before January 1, 2021 are eligible. Up to $10,000 of wages may be counted towards the credit for each eligible employee, limiting the credit to a maximum of $5,000 per eligible employee. If the credit exceeds the employer’s applicable employment taxes for any calendar quarter, the excess will be paid to the employer as if it were an overpayment of employment taxes. It is thus a “refundable” credit. In addition, the IRS has been instructed to devise a mechanism for advance refundings of this credit, to be trued up and subsequently recaptured from the taxpayer if a refund exceeds the allowable credit.
Eligible employers include two classes of employers who carry on a trade or business during the 2020 calendar year. First are those employers whose trade or business is fully or partially suspended during the calendar quarter due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings due to COVID-19. Second, are those employers whose gross receipts for any calendar quarter are less than 50 percent of the employer’s gross receipts for the same calendar quarter in 2019. Qualification as an eligible employer continues under this second test for subsequent quarters and ends with the first quarter after the quarter in which gross receipts exceed 80 percent of gross receipts for the same quarter in 2019.
Qualified wages for employers whose average number of full-time employees in 2019 was greater than 100 include only wages paid to employees who do not work owing to the business closure, partial business suspension, or decrease in gross receipts referred to above, provided that qualified wages for any employee may not exceed the amount the employee would have been paid for working an equivalent duration during the 30 days preceding such period. Qualified wages for employers whose average number of full-time employees in 2019 did not exceed 100 include all wages for the period during which the employer was an eligible employer. Qualified wages for any employee may be increased by an allocable portion of the employer’s qualified health plan expenses.
Rules coordinate this new credit with other employer credits and with small business interruption loan eligibility to eliminate certain potential double benefit situations. The law also liberalizes rules for waiver of penalties (but not interest) if an employer overestimates the credit and must repay benefits to the IRS.
Delay in Payroll Taxes
The CARES Act permits employers and self-employed individuals to defer payment of the employer’s share (or, in the case of a self-employed individual, the corresponding share) of the Old Age, Survivors, and Disability Insurance tax portion of FICA (Federal Insurance Contributions Act) payments due on 2020 wages, which is imposed on employers at a rate of 6.2% of each employee’s wages that do not exceed $137,700 for the 2020 calendar year. Fifty percent (50%) of the deferred 2020 tax is due to be paid by December 31, 2021 and the remaining 50% is due on December 31, 2022.
Net Operating Loss (“NOL”) Modifications
Prior to enactment of the TCJA, an NOL could be carried back two years and forward twenty years. After enactment of the TCJA, NOLs arising in taxable years beginning after December 31, 2017 generally may only be carried forward, and cannot offset more than eighty percent (80%) of the taxable income in any year to which they are carried. The CARES Act modifies the NOL rules such that an NOL incurred in a year beginning after December 31, 2017 and before January 1, 2021 may be carried back to each of the five taxable years prior to the year of the loss. Moreover, use of the carryback loss is not limited to eighty percent of taxable income in the carryback year for loss years beginning before January 1, 2021.
Losses incurred in 2020 may thus be carried back to 2015, and losses in 2019 and 2018 to 2014, and 2013, respectively. Losses carried back to the earliest year that are not fully used by income in the earliest year are carried to the next latest year. Oldest losses are consumed first. Corporate tax rates were higher in the early years than presently, so the amount refunded for the early years may be correspondingly greater than savings would be at current rates. However, if a taxpayer paid taxes at a low rate in past years the refund will be lower. For example, an individual who paid tax at capital gains rates in 2013 may receive a refund at a twenty percent (20%) rate rather than a 39.6% rate. Similarly, a corporation that paid tax on income of a foreign subsidiary at a 10.5% rate under the global intangible low-tax income (“GILTI”) regime may receive a refund at such lower rate, or perhaps even no refund if taxes were offset in the prior year by deemed-paid tax credits under the GILTI regime.
For taxable years beginning after December 31, 2020, the current law (without the CARES Act modification) will generally continue to apply with certain modifications. As under current law, losses arising in taxable years beginning before January 1, 2018 are not subject to the 80% limitation. Losses arising after that date are subject to a relaxed 80% limitation, in that the base for the 80% is not reduced by deductions under Section 199A (the 20% qualified business income deduction) and Section 250 (the deductions relating to foreign-derived intangible income and global intangible low-taxed income).
In addition, a technical amendment to the TCJA limits the carryover of NOLs arising in a taxable year beginning before January 1, 2018, to the 20 taxable years following the taxable year of the loss. For TCJA losses, this retains the 20-year carryover period that existed prior to the TCJA.
Limitation on Business Losses of Non-Corporate Taxpayers Delayed
Effective for years beginning after December 31, 2017 and before January 1, 2026, the TCJA limited the amount of net business losses non-corporate taxpayers (including individuals, trusts, and estates) may deduct against nonbusiness income (typically investment income and wages) to an inflation adjusted $250,000 (or $500,000 in the case of a joint return). The nondeductible loss is carried over to the subsequent year to be claimed as an NOL, subject to the limitations on NOLs.
The CARES Act delays implementation of this limitation to taxable years beginning after December 31, 2020, allowing taxpayers to potentially obtain a current tax benefit for 2018 and 2019. Certain technical amendments, relating to the calculation of the nondeductible excess business loss, have also been added.
Relaxation of the Limitation on Interest Deductions
For taxable years beginning after December 31, 2017, the TCJA limited deductions for business interest expense to no more than thirty percent (30%) of the taxpayer’s taxable income for the year. Interest subject to the limitation (“excess business interest”) is carried over for deduction in subsequent years subject to the same limitation in the carryover year. In the case of a partnership, in the year the interest is incurred the limitation is imposed on the partnership, but excess business interest of the partnership is passed on to the partners for use as a deduction by the partners in subsequent years, subject to the thirty percent limitation imposed at the partner level.
The CARES Act generally increases the limitation for a taxable year beginning in 2019 or 2020 to fifty percent (50%). For partnerships, the increased limitation does not apply to 2019, and the limitation remains at thirty percent. However, fifty percent (50%) of the excess business interest passed on by the partnership to the partner with respect to 2019 will be treated as an interest deduction for the partner’s first taxable year beginning in 2020, and is not subject to the limitation on deductibility of interest. By increasing interest deductions for 2019, taxpayers may seek a refund of taxes paid in 2019, or increase a NOL for carryback to earlier years under the liberalized NOL carryback rules.Increased deductions for 2020 will reduce taxable income prospectively.
Because a taxpayer’s income may be less in 2020 than 2019 because of the COVID-19 events, taxpayers have the option to use 2019 adjusted taxable income (annualized for any 2019 short taxable year) to determine the limitation for 2020. Taxpayers may also elect not to increase the deduction limitation from 30% to 50%. Waiving the increased limitation may be desirable, for example, if increased deductions would result in the permanent loss of tax benefits due to a limitation in another area of the tax law.
Modification of the Credit for Prior Year Minimum Tax Liability
Prior to January 1, 2018, corporations were subject to a minimum tax as an alternative to the regular tax. The greater of the minimum tax or the regular tax would be due, and if the minimum tax was larger than the regular tax, depending on the cause of such excess, in subsequent years the taxpayer could be entitled to a credit against the regular tax for the minimum tax paid in prior years. The TCJA eliminated the corporate minimum tax and provided that taxpayers were permitted to carry over and use fifty percent (50%) of the remaining unused minimum tax credit in each subsequent year, resulting in a quickly declining balance of unused minimum tax credits. One hundred percent (100%) of any credit remaining unused in 2021 was allowed without limitation. If there was insufficient regular tax liability to use the credit, the IRS considered the excess minimum tax credit to be a refundable credit, and paid refunds to taxpayers without regard to the amount of regular tax.
The CARES Act accelerates to 2019 the right to claim one hundred percent (100%) of the remaining unused minimum tax credit. Corporate taxpayers with a carryover minimum tax credit at the close of 2018 should generally claim the remaining unused credit on their 2019 tax returns. Subject to future IRS guidance, the statute permits taxpayers to submit tentative requests for refund, and (subject to review) the IRS is directed to apply, credit, or refund the unused minimum tax credit claimed by the taxpayer within 90 days.
Bonus Depreciation Amendment — Fix of the “Retail Glitch”
The TCJA increased bonus depreciation to 100% for qualified property acquired and placed in service after September 27, 2017 and before January 1, 2023 (January 1, 2024 in the case of longer production period property and certain aircraft). The technical implementation of the change included combining three groups of depreciable assets—qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property—into a new “qualified improvement property” (“QIP”) category. This new category should have been included in the description of 15-year depreciable property, because the three separate categories had been included in the 15-year property description before the change, and there was no intent to change this. Failure to include QIP in the 15-year property class left it with a depreciable life of 39 years. Since 39-year property is not eligible for bonus depreciation, this glitch left retailers a much longer write-off for QIP than intended.
The glitch fix repairs the omission and is effective as if it was included in the TCJA. Calendar year taxpayers can amend their 2017, 2018, and 2019 returns to claim these additional deductions (assuming the 2019 has already been filed).
Tax Returns and Payments Due April 15 Granted Automatic Extension Until July 15
In IRS Notice 2020-18, which supersedes earlier, narrower guidance in IRS Notice 2020-17, released on March 18, the IRS delayed the due date until July 15, 2020 for all federal income tax returns and tax payments (including payments of estimated income tax and tax on self-employment income) otherwise due April 15, 2020. There is no action needed to take advantage of this extension and it is available to corporations, individuals, and other taxpayers alike. As of the time of writing, most, but not all states with income tax have aligned their deadlines to the federal approach.
Relief Also Available from Certain States and Non-US Jurisdictions
The American Institute of Certified Public Accountants has made available on its Coronavirus (COVID-19) Resource Center a state tax filing relief chart aggregating guidance from the states regarding deadline modifications. In addition, the Tax Foundation has assembled similar information on an international level, which is available on its website. Taxpayers should confirm this information with their advisers.