CARES Act: Business Tax Provisions
Business Law Alert 04/17/20 Patricia A. Hintz, John T. Barry
In addition to the new SBA loans under the Paycheck Protection Program covered here, the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") grants many significant tax benefits to help businesses and tax-exempt organizations stay afloat and retain employees. This article summarizes the tax benefits that are expressly aimed at businesses and tax-exempt organizations. Some of these programs are not allowed to be used in concert with the Paycheck Protection Program, so be sure to review all your options before taking advantage of any programs.
This article covers business tax breaks provided by the CARES Act. Tax provisions related to individuals, such as an expansion on the deductibility of charitable contributions and special rules for retirement funds, please see here.
Employee Retention Credit (ERC)
In the last draft of the legislation before passing it on March 25, 2020, the Senate added an employee retention tax credit to the CARES Act. This credit is meant specifically to help employers that have been affected by COVID-19 -- either because they fully or partially suspended operations as a result of a government order or their gross receipts declined by more than 50% compared with the same quarter in 2019. If the employer qualifies for the credit because of a downturn in business, the credit will continue each quarter (through December 31, 2020) until the gross receipts for a quarter increase to 80% of the gross receipts for the same quarter in the prior year.
Tax-exempt organizations that are exempt under Code Section 501(c)(3) also may qualify for the credit if their operations are fully or partially suspended because of a government order, but there is no gross receipts test for tax-exempt organizations. The credit cannot be taken by the federal government, any state government, or a political subdivision, instrumentality or agency thereof.
The credit is calculated each quarter and equals 50% of the qualified wages paid to each employee during that quarter up to $10,000 of wages per employee (with a maximum credit per employee of $5,000). “Qualified wages” for these purposes include the value of health plan benefits. It was intended to mimic a 50%cut in payroll expenses and enable medium and large businesses to retain their workforce, according to Senator Patrick J. Toomey. The credit is refundable and is limited to the employer portion (6.2%) of Social Security or Railroad Retirement payroll tax paid by the employer during that quarter. The credit is only available for qualified wages paid after March 12, 2020, and before January 1, 2021.
For qualified businesses and tax-exempt organizations with fewer than 100 employees (average in 2019), all employee wages count as qualified wages in the calculation of the credit. For qualified employers with more than 100 employees (average in 2019), wages are qualified wages when they are paid to employees who are not providing services due to a government order or downturn in business.
This credit may be claimed against the employer portion of employment taxes, including Social Security and Railroad Retirement payroll taxes. To the extent the credit exceeds the employer portion of employment taxes due, the credit is treated as an overpayment and is refundable to the employer. Additional guidance is expected regarding the process for claiming the credit and receiving the refund.
An employer who receives small business loans under the Paycheck Protection Program of the CARES Act is not eligible for this tax credit. In addition, any wages used in determining the new payroll tax credit for family medical leave or sick leave under the Families First Coronavirus Response Act may not be considered in determining qualified wages for this credit.
Deferral of Payroll Taxes
Usually, employers pay a 6.2% Social Security or Railroad Retirement tax on employee wages, in addition to 1.45% for the employers' share of Medicare taxes. A provision of the CARES Act allows (a) employers to defer payment of the employer's share of the Social Security tax that would otherwise have to be paid in connection with their employees for 2020, and (b) self-employed individuals to defer payment of 50% of the Social Security component (12.4% total, 6.2% deferrable) of the self-employment tax that would otherwise have to be paid in connection with their self-employment tax liability for 2020. Half of this deferred tax liability will be due by December 31, 2021 and the other half will be due by December 31, 2022. Essentially this deferred tax liability can be considered an interest-free loan.
The provision also states that if an employer directs a certified professional employer organization or other third party (i.e. a payroll company) to defer Social Security withholding under this Act, then the employer is solely liable for the eventual timely payment of the taxes.
The deferral does not apply to Medicare taxes and it does not apply to the employee's contribution to Social Security.
An employer who has small business loans forgiven under the Paycheck Protection Program of the CARES Act is not eligible for this tax deferral. However, employers who have received a PPP loan may defer deposit and payment of the employer's share of Social Security tax that otherwise would be required to be made beginning on March 27, 2020, through the date the lender issues a decision to forgive the loan, without incurring failure to deposit and failure to pay penalties. Once an employer receives a decision from its lender that its PPP loan is forgiven, the employer is no longer eligible to defer deposit and payment of the employer's share of Social Security tax due after that date. However, the amount of the deposit and payment of the employer's share of Social Security tax that was deferred through the date that the PPP loan is forgiven continues to be deferred and will be due on the "applicable dates" of December 31, 2021 and December 31, 2022, respectively.
Net Operating Loss (NOL) Limitations From the 2017 Tax Act Temporarily Relaxed
In response to criticism that the Internal Revenue Code allowed companies to unfairly lower their US tax liabilities, the Tax Cuts and Jobs Act (“2017 Tax Act”) limited net operating losses (NOLs) in two ways. First, for NOLs arising in taxable years beginning after December 31, 2017, current year NOLs could only be used to offset 80% of net taxable income. Second, it disallowed NOL carrybacks. Many companies will obviously be confronting significant NOLs in 2020. Therefore, the CARES Act temporarily walks back these two limitations.
The CARES Act removes the 80% income limitation for NOL carryovers that can be deducted in tax years beginning before January 1, 2021 and for tax years beginning after December 31, 2017 (i.e., 2018, 2019 and 2020 for calendar year taxpayers). Second, an NOL arising in a tax year beginning after December 31, 2017 and before January 1, 2021 can now be carried back five years. The intention is to provide tax refunds while businesses are strapped for cash due to loss of revenue caused by COVID-19.
Taxpayers with unused NOLs should amend past tax returns to take advantage of this relaxation of the NOL limitations which should provide two great benefits. First, of course, it allows taxpayers to monetize their NOLs sooner. Second, the newly permitted NOLs could potentially be worth more because they can be carried back to years prior to the 2017 Tax Act when tax rates were higher. For example an NOL carried back to 2017 by a corporation would reduce taxable income in a year when the corporate federal income tax rate was 35% instead of reducing taxable income in a later year when the federal income tax rate is 21%.
Temporary Suspension of Excess Business Loss Limitation
The 2017 Tax Act generally disallows excess business losses for noncorporate taxpayers (which include individuals, estates and trusts) for tax years 2018 through 2026. Generally, an excess business loss is the excess of (a) the taxpayer's aggregate trade or business deductions for the tax year over (b) the sum of the taxpayer's aggregate trade or business gross income or gain plus $250,000 ($500,000 in the case of married filing joint taxpayers).
The CARES Act temporarily removes this limitation for business losses in 2018, 2019 and 2020. Therefore, affected taxpayers may benefit from amending their 2018 returns (and 2019 returns if such returns have already been filed) to claim excess business losses that they were unable to claim on originally filed returns.
Quicker Recovery of Alternative Minimum Tax Credit
The corporate alternative minimum tax (AMT) was repealed by the 2017 Tax Act, but AMT credits for corporations were created as refundable credits over several years through 2021. The credits allow a corporation which had to pay additional tax in a prior year because of the AMT to offset a corporation's current regular tax liability.
The CARES act accelerates those AMT credits so that they can be recovered more quickly over 2018 and 2019, instead of over 2018 through 2021. Therefore, amendments to prior year returns may be very beneficial if a taxpayer can claim additional credit under the AMT credit.
Temporary Increase Limitation on Business Interest under 163(j)
The 2017 Tax Act imposed a limitation on the amount of business interest that can be deducted. The business interest expense deduction was originally limited to 100% of the company's business interest income plus 30% of adjusted taxable income (computed without taking into consideration business interest income). The CARES Act increases the 30% limit to 50% temporarily for tax years beginning in 2019 and 2020.
In addition, for the calculation of the interest limitation for the tax year beginning in 2020, a taxpayer can elect to use its adjusted taxable income from 2019 to calculate the limit. Since many companies can expect higher taxable incomes in 2019 than in 2020, this will increase the amount of deductible interest allowed in 2020.
The CARES Act provides special rules for partnerships. Under the 2017 Tax Act, Section 163(j) of the Code generally “silos” partnerships, treating business interest expense as deductible to the extent the partnership has sufficient business interest income and adjusted taxable income. The CARES Act allows a partnership to elect to partially suspend this treatment for 2019. The 50% limit does not apply to partnerships for the taxable year beginning in 2019. Instead, 50% of the amount of excess business interest allocated to a partner for the taxable year beginning in 2019 is treated as paid or accrued by the partner in the taxable year beginning in 2020 and is not subject to the interest deduction limitation. The remaining 50% remains subject to the “silo” rules for partnerships under Section 163(j) of the Code.
Taxpayers (partnership and individuals) may elect out of the new interest deduction rules under the CARES Act.
Electing real property trades or businesses are not subject to the interest deduction limitation, but then are required to use slower depreciation on their assets. Originally, under the Code, this election was irrevocable. However, on April 10, 2020, the Service published Revenue Procedure 2020-22, which allows taxpayers to revoke their election to be an electing real property trade or business or to make a late election. Some taxpayers, who are eligible but have not yet elected to be an "electing real property trade or business," may wish to continue to delay the election and take advantage of the temporarily higher interest rate limitation. Some taxpayers who have made the election may wish to revoke it in order to take advantage of the higher limitation without being subject to slower depreciation. Taxpayers should remember to re-run their calculations with this new information to make the best decision about if and when to make the election to be an electing real property trade or business.
Fix for the "Retail Glitch"
One of the most well-known drafting issues in the 2017 Tax Act was the so-called "retail glitch," which was caused when the term "Qualified Improvement Property" was inadvertently omitted from the list of 15-year property items that are eligible for 100% bonus depreciation in the year they are placed in service or acquired. Congress admitted that the oversight was a mistake, but had been unable to work together to fix it.
Under the CARES Act, qualified improvement property no longer must be depreciated over 39.5 years and may instead be written off immediately in year one if bonus depreciation is taken -- or over 15 years if a taxpayer elects out of bonus depreciation. Qualified improvement property means any improvement made by the taxpayer to the interior portion of a nonresidential building after the building is initially placed in service. This fix will be especially important to businesses in the hospitality and restaurant industries.
Temporary Excise Tax Exemption for Alcohol Used to Produce Hand Sanitizer
Normally, undenatured ethanol is subject to an excise tax on distilled spirits that applies to alcoholic products for consumption. The current tax rate on distilled spirits is $13.50 per proof gallon. A proof gallon is 50% alcohol. The change provided in the CARES Act would exempt distilled spirits from the excise tax if used to make hand sanitizer in 2020.
Small Business Relief from Cancellation of Indebtedness
The CARES Act allows the Small Business Administration to make loans to small businesses and certain nonprofits during the period from February 15, 2020 through June 30, 2020. The loans are to be used to allow such businesses to pay expenses such as salaries, sick leave, mortgage, rent and utility payments. The CARES Act provides that certain of these loans may be eligible for forgiveness, and that loans forgiven are not treated as cancellation of indebtedness income. Accordingly, interest on these loans should be deductible.
Tax Treatment of CARES Act Loans
The Cares Act authorizes the Secretary of the Treasury to make certain loans, loan guarantees, and other investments of up to $500 billion to eligible businesses, states, and municipalities. The exact terms of these arrangements have yet to be determined, although the CARES Act does provide some general rules for the loans. The CARES Act provides that any loan made by or guaranteed by the Department of Treasury under the CARES Act will be treated as indebtedness for US federal income tax purposes, will be treated as issued for its stated principal amount, and stated interest on such loans shall be treated as qualified stated interest.
Payroll Tax Credit
The CARES Act provides for a refundable payroll tax credit for each calendar quarter for qualified wages paid by an eligible employer to each employee for paid sick leave and expanded FMLA leave programs under the Families First Coronavirus Response Act (FFCRA) during the COVID-19 crisis. This is discussed in detail here.
The complete text of the CARES Act is here.
This is a fluid and rapidly changing situation and these resources are current only as of the date of publication. We recommend that you contact your local Quarles & Brady attorney regarding the most up-to-date information or with any other questions regarding this subject matter, or contact