On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The enactment of the CARES Act is the latest action taken by the U.S. Government to assist individuals, families, and businesses impacted by the COVID-19 pandemic and the damage it has inflicted on the U.S. economy. This DGS Legal Alert summarizes the key business-related tax provisions contained in the CARES Act and other COVID-19 legislation, as well as the tax implications of actions taken by the President and the Internal Revenue Service (“IRS”) in response to the COVID-19 pandemic.
As discussed in more detail below, the key business-related tax developments are:
- CARES Act:
- For taxable years beginning before January 1, 2021, net operating loss carryovers (“NOLs”) are no longer subject to an 80% taxable income limitation, and NOLs from 2018, 2019, or 2020 can be carried back five years;
- For taxable years beginning in 2019 or 2020, the interest expense limitation in Code section 163(j) is increased from 30% to 50% of adjusted taxable income, and taxpayers can use 2019’s adjusted taxable income for purposes of the 2020 calculation;
- The forgiveness of loans under the “Paycheck Protection Program” will not create cancellation of indebtedness income;
- Excess business loss limitations for individual taxpayers have been eliminated for 2018, 2019 and 2020;
- Corporate AMT credits are 100% refundable as of 2019;
- The creation of an employee retention credit of up to $10,000 per employee (subject to certain limitations);
- The deferral of employer payroll taxes due for the rest of 2020 (50% due at the end of 2021 and the other 50% due at the end of 2022); and
- Corrected the so-called “retail glitch” so that businesses may immediately deduct amounts spent on certain improvements to property.
- Families First Act: Certain amounts paid as wages under the emergency expansion of the Family Medical Leave Act and Paid Sick Leave Act are available as refundable payroll tax credits.
- National Emergency Declaration: Allows employers to make payments to employees to reimburse expenses related to COVID-19 that are tax free to the employee and fully deductible by the employer.
- Notice 2020-18: Delayed tax filing and payment deadlines from April 15 to July 15.
Net Operating Losses
Under the Tax Cuts and Jobs Act of 2017 (“TCJA”), NOLs generated after 2017 generally could only be carried forward to future years and could not be carried back to previous years. Additionally, such NOLs could only be used to offset 80% of a taxpayer’s otherwise taxable income. Under the CARES Act, NOLs that arise in 2018, 2019, or 2020 can now be carried back up to 5 years, and the 80% limitation will not apply for all tax years that begin before January 1, 2021.
These changes will allow businesses to obtain immediate and critical cash flow by utilizing NOLs resulting from the current COVID-19 crisis (or the preceding two years) by filing amended tax returns for prior years to obtain refunds. In addition, these changes allow a corporation to carryback NOLs to years in which the corporate tax rate was 35%, increasing the value of such NOLs.
Limitation of Business Interest
Section 163(j) of the Code limits the ability of certain taxpayers to deduct business interest in a given taxable year. Prior to the CARES Act, the limitation for a taxable year was generally equal to the sum of (i) the business interest income of the taxpayer, and (ii) 30% of the adjusted taxable income of the taxpayer. Under the CARES Act, the calculation of the business interest deduction limitation for tax years beginning in 2019 and 2020 now includes 50% (rather than 30%) of the taxpayer’s adjusted taxable income.
For 2020, any taxpayer can elect to utilize its 2019 adjusted taxable income rather than its 2020 adjusted taxable income in calculating its 2020 business interest deduction limitation, increasing the deductible business interest expense for taxpayers with higher adjusted taxable income in 2019 than in 2020.
Paycheck Protection Program Loans with Loan Forgiveness
The Small Business Administration is to provide $349 billion in loans to eligible recipients including small businesses, self-employed individuals, and nonprofits. The loan proceeds may be used for payroll, rent, mortgage payments, and utility costs. To the extent such funds are so used within the 8-week period beginning on the date the loan is originated, such amounts may be forgiven without the recognition of cancellation of indebtedness income. The amount forgiven is determined by reference to the number of employees retained (without significant reduction in salary or wages).
Excess Business Loss Limitation
TCJA capped the amount of “net business losses” that an individual could take against other sources of income at $250,000 for single filers ($500,000 if married filing jointly). Any excess business losses were converted to net operating losses, subject to additional limitations. The CARES Act eliminates the excess business loss limitation for 2018, 2019 and 2020.
Refundable AMT Credits
While TCJA eliminated the alternative minimum tax (“AMT”) for corporations, corporations that were previously subject to the AMT received refundable credits. Fifty percent of any available credits not used for each of the tax years 2018, 2019 and 2020 were to be refunded to the taxpayer, and 100% percent of any remaining excess credits were to be refunded to the taxpayer in 2021.
The CARES Act accelerates the refundability of the AMT credits by providing for 50% refundability in 2018 and 100% refundability for any remaining tax credits in 2019.
Employee Retention Credit
The CARES Act provides a refundable employee retention credit for employers against the 6.2% Social Security tax on employee wages. Eligibility for the credit is restricted to employers whose business operations (i) were fully or partially suspended during any quarter of 2020 due to orders from a government authority resulting from COVID-19, or (ii) remained open in 2020 but had gross receipts in any quarter that were less than 50% of the gross receipts from the corresponding quarter in 2019. Under the second of the preceding conditions, the employer would be entitled to a credit for each quarter until their business operations produce gross receipts that exceed 80% of gross receipts from the corresponding 2019 quarter.
The credit will be calculated quarterly and will be an amount equal to 50% of the qualified wages paid to each employee after March 12, 2020 and before January 1, 2021 up to $10,000 per employee. This is intended to provide an incentive for employers to continue to pay employees that are not working due to a full or partial business shutdown or a significant decrease in gross receipts.
For eligible employers with more than 100 full-time employees, qualified wages are wages paid to employees when they are not providing services due to COVID-19-related circumstances. For eligible employers with 100 or fewer full-time employees, all employee wages are qualified wages, whether such employer is open for business or subject to a shut-down order. Amounts paid by an eligible employer to provide and maintain a group health plan are also included in qualified wages.
If, during any calendar quarter, the amount of the employee retention credit exceeds the applicable employment taxes during such calendar quarter, the excess will be treated as an overpayment and refunded to the employer.
An employer may not include any employee for which the employer is allowed a credit under any other section of the Code. Furthermore, any wages taken into account in determining the employee retention credit cannot be taken into account for purposes of determining the employer credit for emergency Family Medical Leave Act and Paid Sick Leave Act (discussed below under the Families First Act). Also, an employer is not eligible for this employee retention credit if the employer receives a covered loan under the Small Business Act, as added by Section 1102 of the CARES Act.
Delay of Payment of Employer Payroll Taxes
Under the CARES Act, payroll taxes that are due between March 27 and December 31, 2020, may be deferred with 50% of the deferred payroll taxes payable on December 31, 2021 and the other 50% payable on December 31, 2022. This deferral will also apply to 50% of self-employment taxes for self-employed individuals.
Technical Correction of the “Retail Glitch”
Although not related to the COVID-19 pandemic, the CARES Act provides a much-anticipated technical correction to TCJA. TCJA intended to accelerate the depreciation of “qualified improvement property” (“QIP”), which is generally defined as any improvement made to the interior portion of a nonresidential building any time after the building was placed in service. As a result of a drafting error in the TCJA, however, the depreciable life of QIP defaulted to a term of 39 years, instead of the intended term of 15 years. The CARES Act provides a technical amendment to correct the foregoing drafting error by reducing the depreciable life of QIP from 39 years to 15 years, making QIP also eligible for 100% bonus depreciation applicable to assets with a recovery period of 20 years or less. The change is retroactive to the enactment of TCJA in 2017, and thus, taxpayers should be entitled to file amended tax returns to receive the benefits of accelerated depreciation for QIP.
Families First Act
The Families First Coronavirus Response Act (“Families First Act”) was signed by President Trump on March 18, 2020. The Families First Act, among other things, provides employees access to: (i) 12-weeks of job-protected leave under an emergency expansion of the Family and Medical Leave Act (“Emergency FMLA”), and (ii) 2-weeks of paid sick leave pursuant to adoption of new paid sick leave requirements (“Emergency PSLA”). These provisions apply only to (a) private employers with fewer than 500 employees, and (b) covered public employers. Although the details of these programs are beyond the scope of this DGS Legal Alert, the Families First Act also provides employers certain payroll tax credits to offset the cost of the Emergency FMLA and Emergency PSLA and provides that the amounts paid under the Emergency FMLA and the Emergency PSLA are not subject to the employer’s portion of the Social Security tax.
Expanded Paid Family Leave Credit
Employers are eligible for a refundable credit against the employer’s portion of the Social Security tax for amounts paid by an employer each quarter under the Emergency FMLA. The amount of qualified family leave wages taken into account for each employee is capped at $200 per day and $10,000 for all calendar quarters. The credit is refundable if the credit exceeds the employer’s total liability for the Social Security portion of its payroll taxes.
Eligible self-employed individuals (individuals who would be entitled to receive paid leave pursuant to the Emergency FMLA if the individual was an employee of an employer other than itself) receive a credit against their income tax for 100% of the qualified family leave equivalent amount. The qualified family leave equivalent amount is capped at the number of days the benefit is paid (up to 50) multiplied by the lesser of $200 per day or 67% of the average daily self-employment income for the taxable year (net earnings from self-employment divided by 260). Only days that the individual is unable to work for reasons that would entitle the individual to receive paid leave pursuant to the Emergency FMLA can be taken into account.
Paid Sick Leave Credit
Employers receive a refundable credit against the employer’s portion of the Social Security tax for the sick leave wages paid each quarter under the Emergency PSLA. The credit is limited to $511 per day for employees who are unable to work in order to:
- Comply with a public quarantine or isolation order;
- Self-quarantine based on the advice of a healthcare provider; or
- Obtain medical care for COVID-19 symptoms (collectively, the “Personal Requirements”).
The credit is limited to $200 per day for employees who are:
- Caring for an individual who is under quarantine or isolation;
- Caring for a child, if the child’s school or daycare closed or the childcare provider is unavailable due to COVID-19; or
- In any other substantially similar condition specified by the Secretary of HHS in consultation with the Secretary of the Treasury and the Secretary of Labor (collectively, the “Caregiver Requirements”).
The credit is further limited to an aggregate of 10 days of paid benefits. The credit is refundable if the credit exceeds the employer’s total liability for the Social Security portion of its payroll taxes.
Eligible self-employed individuals (individuals who would be entitled to receive paid leave under the Emergency PSLA if the individual was an employee of an employer other than itself) who satisfy the Personal Requirements or Caregiver Requirements are entitled to a qualified sick leave equivalent amount for an aggregate of 10 days. The qualified sick leave equivalent amount for self-employed individuals who satisfy (i) the Personal Requirements is equal to the lesser of $511 per day or 100% of their average daily self-employment income for the taxable year, and (ii) the Caregiver Requirements is equal to the lesser of $200 per day or 67% of the average daily self-employment income for the taxable year.
National Emergency Declaration
President Trump declared a national emergency under the Robert T. Stafford Disaster Relief and Emergency Assistance Act on March 13, 2020. The IRS thereafter issued Notice 2020-18, which delayed April 15th tax filing and payment deadlines until July 15th based on its authority to do so when there is a “federally declared disaster.” The IRS’s position that the President’s emergency declaration constitutes a federally declared disaster provides support for employers to provide certain benefits to employees impacted by COVID-19 in the form of “qualified disaster relief payments.” Under Section 139 of the Code, these payments will be tax-free to the employee, but fully deductible by the employer.
Section 139 allows for tax-free payments to reimburse or pay the employee for the expenses that are not otherwise compensated for by insurance that are (i) reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster, or (ii) reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence or repair or replacement of its contents to the extent that the need for such repair, rehabilitation, or replacement is attributable to a qualified disaster. Certain COVID-19 related expenses should clearly qualify as reimbursable expenses under Section 139 of the Code, such as
- Medical expenses not compensated for by insurance related to COVID-19, including co-pays and deductibles;
- Other health-related expenses including over-the-counter medication or hand sanitizer; and
- Funeral expenses of the employee’s family as a result of COVID-19.
In addition, absent future IRS guidance to the contrary, an employer should be able to make payments to employees to reimburse the following types of expenses related to COVID-19:
- Child care for workers whose normal source of child care is unavailable due to COVID-19;
- Tutoring expenses for employees’ children;
- Increased telecommuting costs such as computers, printers, or supplies;
- Any increased utility costs associated with the employee and his or her family being quarantined or otherwise confined to the home;
- Housing for additional family members; and
- Increased commuting costs related to the employee’s inability to commute via the usual means of transportation (e.g., using a personal car in lieu of public transit.)
Plan Design and Implementation
Section 139 payments may be made to all of a company’s employees, regardless of length of service. There is also no limitation on the amounts that can be paid to any individual employee or to all employees in the aggregate and be deductible to the employer. In addition, these payments are excluded from gross income and wages for payroll tax purposes and are not subject to information reporting on Forms W-2 or Forms 1099-MISC.
Although an employer does not need to adopt a formal written plan or policy, DGS recommends adopting a written program containing certain key aspects of the program. For example, a written program document will help ensure that the program is administered fairly and equitably to avoid potential claims of discrimination. Employers should also consider providing notice of the program to employees to ensure those in need of assistance are aware of its availability. Other aspects of a disaster relief program that an employer should consider adopting in a written plan include the following:
- Limiting the program to those affected by the current COVID-19 pandemic;
- The class of employees eligible under the program;
- Any aggregate or per-employee dollar limits on assistance;
- The types of expenses that will be reimbursed or paid;
- The process for employees to request assistance (e.g., written application, telephone, email);
- Identification of who will be granted the discretion to determine whether to pay a claim;
- The date, which may be retroactive, on which expenses will be eligible for reimbursement/payment; and
- The date by which claims must be submitted (e.g., 30 days following the end of the declared emergency).
Notice 2020-18 was released on March 20, 2020 and restated and expanded Notice 2020-17 that had been released two days earlier. These notices provided that for all taxpayers:
- The due date for filing U.S. federal income tax returns due April 15, 2020 is automatically postponed to July 15, 2020 without need for the taxpayers to file an extension.
- The due date for making U.S. federal income tax payments (including estimated income tax payments and payments of self-employment tax) due April 15, 2020 is automatically postponed to July 15, 2020.
- The period beginning on April 15, 2020 and ending on July 15, 2020 will be disregarded in the calculation of any interest, penalty, or addition to tax for failure to file any U.S. federal income tax return or pay any U.S. federal income tax postponed by Notice 2020-18. Interest, penalties, and additions to tax with respect to such tax return filings and payments will begin to accrue on July 16, 2020.