FML leadership shares insights that could affect how your business approaches this legislation
On March 27, 2020, President Trump signed into law the $2 trillion bipartisan Coronavirus Aid, Relief, and Economic Security (CARES) Act (H.R. 748).
The CARES Act includes many federal income tax relief provisions for business taxpayers and their owners. Some CARES Act changes interact with the very recently enacted 2017 Tax Cuts and Jobs Act (U.S. Tax Reform).
FML’s Justin Wilcox, Lisa Willauer and Bill Claffey have explored potential opportunities within the less publicized CARES Act business tax reliefs that can be claimed very soon through refund claims or amended tax returns.
Payroll Tax Benefits
- Employee Retention Credit
The CARES Act provides eligible employers with a refundable credit against payroll taxes. The credit is equal to 50% of qualified wages paid to employees (on the first $10,000 of wages for all calendar quarters). An employer is eligible if either of the following occur:
- An employer is eligible for a quarter in which operations are partially or fully suspended as a result of a government order related to COVID-19;
- An employer is eligible beginning in the first quarter in which gross receipts are less than 50% of the same quarter in the prior year (a significant decline in gross receipts). The eligibility ends in the first subsequent quarter in which gross receipts are greater than 80% of the same quarter in the prior year.
If an employer has more than 100 average full-time employees during 2019, the credit only relates to wages paid to employees who are not providing services during the eligibility period that applies.
For employers with less than 100 average full-time employees during 2019, the qualified wages will include all wages paid during the eligibility period that applies.
Companies should closely examine any federal or state government orders related to COVID-19 which would serve to qualify employers under the first broad “full/partial cessation” standard.
Interim financial accounting analysis will be imperative to accurately capturing the necessary gross receipts thresholds for the 50% start-of-eligibility and the 80% end-of-eligibility.
Employers with more than 100 full-time employees should consider how employee time will be tracked for purposes of the “not providing services” standard.
2. Payroll Tax Deferral
The CARES Act provides employers an opportunity to defer the payment of the 6.2% FICA tax (and half of the self-employment FICA Taxes for a Schedule C) for the employer’s payroll periods from March 27, 2020 through December 31, 2020. Deferred payroll taxes will be due over two years as follows:
- First 50% deferred is due on December 31, 2021
- Remaining 50% deferred is due December 31, 2022
The deferral provides much needed cash flow relief; however, taxpayers should be aware the deferred taxes will eventually be repaid, there is no forgiveness at this time.
1. Temporarily Remove Post-2017 80% NOL Limitation
Prior to the enactment of the CARES Act, a net operating loss carryforward arising in taxable years beginning after December 31, 2017 is limited when carried forward to an income year; limited to 80 percent of taxable income arising in the taxable income year. On the other hand, carryforwards attributable to losses that arose in tax years beginning before January 1, 2018 were not subject to the 80 percent limitation and could offset taxable income in a carryforward year in full.
As a result of the CARES Act, for carryforwards of net operating losses arising in a tax year beginning before January 1, 2021, a net operating loss carryover will be allowed in full against taxable income for that carryforward year.
FML’s Take: This CARES Act change removed the embedded minimum cash tax which would have otherwise applied to loss generating corporations who turned income positive in 2019 and may still be income positive in 2020. Taxpayers who claimed a limited net operating loss on a 2019 tax return filing (or 2018 short year with a limit from a prior 2018 year NOL) may need to amend their tax return for file or a refund claim. IRS guidance is expected to follow shortly.
2. Temporarily Re-institute Carrybacks and Technical Amendment to 2017/2018 Fiscal Years
Prior to the enactment of the CARES Act, the 2-year carryback period was removed for net operating losses generated in years ending after December 31, 2017; and all net operating losses generated in years ending after December 31, 2017 could be carried forward indefinitely. On the other hand, net operating losses arising in tax years ending before December 31, 2017 could be carried forward 20 years or carried back 2 years.
As a result of the CARES Act,
- Net operating loss arising in a taxable year beginning after December 31, 2017 and before January 1, 2021 may be carried back up to 5 prior tax years.
- However, a net operating loss carryback in the 2018-2020 period results in a deemed election not to apply the carryback to a Mandatory Repatriation (“toll charge”) inclusion in the carryback year, under Section 965(n). A taxpayer may alternatively elect to exclude Section 965 inclusion years from the carryback period.
- A technical correction permits corporations with a fiscal year beginning before December 31, 2018 and ending after December 31, 2017 to carry back a net operating loss generated in such year to the prior 2 taxable years under the pre-Tax Cuts and Jobs Act carryback provisions.
Taxpayers with 2018-2020 losses will have an opportunity to obtain refunds as far as 5 years back from the loss year. Taxpayers with 2018 and 2019 net operating losses on filed tax returns can pursue this opportunity now via refund claims or amended tax returns. IRS guidance is expected to follow shortly.
Note, corporations with Mandatory Repatriation income in 2017/2018 due to the “toll charge” will not be able to return their toll charge cash taxes via this carryback provision, preserving the NOL carryback to offset income taxed between 21% and 35% in the carryback years (Mandatory Repatriation income in 2017/2018 was taxed at lower rates between 8% and 15.5% for calendar year corporations).
Prior to the 2017 Tax Cuts and Jobs Act, interest-based losses from leveraged buyouts could not be carried back (“CERT limit”). However, the CERT limit was removed with the Tax Cut and Jobs Act. The CERT limitation does not appear to be re-instated with the CARES Act. Thus, companies with leveraged stock acquisition/redemption transactions occurring after December 31, 2017 may have more flexibility in obtaining refunds via NOL carryback vs. in the prior tax regime, due to not being subject to the pre-Tax Cuts and Jobs Act corporate equity reduction transaction limitation, but see the SRLY and Section 382 limitation that may apply to the use of these attributes in a carryback or carryforward period. We expect that regulations will develop to clarify the effect of statutory limitations to the 2018-2020 carrybacks.
In addition, fiscal year taxpayers with losses for their 2017 tax year ending in 2018 will now have the ability to file carryback claims to obtain refunds in tax years ending in 2016/2017, which will result in a refund of cash taxes paid in the pre-TCJA 34-35% tax bracket (vs. a carryforward to post-2017 years with a blended-or-21% bracket), resulting in rate arbitrage and an “unexpected” immediate cash infusion. Note, the Senate Finance Committee previously advised the IRS to allow this carryback claim via a letter to the IRS in the summer of 2018; however, as of recent, the IRS instructions for carrybacks only incorporated the law as written (with the typo). Now, the IRS will be expected to quickly permit the intended treatment for the carryback of 2017/2018 fiscal year losses.
Modifications to the Loss Limitation for Non-Corporate Taxpayers
Prior to the enactment of the CARES Act, non-corporate taxpayers were limited in the amount of net business losses that were claimed on post-2017 tax returns (which applied through 2025). An individual taxpayer could be limited with respect to their Schedule C or E (including K-1) losses. The limitation on the use of the net loss was $250,000 ($500,000 filing jointly), adjusted for inflation each year. As a result of the CARES Act, the excess loss limitation is delayed until tax years beginning after December 31, 2020.
This change is retroactive back to the 2017 Tax Cuts and Jobs Act. Taxpayers who filed 2018 or 2019 tax returns with excess loss limitations can explore the opportunity to amend their tax returns for a refund; or file a refund claim. IRS guidance is expected to follow shortly.
Modifications for Alternative Minimum Tax Refunds for C-Corporations
Prior to the CARES Act, due to the repeal of the corporate alternative minimum tax, pre-2018 alternative minimum tax credits of corporations were fully refundable over a period of time, starting in 2018 through 2021.
As a result of the CARES Act, the 2018 alternative minimum tax credit carryovers are fully refundable in 2019 (unless elected to be claimed in 2018).
Corporations with alternative minimum tax credit carryforwards who have already filed 2018 tax returns and have not yet filed 2019 tax returns have the option to claim the full refund on the 2019 tax filing, or file a refund claim with the IRS to receive the additional AMT tax credit refund on account of 2018. Taxpayers who have already filed their 2019 tax return may need to amend their return to claim an additional refund, or file a refund claim with the IRS to receive the additional AMT tax credit refund on account of 2019. IRS guidance is expected to follow shortly.
Modifications for Business Interest Expense Deduction Limitations
Prior to the CARES act, large business taxpayers ($25 million or more gross receipts adjusted for inflation) are subject to the Section 163(j) limitation, which caps their deduction for business interest expense. The expense cap is generally equal to 30% of tax basis Earnings Before Interest, Income Taxes, Depreciation, & Amortization (EBITDA, although state income tax deductions are permitted) plus business interest income. Beginning in 2022, Depreciation & Amortization are excluded as “add-backs” in calculating the limit.
As a result of the CARES Act, the limitation is increased from 30% to 50% for tax years beginning in 2019 and 2020. However, for partnerships, the change only applies in 2020, and partners will need to make special allocations pertaining to the 2019 change on their personal tax returns. Taxpayers may, however, elect out of the 50% limitation for 2019 and 2020 (only 2020 for partnerships).
In addition, taxpayers may choose to use the 2019 tax year for determining the adjusted taxable income limitation for 2020 (but still are required to use 2020 business interest in determining that component of the limitation). For partnerships and partners, this decision is made at the partnership level.
Taxpayers will have more cash tax savings with respect to their interest-based tax deductions based on 50% of their tax basis EBITDA (plus interest income). Taxpayers with a down 2020 year due to COVID will have some relief in using the 2019 tax basis EBITDA in re-figuring the 2020 Section 163(j) interest limitation. IRS guidance is expected to follow shortly. Some taxpayers who have already filed their 2019 tax filing and were subject to the 163(j) limitation at the 30% regime may need to evaluate amending the tax filings on account of the increased 50% limitation. IRS guidance is expected to follow shortly.
Modifications for Qualified Improvement Property Placed in Service after December 31, 2017
Prior to the CARES Act, due to a typo in the 2017 Tax Cuts and Jobs Act, a taxpayer’s qualified improvements placed in service after December 31, 2017 were treated as depreciable on a straight-line basis over a 39-year period and ineligible for 100% bonus depreciation.
As a result of the CARES act, the treatment of qualified improvement property is fixed retroactive to January 1, 2018, to treat such property as eligible for 100% bonus depreciation (a 100% “bonus rate” through 2022, then this rate declines) and subject to a 15-year recovery period.
Taxpayers who have previously treated post-2017 improvements as 39-year non-bonus property without bonus depreciation should consider the need to either amend prior year tax filings or file an accounting method change(s) in their next unfiled year. IRS guidance is expected to follow shortly.
Note, the Senate Finance Committee previously advised the IRS to permit taxpayers to treat post-2017 qualified improvement property as eligible for bonus depreciation and subject to the 15-year recovery period. Thus, some taxpayers who have taken bonus depreciation and 15-year recovery periods on post-2017 improvements have no further action required related to this change, as their originally filed tax return(s) reflected the intended tax treatment under the 2017 Act.
2020 Charitable Contributions
Prior to the CARES Act, individual charitable contribution deductions (which can be passed through on LLC/S-Corporation K-1s) are subject to a 50% of adjusted-gross-income limitation, and corporate charitable contribution deductions are subject to a 10% of taxable income limitation.
As a result of the CARES Act, individual cash charitable contribution deductions are not capped by adjusted gross income for the 2020 tax year. In addition, corporate cash charitable contribution limitations are capped at 25% of taxable income for the 2020 tax year.
Taxpayers with contributions over a period of years may consider whether it would be more beneficial to accelerate post-2020 contributions into 2020.
There are many compliance driven tax relief provisions that can be quickly put into action for cash tax refunds or reductions of estimated tax payments. FML will stay on top of emerging IRS guidance in the coming weeks and months to execute on these benefits for our clients.