The U.S. Congress has enacted several significant pieces of legislation over the last few weeks. First, the Coronavirus Preparedness and Response Supplemental Appropriations Act was signed into law by President Trump on March 6, 2020. Second, the Families First Coronavirus Act, was signed into law on March 18, 2020. The Polsinelli Tax Team recently summarized the tax impact of these two laws.
Most recently, on March 25, 2020, the Senate unanimously passed “phase III” of the relief program, which is known as the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”). The bill was passed in the House the morning March 27, 2020, and was quickly signed by President Trump in the afternoon of March 27, 2020. The CARES Act is estimated to cost $2.2 trillion dollars and contains numerous tax provisions aimed to benefit both individuals and businesses.
This update provides a summary of the relevant tax sections contained in the CARES Act. In this e-alert we also include a discussion of the possible use of a special code section addressing disaster relief payments as a tool for employers and provide a brief summary of how state legislatures are responding to various tax deadlines.
Employer Tax Credit Availability. A tax credit against employment taxes is available for certain businesses. An employer is eligible for this credit if the operation of the trade or business is fully or partially suspended during the calendar quarter fully or partially suspended due to orders of a governmental authority that limited commerce, travel or group meetings. An employer is also eligible for this credit in the first calendar quarter in which the employer has a reduction of gross receipts of more than 50% in a calendar quarter as compared to the same calendar quarter in the prior year, and eligibility for the credit continues in each calendar quarter as long as the employer has a reduction of gross receipts of more than 80% reduction of gross receipts from the calendar quarter in the prior year.
The amount of the tax credit is 50% of the qualifying wages of the employer. In general terms, qualifying wages for each employee are limited to $10,000 for all quarters and wages paid to certain employees are subject to additional limitation or exclusions. In addition, the credit is not available if the employer is a borrower under the Payroll Protection Loan Program described below. Further, the amount of the credit is reduced by any credits allowed under Section 7001 or 7003 of the Families First Coronavirus Relief Act (i.e., the sick leave and family leave credits).
Delay of Payment of Employer Payroll Taxes. Employers are responsible for paying a 6.2% Social Security tax on employee wages. From the time the CARES Act is signed into law through December 31, 2020, many employers will be allowed to defer paying their share of this Social Security tax. Half of this deferred amount would be due on December 31, 2021 and the other half by December 31, 2022. Similar provisions apply to self-employed individuals, however, 50% of the self-employment tax still needs to be remitted on the existing deadlines.
Modification of Net Operating Losses (“NOLs”). The Tax Cuts and Jobs Act (the “TCJA”), which was enacted in 2017, eliminated net operating loss carrybacks for certain years (which generally included NOLs arising after 2017. Under the TCJA, NOLs arising after 2017 could be carried forward indefinitely, but were limited to 80% of taxable income in the relevant period. These rules were changed by the CARES Act to allow NOLs arising in tax years 2018, 2019 and 2020 to be carried back five years. In addition, the 80% limitation created by the TCJA has been eliminated for tax years beginning before January 1, 2021.
Taxpayers will be able to amend tax returns for the applicable years to claim refunds arising from the use of these NOLs. Amended returns seeking refunds for earlier years must be filed by the due date, including extensions, of the taxpayers return for the first taxable year ending after the enactment of the CARE Act. Thus, calendar year taxpayers have until March 15, 2021 (or September 15, 2021 if the return due date is extended) to file refund claims. Note that there are special provisions for REITs (denying carrybacks for any year the REIT was a REIT) and for companies that recognize foreign income under the “Subpart F” rules of the Code.
Taxpayers seeking to carry back 2020 losses to earlier years will have to wait until their 2020 returns are filed, which may not be until late January or early February, 2021, to apply for a refund for prior years related to a 2020 NOL. Nonetheless, these NOL carryback rules provide opportunities for businesses to retool and prepare for the recovery. For example, businesses can purchase needed equipment and machinery in 2020 and claim a deduction for the cost of these items under the existing “bonus depreciation” rules. Similarly, in connection with an acquisition of developed real estate, the real estate owner can increase deductions available under the bonus depreciation rules by doing a cost segregation study to identify the property eligible for this bonus depreciation treatment. In either case, if the increased deductions arising from bonus depreciation creates an NOL in 2020, it can be applied to a prior year so that a refund can be claimed.
Modification of Limitation on Losses for Non-Corporate Taxpayers. The TCJA added Section 461(I) to the Code, which limited non-corporate taxpayers’ (individuals, trusts, estates) ability to deduct excess business losses. Excess business losses are defined basically as the excess of aggregate business gross deductions over aggregate business gross income. Deduction of these excess business losses by non-corporate taxpayer’s was limited to $250,000 per year ($500,000 married filing jointly). Unused excess business losses are carried forward as NOLs. These limitations continue through the 2026 tax years. The new provision delays the application of the excess business loss limitation until 2021. Non-corporate taxpayers may be able to deduct all excess business losses created through the end of the 2020 tax year. Taxpayers with losses in 2018 and 2019 that were disallowed by the limitation may file for refunds.
This is potentially a very significant benefit to many business. For example, individuals in the real estate business may be able to deduct large losses arising from the 100% bonus depreciation provision in the TCJA (as well as other losses) that would otherwise be limited. This may be especially valuable to individuals who qualify as “real estate professionals,” generally by spending at least half their time (and at least 750 hours) materially participating in real estate businesses. However, based on what we know so far, the new provision does not override the passive loss and at-risk limitations, so the provision may be less favorable for passive investors.
Acceleration of Refundable Alternative Minimum Tax Credit. The CARES Act expands the ability of companies to claim refundable AMT tax credits and obtain additional cash flow during the COVID-19 emergency. The TCJA previously repealed the Alternative Minimum Tax (“AMT”) for corporate taxpayers effective for tax years beginning after December 31, 2017. However, it allowed taxpayers to claim refundable AMT credits over the period 2018-2021. The Cares Act accelerates the allowance of refundable AMT tax credits to tax years 2018-2019 and provides for expedited refund procedures designed to allow corporations to obtain additional cash flow.
Relaxation of Limitations on Business Interest Expense Deduction. The CARES Act temporarily increases the amount of interest expense businesses are allowed to deduct on their tax returns, by increasing the adjusted taxable income limitation from 30% to 50% for 2019 and 2020. The TCJA previously limited the deduction for business interest for taxpayers with average gross receipts of $25,000,000 or more to 30% of the taxpayer's adjusted taxable income for tax years beginning in 2018. In addition, the CARES Act allows a taxpayer to elect to treat its 2020 adjusted income as if it were the same amount as its 2019 adjusted taxable income for purposes of applying the interest expense limitation. This may be a significant benefit to some taxpayers and may create additional NOL’s in 2020, which could be carried back to previous tax years under the net operating loss modifications addressed above.
Technical Amendment Regarding Qualified Improvement Property. The TCJA included a drafting error that required so-called “qualified improvement property” to be depreciated over the same 39 years as the building itself. Under the TCJA, qualified improvement property is defined to include interior improvements to nonresidential property which is placed in service after the building itself is placed in service. Improvements to the structure of the building and elevators and escalators are excluded from the definition of qualified improvement property. The intent of the TCJA was to allow qualified improvement property to be depreciated as personal property, generally over 5-15 years, and to be eligible for bonus depreciation. However, the drafting error precluded this. Thus, under the TCJA as drafted, qualified improvement property had to be depreciated over 39 years and was not eligible for bonus depreciation.
This CARES Act eliminated this drafting error and taxpayers are now allowed to claim bonus deprecation for the costs associated with improving facilities instead of having to depreciate those improvements over the 39-year life of the building. Further, this provision states that taxpayers may treat the change in law as if it was always in the law. This means that the change applies to 2018 and 2019. Accordingly, taxpayers should analyze their depreciation schedules to determine whether they should file amended returns to claim additional deductions under the bonus depreciation rules for improvements made to their facilities in these prior years.
Expansion of Eligibility for SBA Loans. Under the so-called “paycheck protection program” eligible employers, self-employed individuals, charitable organization and Tribal businesses are eligible to borrow SBA-backed loans to fund payroll expenses, healthcare benefits, rent, utilities and other designated operating costs. Loans obtained under this program can have up to a 10-year term and must have an interest rate of less than 4%. Unlike other types of SBA loans, loans made under the paycheck protection program will be non-recourse.
The amount of the loan is subject to a limitation that is based on the product of average monthly payroll costs of the borrower for the one-year period prior to the making of the loan multiplied by 2.5. Certain payroll costs are excluded from this calculation, such as payments of salaries in excess of $100,000 and payments covered under the Families First Coronavirus Relief Act.
The period to apply for a payroll protection loan ends on June 30. Among the conditions for obtaining a payroll protection loan, the borrower must be unable to obtain credit from another source and that the borrower covenant to the lender that the borrower will use the borrowed funds solely to maintain payroll, make rent or mortgage payments or pay other designated expenses.
Air Travel Excise Tax Relief. Certain excises taxes that are imposed under Code Section 4261 (passenger travel) and Code Section 4171 (transportation of goods by air) are waived if the purchase of such travel occurs after the date of enactment of the CARES Act and travel occurs prior to January 1, 2021. In addition, the excise tax that applies to the use of kerosene in commercial aviation is waived until January 1, 2021.
Employer Student Loan Payments. Employers are allowed to provide a limited student loan repayment benefit to its employees on a tax-free basis. Specifically, employers may contribute up to $5,250 annually to each employee on a tax-free basis. The annual limitation applies to both the new student loan repayment benefit as well as other educational assistance provided by the employer under current law (ex. tuition, fees, books, etc.). The provision applies to student loan payments made after the enactment date and before January 1, 2021.
Recovery Rebate Checks. Recovery rebate checks of up to $1,200 ($2,400 for taxpayers married filing jointly) will be made available to most individuals and families, with an additional $500 for every child. There are no limits on the number of children that qualify. These recovery rebate checks are reduced by $5 for each $100 a taxpayer’s income exceeds $75,000 ($150,000 for taxpayers married filing jointly and $112,500 for head of household). This means that taxpayers making below $99,000 ($198,000 for taxpayers married filing jointly) will generally receive at least some amount of a recovery rebate check.
The complete phase out of the recovery rebate check is dependent on each taxpayer’s filing status, adjusted gross income in the applicable tax year, and the number of children claimed by the taxpayer. In general, the rebate checks will be based on a taxpayer’s 2020 taxable income. Since nobody knows those amounts yet, these new rules provide that qualifying income levels can be tentatively based on the taxpayer’s most recently filed tax return (either 2019 or 2018). Certain taxpayers that are not required to file a tax return, such as when receiving Social Security benefits, are still eligible for the recovery rebate checks. Instead of using a tax return the government can use information from the Social Security Information.
The refund checks are generally not taxable income and are instead treated as an advance of the refund a taxpayer would normally receive when filing their 2020 tax return. This means that in 2021 the taxpayer will have to recalculate the amount of their credit based on their 2020 information. If there is a change in circumstances for the taxpayer where they are currently phased out based on a 2019 (or 2018) tax return, but would otherwise be entitled to the full credit based on their 2020 tax return, the taxpayer will receive a credit in 2020 for the difference.
An open issue in this piece of legislation is what happens to those taxpayers who receive a rebate check based on 2019 (or 2018) tax information but would have received a lesser amount based on their 2020 income. The CARES Act does not explicitly require income recognition on any excess credit (which was required in the House’s bill). We anticipate that future regulations may address this issue.
Special Rules for Use of Retirement Funds. The CARES Act provides some retirement account relief for coronavirus related distributions. First, the 10% early withdrawal penalty from qualified retirement accounts is waived for distributions of up to $100,000 if a withdrawal from a retirement account is for a coronavirus-related distribution. A “coronavirus-related distribution” is defined as a distribution made to an individual: (1) who is diagnosed with COVID-19, (2) whose spouse or dependent is diagnosed with COVID-19, or (3) who experiences adverse financial consequences as a result of being quarantined, furloughed, laid off, having work hours reduced, being unable to work due to lack of child care due to COVID-19, closing or reducing hours of a business owned or operated by the individual due to COVID-19, or other factors as determined by the Treasury Secretary.
In addition, the time period in which to pay the income tax attributable to a coronavirus related distribution is extended to allow for payments of this tax over three years. Taxpayers may re-contribute the funds withdrawn for a coronavirus-related distribution within three years without regard to that year’s cap on contributions. Provisions that provide for increased loans from certain retirement plans are also revised so there may be some circumstances in which pursuing one of the loan options may provide for a way to minimize the tax costs from what would otherwise be a coronavirus-related distribution.
The Act also waives the required minimum distribution rules for certain defined contribution plans and IRAs for calendar year 2020. This provision provides relief to individuals who would otherwise be required to withdraw funds from such retirement accounts.
Treatment of Charitable Deductions. Generally, taxpayers must itemize their deductions to take advantage of charitable deductions. This itemized deduction requirement is eliminated for charitable deductions of up to $300 for most contributions for the 2020 tax year. Note that not all charitable deductions are eligible for this treatment. Specifically, charitable contributions made to a private foundation or donor-advised fund, are not eligible for the above-the-line charitable deduction.
In addition, the limitation that applies to the amount of a charitable deduction that can be claimed by individual taxpayers is based on a percentage of the individual taxpayer’s adjusted gross income is also eliminated for 2020.
COVID-19 and Disaster Relief Payments
Code Section 139 was enacted in 2002 as a response to the attacks on September 11, 2001. The primary purpose of Code Section 139 is to allow employers to make “qualified disaster relief payments” to its employees in a manner that is tax-free to the employee but deductible to the employer.
In general, Code Section 139 is triggered when the employer makes payments that are designated as “qualified disaster relief payments” which generally include any amount paid to or for the benefit of an individual to reimburse or pay reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a “qualified disaster” to the extent the expense is not covered by insurance or is otherwise reimbursable. Recently, the IRS issued Notice 2020-18 which appears to indicate that the shelter in place orders and other governmental actions taken in respect of COVID-19 meets the definition of a qualified disaster for purposes of Code Section 139.
Code Section 139 treatment does not apply to all payments made by an employer. Generally, if a payment is made to replace lost income (such as payments for sick leave or family medical leave) it is not eligible for Code Section 139 treatment. In contrast, payments made by an employer to help an employee pay expenses related to rent, groceries, and other household expenses that are attributed to the COVID-19 pandemic (and are not otherwise covered by insurance) may qualify.
We note that Code Section 139 has never been used for a national pandemic and, historically it has only been used for local disasters, such as hurricanes, floods, and tornadoes. We are continuing to examine the availability of Code Section 139 as an opportunity for employers to make “qualified disaster relief payments” to their employees in a manner that is tax-free to the employee but deductible to the employer and will issue a separate “client alert” once this analysis is complete.
State Legislative Actions (as of 3/25/2020)
Most states have extended their income tax payment and/or filing deadlines for the 2019 tax period, with 32 states and the District of Columbia matching the July 15 federal deadline. Of states which impose a tax on wage income, only Illinois, Maine, Massachusetts, Michigan, Ohio, and West Virginia have yet to delay either filing or payment deadlines or both. In addition to extending income tax filing deadlines, many states have announced extensions for the payment and/or filing of other major taxes—including sales and use taxes, property taxes, franchise taxes, and alcoholic beverage taxes—as well as smaller taxes and fees that would otherwise be due this spring. At least 13 states and the District of Columbia have announced extended deadlines for major taxes besides income taxes, including Alabama, Connecticut, Idaho, Illinois, Iowa, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Vermont, Virginia and Washington.