Updated: May 5, 2020
Loans, Tax Credits, & Tax Implications: Coronavirus Aid, Relief, and Economic Security Act (CARES Act), Public Law 116-136, 134 Stat. 281, 286-93 (March 27, 2020)
Enacted on March 27, 2020 the Coronavirus Aid, Relief & Economic Security Act (“CARES Act”) contains several important tax provisions (and potentially forgivable) loan benefits for businesses and individuals to expand business access to capital.
In general, as stimulus support during COVID-19, borrowers may apply for different types of Small Business Administration (SBA) loans, either administered directly through the SBA or through permitted third-party lenders. Although limited funds are available, there are several limitations with claiming the Paycheck Protection Program (PPP) loans and other tax benefits available under the CARES Act.
For example, by combining the [refundable against payroll taxes] Employee Retention Credit with the Payroll Tax Deferral under the CARES Act, employers may reduce (or receive a cash refund) their 2020’s Social Security tax and defer the remaining balance due to 2021 and 2022, subject to further guidance by the IRS and/or U.S. Treasury Department. Although the payroll deferral under the CARES Act is essentially an interest free loan, the amount payroll taxes incurred will still need to be paid in the near future.
However, employers must decide which relief program they qualify (e.g. PPP loan forgiveness v. Employee Retention refundable payroll tax credits) and intend to use because utilization of loan forgiveness options under the CARES Act may then disqualify the use of the both the Payroll Deferral and Employee Retention Programs to that specific taxpayer seeking financial support.
Regardless of whether your business pursues PPP loan forgiveness or Employee Retention Credits, taxpayers should also strongly consider whether their business is eligible (e.g. less than $5M in gross receipts) for up to $250,000 per year in R&D tax credit payroll offset opportunities as an immediate and supplemental cash saving opportunity in addition to claiming either the CARES Act PPP or Employee Retention Credit stimulus support. Taxpayers and recently formed businesses across all industries may qualify for the R&D credit.
Subject to further guidance by the IRS and/or U.S. Treasury, if your business does qualify for the R&D tax credit payroll offset, one potential tax strategy to maximize your cash flow in the short-term may include (1) maximizing and claiming R&D tax credits (non-refundable) against your business payroll taxes, then (2) applying the Employee Retention Credits (up to $5,000 refundable per employee) to eliminate any remaining payroll liability (which may even turn into a cash refund) to maximize both R&D and Employee Retention credits simultaneously.
Contact AndreTaxCo to learn more about the R&D tax credit, timing requirements for payroll offset election on original returns only, credit utilization, and other tax incentives to help you and your business in addition to the stimulus options under the CARES Act.
Another consideration to note, the IRS recently published Notice 2020-32 which clarifies the following regarding the tax impact to loan recipients under the CARES Act:
(1) No deduction is allowed under the Internal Revenue Code (Code) for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan pursuant to section 1106(b) of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), Public Law 116-136, 134 Stat. 281, 286-93 (March 27, 2020). See also IRC § 265(a)(1); Treas. Reg. § 1.265-1 (prevents a double tax benefit regarding a “class of exempt income”); and
(2) Income associated with the forgiveness is excluded from gross income for purposes of the Code pursuant to section 1106(i) of the CARES Act. Forgiven amounts will not constitute cancellation of indebtedness income for federal tax purposes.
As further background, here are some of the key provisions (see summary list & specific subsections below) for individuals & businesses, summary benefits, and criteria for qualification provided or expanded under the CARES Act. However, be aware that additional rules and restrictions may apply.
Governmental Funding & Relief include the following:
Paycheck Protection Program (PPP) ~ up to $10M forgivable;
Economic Injury Disaster Loan (EIDL) Emergency Advance ~ $10K forgivable;
Small Business Administration (SBA) Express Bridge Loans ~ up to $25,000 for disaster-related purposes;
SBA Debt Relief ~ SBA will pay 6 months of principal, interest, and associated fees for specified borrowers (excluding PPP or EIDL borrowers); and
Additional Debt Relief ~ SBA Serviced Disaster (Home and Business) Loans automatic deferments through December 31, 2020
Notable Business Tax Provisions include the following creations and/or modifications:
[New] Employee Retention Credit ~ up to $5,000 in refundable payroll credits per eligible employee;
Delayed Payment of Certain Employer Payroll Taxes;
Increase in the Section 163(j) Interest Expense Limitation ~ deduction increased from 30% to 50%;
Modifications to the Net Operating Loss Rules ~ temporary 5 year carryback & 80% limitation pause until 2021; and
Modifications to the 2017 Tax Cuts and Jobs Act (TCJA) - e.g. allow businesses to immediately expense certain qualified improved property (QIP).
For Individuals, the CARES Act also creates the following:
Economic Impact Payments (e.g. $1,200 advance rebate) for 2020;
Expands the Charitable Deduction;
Relaxes Certain Rules Relating to Retirement Accounts; and
Exclusion for Certain Employer Payments of Student Loans.
Governmental Funding & Relief Options
In addition to traditional SBA funding programs, the CARES Act established several new temporary programs to address the COVID-19 outbreak as further outlined below.
*SBA Notice: PPP Resumed April 27, 2020
Note, the SBA has publicly announced resumed accepting Paycheck Protection Program applications from participating lenders on Monday, April 27, 2020 at 10:30am EDT. However, due to the limitation of funds available, and prior applications in the queue, it may be difficult for any new applications to receive funding approval.
The Paycheck Protection Program was established by Sec. 1102 of the CARES Act. The PPP was initially administrated as a $349 billion loan program (and since recently infused with additional stimulus) by the Small Business Administration (SBA) intended to help U.S. employers keep workers on their payrolls.
Pursuant to Sec. 1102 under the CARES Act, the PPP generally applies to taxpayers who have fewer than 500 employees (full or part-time) regarding potential qualification.
However, taxpayers with “small business concerns” (as defined in section 3 of the Small Business Act, 15 U.S.C. 632) can be eligible borrowers even if they have more than 500 employees, as long as they satisfy the existing statutory and regulatory definition of a “small business concern” under section 3 of the Small Business Act, 15 U.S.C. 632. A business can qualify if it meets the SBA employee-based or revenue-based size standard corresponding to its primary industry. See www.sba.gov/size for the industry size standards. See also U.S. Treasury “PAYCHECK PROTECTION PROGRAM LOANS Frequently Asked Questions (FAQs)” (April 29, 2020).
PPP loans can be as large as $10 million. However, most organizations will receive smaller amounts (e.g. generally a maximum of 2.5 times their average monthly payroll costs).
In general, eligible entities for the PPP may include the following:
Businesses and entities that were in operation on February 15, 2020
Small businesses, 501(c)(3) nonprofit organizations, 501(c)(19) veterans organization, or Tribal businesses that have fewer than 500 employees, or the applicable size standard in number of employees for the North American Industry Classification System (NAICS) industry as provided by SBA, if higher
Individuals who operate a sole proprietorship or as an independent contractor and eligible self-employed individuals
Any business concern that employs not more than 500 employees per physical location of the business concern and that is assigned a NAICS code beginning with 72 (Hotels and Restaurants), for which the affiliation rules are waived
Affiliation rules are also waived for any business concern operating as a franchise that is assigned a franchise identifier code by the Administration, and company that receives funding through a Small Business Investment Company
PPP loans may be forgiven, so long as you follow the specified rules. Under section 1106(b) of the CARES Act, a recipient of a covered loan may receive forgiveness of indebtedness on the loan regarding payments made for the following expenses during the 8-week “covered period” beginning on the covered loan’s origination date:
(1) Payroll Costs;
Compensation (salary, wage, commission, or similar compensation, payment of cash tip or equivalent); Payment for vacation, parental, family, medical, or sick leave; Allowance for dismissal or separation; Group health care benefits, including insurance premiums; Retirement benefits; State or local tax assessed on the compensation of employees.
Employee/owner compensation in excess of $100,000. However, the exclusion of compensation in excess of $100,000 annually applies only to cash compensation, not to non-cash benefits, including: (1) employer contributions to defined-benefit or defined-contribution retirement plans; (2) payment for the provision of employee benefits consisting of group health care (3) coverage, including insurance premiums; and (4) payment of state and local taxes assessed on compensation of employees.
Taxes imposed or withheld under chapters 21, 22, and 24 of the IRS code
Compensation of employees whose principal place of residence is outside of the U.S.
Qualified sick and family leave for which a credit is allowed under sections 7001 and 7003 of the Families First Coronavirus Response Act (Public Law 116–127).
(2) Interest on Mortgage (or other existing debt) Obligations (incurred before the "Covered Period");
E.g. payments of interest on any mortgage obligation but excluding any prepayments or payments of principal
(3) Rent (including rent under a lease agreement); and
However, section 1106(d) of the CARES Act provides that the amount of the covered loan forgiveness is reduced if, during the covered period:
(1) the average number of full-time equivalent employees of the recipient is reduced as compared to the number of full-time employees in a specified base period (period from either February 15, 2019, through June 30, 2019, or January 1, 2020, through February 29, 2020, as selected by the borrower), or
(2) the salary or wages for any individual making less than $100,000 per year is reduced by more than 25% as compared to against the most recent full quarter before the covered period. Reductions in the number of employees or compensation occurring between February 15, 2020, and 30 days after enactment of the CARES Act will generally be ignored to the extent that reductions are reversed by June 30, 2020.
In addition, pursuant to an interim final rule issued by the Small Business Administration, no more than 25% of the amount forgiven can be attributable to non-payroll costs. See Q&A 2.o. in Part III of the interim final rule, Business Loan Program Temporary Changes; Paycheck Protection Program, Docket No. SBA-2020-0015, 85 Fed. Reg. 20811, 20813-20814 (April 15, 2020).
*Notice: Lapse in Appropriations
As of May 1, 2020, the SBA COVID-19 website publication states the “SBA is unable to accept new applications at this time for the Economic Injury Disaster Loan (EIDL)-COVID-19 related assistance program (including EIDL Advances) based on available appropriations funding. However, applicants who have already submitted their applications will continue to be processed on a first-come, first-served basis."
The CARES Act contains provisions related to SBA’s existing Economic Injury Disaster Loan program. The program operates pursuant to Section 7(b) of the Small Business Act and provides low-interest (i.e. 3.75% for small businesses, 2.75% for nonprofits) long-term loans to small businesses located in areas that SBA has declared to be geographic disaster zones.
Small businesses can apply for up to $2 million in 7(b) Disaster Loans if they are located within the geographic disaster zones.
Although the maximum loan size is $2 million, applicants who apply for this loan may request an expedited advance (e.g. distributed within 3 days) of up to $10,000 from the SBA. This loan advance may be forgivable and provide up to $10,000 of economic relief to businesses that are currently experiencing temporary difficulties or temporary loss of revenue.
Small business owners in all U.S. states, Washington D.C., and territories are eligible to apply for an Economic Injury Disaster Loan in response to the COVID-19 pandemic.
In general, the EIDL loan may be used for financial obligations and operating expenses that could have been met had the disaster not occurred. For example, Section 7(b) Disaster Loans may be used to pay fixed debts, payroll, accounts payable and other costs, but are not intended to replace lost sales or profits and cannot be used for certain purposes, including to refinance debt, make payments on loans owed by another federal agency, to pay tax penalty obligations, repair physical damages, or to pay dividends to stockholders. These Disaster Loans also offer long-term repayments in order to keep payments affordable, up to a maximum of 30 years. Terms are determined on a case-by-case basis, based upon each borrower’s ability to repay.
Key changes to the EIDL from the CARES Act include:
Section 1110 of the CARES Act provides that SBA Disaster Loans will be available until December 31, 2020. (Note that the “covered period” for the Section 7(a) loans described above runs only until June 30, 2020.)
CARES Act similarly changes the definition of “small business,” for the purposes of a Disaster Loan, to include a company with no more than 500 employees, but does not waive the affiliation rules for Sector 72.
CARES Act also waives the personal guaranty requirement and the requirement for applicants to demonstrate that they are unable to obtain credit from other sources.
CARES Act provides for a $10,000 emergency advance (within three days of submitting an application) while an applicant’s loan application is pending, which SBA will not require to be repaid. However, the Act provides that an applicant may receive this advance while still applying for a Section 7(a) loan described above and that, if the applicant later receives a 7(a) loan, the amount of the advance will “be reduced from the loan forgiveness amount for a loan for payroll costs.”
(1) Any small business affected by COVID-19 with less than 500 employees
Including sole-proprietors, independent contractors and self-employed persons;
Cooperative with not more than 500 employees;
An Employee Stock Ownership Plan (ESOP), as defined in 15 U.S.C. 632, with not more than 500 employees;
A tribal small business concern, as described in 15 U.S.C. 657a(b)(2)(C), with not more than 500 employees;
501(c)(19) veterans organizations;
An agricultural cooperative, aquaculture enterprise, nursery, or producer cooperative, that is small under SBA Size Standards;
A private non-profit organization that is a non-governmental agency or entity that currently has an effective ruling letter from the IRS granting tax exemption under sections 501(c),(d), or (e) of the Internal Revenue Code of 1954, or satisfactory evidence from the State that the non-revenue producing organization or entity is a non-profit one organized or doing business under State law, or a faith-based organization
(2) Businesses in certain industries may have more than 500 employees if they meet the SBA’s size standards for those industries.
Affiliation rules may apply when the SBA is deciding whether a business’s affiliations preclude them from being considered “small.” Generally, affiliation exists when one business controls or has the power to control another or when a third party (or parties) controls or has the power to control both businesses.
Pursuant to its authority under the Small Business Act, the U.S. Small Business Administration (“SBA” or the “Agency”) provides direct loan assistance to small businesses located in communities impacted by Presidential-declared disasters and disasters declared by SBA under its own authority.
The EBL Pilot Program, announced by publication of a notice in the Federal Register on October 16, 2017 (82 FR 47958), is designed to supplement the Agency’s direct disaster loan capabilities. As originally announced, the EBL Pilot Program authorizes SBA Express Lenders to provide expedited SBA-guaranteed bridge loan financing on an emergency basis in amounts up to $25,000 for disaster-related purposes to small businesses located in communities affected by Presidential-declared disasters while those small businesses apply for and await long-term financing (including through SBA’s direct Disaster Loan Program, if eligible).
Effective March 25, 2020, SBA expanded program eligibility to include small businesses nationwide adversely impacted under the Coronavirus Disease (COVID-19) Emergency Declaration issued by President Trump on March 13, 2020 (“COVID-19 Emergency Declaration”). Because the COVID-19 Emergency Declaration covers all states, territories, and the District of Columbia, eligible small businesses under the EBL Pilot Program include small businesses located in any state, territory and the District of Columbia that have been adversely impacted by the COVID-19 emergency. This notice also stated that all references to disasters in the EBL Pilot Program requirements will include the COVID-19 emergency. In the same notice, SBA extended the term of the EBL Pilot Program through March 13, 2021.
EBL loans can only be made up to six months after the date of an applicable Presidential Disaster Declaration. For the COVID-19 Emergency Declaration, EBL loans can be approved through March 13, 2021.
In general, the SBA Express Bridge Loans enable small businesses who currently have a business relationship with an SBA Express Lender to access up to $25,000 quickly as support during the COVID-19 economic disaster. This pilot program allows SBA Express Lenders authority to deliver expedited SBA-guaranteed financing on an emergency basis for disaster-related purposes to eligible small businesses, while the small businesses apply for and await long-term financing (e.g. SBA Economic Injury Disaster loan).
General Terms & Background:
Up to $25,000
Will be repaid in full or in part by proceeds from the EIDL loan
In support of coronavirus debt relief efforts, the SBA will pay 6 months of principal, interest, and any associated fees that borrowers owe for all current 7(a), 504, and Microloans in regular servicing status as well as new 7(a), 504, and Microloans disbursed prior to September 27, 2020.
However, this relief is NOT available for Paycheck Protection Program (PPP) loans or Economic Injury Disaster loans (EIDL). In general, borrowers do not need to apply for this assistance. It will be automatically provided as follows:
For loans not on deferment, SBA will begin making payments with the next payment due on the loan and will make six monthly payments.
For loans currently on deferment, SBA will begin making payments with the next payment due after the deferment period has ended and will make six monthly payments.
For loans made after March 27, 2020 and fully disbursed prior to September 27, 2020, SBA will begin making payments with the first payment due on the loan and will make six monthly payments.
SBA has notified 7(a), 504 and Microloan Lenders that it will pay these borrower loan payments. Lenders have been instructed to refrain from collecting loan payments from borrowers. If a borrower's payment was collected after March 27, 2020, lenders were instructed to inform the borrower that they have the option of having the loan payment returned by the lender or applying the loan payment to further reduce the loan balance after SBA's payment.
For current SBA Serviced Disaster (Home and Business) Loans: If your disaster loan was in “regular servicing” status on March 1, 2020, the SBA is providing automatic deferments through December 31, 2020.
What does an “automatic deferral” mean to borrowers?
Interest will continue to accrue on the loan.
1201 monthly payment notices will continue to be mailed out which will reflect the loan is deferred and no payment is due.
The deferment will NOT cancel any established Preauthorized Debit (PAD) or recurring payments on your loan. Borrowers that have established a PAD through Pay.Gov or an OnLine Bill Pay Service are responsible for canceling these recurring payments. Borrowers that had SBA establish a PAD through Pay.gov will have to contact their SBA servicing office to cancel the PAD.
Borrowers preferring to continue making regular payments during the deferment period may continue remitting payments during the deferment period. SBA will apply those payments normally as if there was no deferment.
After this automatic deferment period, borrowers will be required to resume making regular principal and interest payments. Borrowers that cancelled recurring payments will need to reestablish the recurring payment.
Notable Business Tax Provisions
The CARES Act rolls back several provisions of the Tax Cuts and Jobs Act (TCJA) to help improve cash flow for businesses during the COVID-19 crisis. For example, the CARES Act temporarily scales back TCJA deduction limitations and provides tax credit opportunities as listed below.
For businesses forced to close or experience a significant economic decrease during the pandemic, CARES Act (Section 2301) creates a new employee retention credit (the Retention Credit) for wages paid from March 13, 2020 to December 31, 2020. “Eligible employers” are allowed a refundable credit against employment taxes equal to 50% of qualified wages, up to $10,000 for each employee (i.e. $5,000 maximum per employee).
Tax exempt organizations under 501(c) of the Internal Revenue Code may also receive relief under the Retention Credit Program within the same criteria described below. However, governmental employers and any employer that receives a Paycheck Protection Program loan (Sec. 1102) are NOT eligible for the Employee Retention Credit (Sec. 2301(j)).
The Employee Retention Credit applies to:
The employer's share of Social Security tax under IRC Section 3111(a) (6.2% of wages)
The portion of the employer's and employee representative's share of RRTA tax under IRC Sections 3211(a) and 3221(a) that corresponds to the 6.2% Social Security tax rate
The credit is calculated on a quarterly basis. Under Section 2301(b)(3), if the Employee Retention Credit exceeds the employer's Social Security or RRTA tax liability for the quarter, the excess will be treated as an “overpayment” that shall be refunded to the employer. This refund owed to the employer as a “customer" even if it utilizes services of a certified professional employer organization.
The CARES Act creates a new payroll tax credit for an “eligible employer” for a given quarter if either of two criteria are met:
(1) Their 2020 operations are partially or fully suspended because of certain government orders related to the COVID-19 pandemic (i.e. stay-at-home orders issued by county or state authorities), or
(2) Experienced “significant decline” in gross receipts beginning first quarter 2020 (defined as less than 50% of gross receipts for the same calendar quarter of 2019).
In this case, the employer continues to be an eligible employer until the next calendar quarter in which “Significant decline” ends when its gross receipts exceed 80% of its gross receipts for the same quarter the previous year.
As such, shutting down partially or fully may qualify a business under this provision. Alternatively, if the business did not shut down entirely or partially, the Employee Retention Credit Program is also accessible from the time that a business experienced at least a 50.01% decline in gross receipts compared to the previous year’s corresponding quarter, until the gross receipts of a subsequent quarter increase to being only a 20% decline compared to its previous year’s corresponding quarter.
Qualified Wages Under the Employee Retention Credit
The amount treated as qualified wages with respect to an employee cannot exceed the amount the employee would have been paid for working an equivalent duration during the preceding 30-day period.
For all eligible employers, qualified wages also include health plan expenses to the extent they are properly allocable to qualified wages. Wages paid to certain related individuals are excluded from qualified wages.
The credit is limited to 50% of the first $10,000 in total qualified wages, including health benefits, paid to each eligible employee for all calendar quarters.
In general, wages that qualify are determined based on the number of full-time employees. This is calculated based on the average number of full-time employees during 2019, as determined under IRC Section 4980H.
For eligible employers with more than 100 full-time employees (based on average headcount during 2019), “qualified wages” are wages paid or incurred to employees when they are not providing services due to COVID-19. For example, employees who are furloughed or face reduced hours as a result of their employers’ closure or reduced gross receipts are eligible for the credit. See Sec. 2301(c)(3)(A)(i); and
For employers who had an average number of full-time employees in 2019 of 100 or fewer, all employee wages are “qualified wages”, regardless of whether the employee is furloughed (employee providing services or not). See Sec. 2301(c)(3)(A)(ii).
The limitation for wages paid for such employees are limited to the amount the employee would have been paid for an equivalent amount of work in the 30 days immediately preceding the period for which the employee is paid. See Sec. 2301(c)(3)(B).
In either case, under 2301(c)(3)(C), qualified wages include qualified health plan expenses paid or incurred by the eligible employer for health coverage to the extent excludable from gross income of the employees under IRC Section 106(a). These expenses are allocated to qualified wages as allowed by the Treasury Secretary. Unless otherwise provided by the Secretary, the allocation shall be treated as properly made if it is on a pro-rata basis among employees and periods of coverage (during the COVID-19 emergency period).
This section has a “Denial of Double Benefit” provision to prevent “double dipping.” Any wages taken into account determining the credit allowed for the Employee Retention Program CANNOT be taken into account for:
Wages taken into account under IRC Section 45S (income tax credit for paid family and medical leave);
Wages taken into account under sections 7001 and 7003 of the Families First Coronavirus Act (provides payroll tax credits for paid leave required to be provided by small employers);
Wages paid to ineligible individuals specified in IRC Section 51(i)(1) (e.g. dependents who are employees, individuals who own 50% or more of company stock, fiduciaries, etc.); and
Wages paid to an employee in which the employer is allowed, and claims, a Work Opportunity Credit under IRC Section 51.
Similar to certain other tax credits, no deduction is allowed for qualified wages claimed as an Employee Retention Credit. An eligible employer can also elect not to have the credit apply. Note, certain other rules may prevent the double counting of credits.
The Section 2302 of the CARES Act delays required federal tax deposits for certain employer payroll taxes and self-employment taxes incurred between March 27, 2020 (enactment date) and December 31, 2020. Amounts will be considered timely paid if 50% of the deferred amount is paid by December 31, 2021, and the remainder by December 31, 2022. This provision is NOT a waiver, but a deferral.
However, this provision does not apply to employers who have a covered small business loan forgiven under Section 1106 ("LOAN FORGIVENESS") of the Act.
Employment taxes covered under this provision include:
IRC Section 3111(a): employer's share of Old-Age, Survivors, and Disability Insurance Tax (Social Security), currently set to 6.2% of wages up to the wage base ($137,700 in 2020)
The employer's and employee representative's share of Tier 1 Railroad Retirement Tax Act (RRTA) tax under Internal Revenue Code Sections 3211(a) and 3221(a) (only for railroad employers, and the 6.2% portion that coincides with the Social Security Tax due)
Self-employed individuals: the equivalent amount of Self-Employment Contributions Act (SECA) tax due on net earnings from self-employment under IRC Section 1401(a) (50% of the 12.4% tax)
Deferral may be used by employers that remit payroll taxes via an agent under IRC Section 3504 or certified professional employer organization. Where an employer directs a third party to defer the applicable tax payments, employers may be solely liable for making timely deposits under the deadlines set through the CARES Act, including those related to worksite employees performing services for a certified professional employer organization customer during the covered period.
It is important to note that not all payroll taxes are covered by this provision, including,
federal income tax withholding,
Medicare tax, or
employees’ share of Social Security Tax.
Additionally, there is no dollar cap on the wages that are counted in calculating the taxes that may be deferred.
As previously noted, employers that take advantage of the Small Business Act loan through the Paycheck Protection Program enacted by the CARES Act preclude usage of the Payroll Tax Deferral program if the loans are later forgiven (“[Section 2302] shall not apply to any taxpayer if such taxpayer has had indebtedness forgiven under [the Paycheck Protection Program]”).
The Section 163(j) limitation on business interest deductions is increased from 30% to 50% (Sec. 2306) of adjusted taxable income for tax years beginning in 2019 and 2020. Importantly, for 2020, taxpayers (including partnerships) can also elect to use their 2019 adjusted taxable income as the base for computing their 2020 limitation, instead of their 2020 adjusted taxable income which might be considerably lower (or even zero).
Special provisions are added to allow partners in partnerships to benefit from the provision without the need for partnership amended returns (which have become complicated under the new partnership audit rules).
The CARES Act makes two temporary changes (Sec. 2303) to the net operating loss (NOL) rules to offer more immediate relief to taxpayers with losses:
(1) provides for a five-year NOL carryback period, and
(2) pauses the 80%-of-taxable-income limitation on utilizing NOL carryforwards.
Both rules apply to NOLs arising in tax years that begin in 2018, 2019, or 2020.
Under this provision, if a taxpayer carries back NOLs to a Section 965 (repatriation tax) inclusion year, the taxpayer will be treated as having made an election under Section 965(n) not to apply the NOL deduction against its Section 965 income. The Act also offers a special election to exclude a taxpayer’s Section 965 inclusion years from the five-year carryback period.
The Act also amends the effective date of the Tax Cuts & Jobs Act (TCJA) NOL rule changes. The pre-TCJA NOL rules now apply to NOLs arising in tax years that began before January 1, 2018. Those NOLs can be carried back two years, and then forward 20 years without the 80%-of-taxable-income limitation. NOLs arising in tax years that begin after December 31, 2017, will have an unlimited carryforward period. Once the temporary rules expire, NOLs arising in tax years that begin after December 31, 2020, cannot be carried back, and when carried forward will be subject to the 80% limitation.
Finally, the Act makes certain technical changes to the NOL utilization rules. These changes are permanent, and will apply to tax years beginning after December 31, 2020.
Modification of Limitation on Losses for Taxpayers Other Than Corporations
The CARES Act modified the TCJA's loss limitation rules of Section 461(l) for pass-through businesses and sole proprietors, and will now be delayed and only apply to tax years beginning after December 31, 2020. See Sec. 2304 of the CARES Act. These loss limitation rules provide that non-corporate taxpayers can use a maximum of $250,000 ($500,000 for married filing jointly) in business losses per year to offset other income. For partnerships, S corporations, and other pass-thru business entities, the loss limitation applied at the partner/shareholder level, not the entity level.
Although the TCJA of 2017 made several changes to the U.S. tax code, a notable key provision was the new limitation on excess trade or business losses imposed on individual taxpayers. Before the TCJA, such losses were often unlimited as long as the taxpayer materially participated in its pass-thru businesses. Post-TCJA, Section 461(l) limited even participating owners’ ability to use net business losses to offset “non-business” income. This may include passive or investment income (capital gains, trust distributions, dividends, interest, and some rental income) and potentially W-2/employee income.
The CARES Act retroactively clarified that excess business loss calculations “shall be determined without regard to any deductions, gross income, or gains attributable to any trade or business of performing services as an employee.” As such, W-2/employee income is not business income and capital losses will not be included in a taxpayer’s aggregate deductions for 461(l) calculation purposes. A business’s capital gains, however, may be included in aggregate business income, but only to the extent of the lesser of (1) the net capital gain income attributable to the taxpayer’s trade or business, or (2) the taxpayer’s capital gain net income.
When Section 461(l) was first enacted, it was intended to limit pass-thru “excess business losses” for taxable years 2018 through 2025. However, the CARES Act removes the excess business loss limitation for 2018, 2019, and 2020. Beginning in 2021, however, the limit comes back into effect and will limit pass-thru loss deductions as previously legislated.
This new limitation (recently modified by the CARES Act) was enacted as an “anti-tax-shelter” mechanism, although it impacts taxpayers (e.g. small business owners) who generally do not utilize business losses as a tax shelter abuse device. The limitation was intended to restrict the ability of taxpayers (other than C corporations) to use trade or business losses to offset other sources of income, such as investment income. Trade or business losses have historically been subject to a variety of limitations at the shareholder level (e.g. passive activity loss limitations, at-risk basis limitations). This new overall loss limitation was intended to create another restriction on top of the other limitations that continue to apply.
Under new IRC Section 461(l), an “excess business loss” is the excess of aggregate trade or business deductions over the taxpayer’s aggregate trade or business gross income or gain plus a threshold amount. In general, the threshold amount is $500,000 for married filing jointly taxpayers and $250,000 for all other taxpayers (as adjusted for inflation). To the extent a taxpayer has an “excess business loss” for the tax year, that portion of the loss is disallowed and will become a net operating loss (NOL) that will be carried forward to future tax years.
CARES Act Amendments to Section 461(l) Summary
The CARES Act retroactively removes that impact by providing those taxpayers with refunds for 2018 and 2019, and removes excess business loss limits in 2020 through the following:
Eliminating “excess business loss” limitations for taxable years 2018 through 2020;
Clarifies deductions under IRC Sec.172 and Sec. 199A are not taken into account in determining the amount of a taxpayer’s deductions used to calculate its “excess business loss”;
Provides neither deductions, gross income, nor gains from employee services are included in the excess business loss calculation; and
Adds provisions relating to the application of capital gains & losses in determining a taxpayer’s excess business loss.
As such, prior to the CARES Act's delay of implementing the loss limitation to non-C Corp taxpayers until 2021, this new law limits a taxpayer’s deductible net business losses to the threshold amount for the tax year incurred, and forces taxpayers to wait at least one year before utilizing those losses in excess of the threshold.
Example: In 2021, a married taxpayer filing jointly has investment income of $1 million. In addition, she has aggregate business losses of $1.25 million. The taxpayer’s excess business loss is $750,000 ($1.25 million aggregate loss - $500,000 threshold). The excess business loss is disallowed in 2021 and treated as part of her NOL carryforward to later years. As a result, the taxpayer’s gross income for 2021 is $500,000 ($1 million investment income - $500,000 limited business loss).
This example illustrates how the new law could severely limit a taxpayer’s ability to offset his other income with his business losses and could result in a tax liability for 2021. However, as mentioned above, under Sec. 2304 of CARES Act, the taxpayer’s business losses may now be fully utilized until IRC Section 461(l) “excess business loss” limitation new effective date beginning after December 31, 2020.
For taxpayers that anticipate aggregate business losses above the threshold amount in 2021, they may need to engage in some additional tax planning and potentially prepare to pay tax liabilities where they previously would not have had a tax payment due. As mentioned above, a taxpayer’s excess business loss will become an NOL and carried to future tax years, subject to further guidance or applicable threshold limitations (e.g. 80% of tax income limitation).
Modification of AMT Refundable Credits
When the TCJA repealed the corporate alternative minimum tax (AMT), corporate AMT credits from pre-TCJA years were potentially available as refundable credits over several tax periods, ending in 2021. However, the CARES Act (Sec. 2305) accelerates the recovery of AMT credits and helps ensure all corporate taxpayers will recover AMT credits in full. Corporate taxpayers may elect to claim the entire remaining refundable AMT credits in a tax year beginning in 2018. Absent an election, the credits are refunded in the corporation’s tax years beginning in 2018 and 2019. The CARES Act also provides a procedure to file for a tentative refund to obtain these refundable credits within 90 days.
Immediate Deduction for Qualified Improvement Property
The CARES Act (Sec. 2307) amends depreciation rules (as modified by TCJA) to allow businesses to elect to immediately write off costs associated with “qualified improvement property” acquired after September 28, 2017, and before January 1, 2023. Absent taxpayer election, qualified improvement property will be depreciable over 15 years, rather than 39 years. In general, “Qualified improvement property” includes any improvement(s) made to the interior portion of a commercial building that is placed in service after the date the building was placed in service.
Temporary Exception from Excise Tax for Alcohol Used to Produce Hand Sanitizer
Sec. 2308 under the CARES Act waives, for 2020, the federal excise tax on distilled spirits used for or contained in hand sanitizer that meet FDA standards. This provision provides relief to distilleries that have shifted their production capacity from distilled spirits to hand sanitizer in response to the COVID-19 crisis.
Notable Individual Tax Provisions
As further economic support, the CARES Act also provides various individual tax provisions during the COVID-19 crisis. For example, the CARES Act provides the following individual tax rebates and savings opportunities as listed below.
The CARES Act (Sec. 2201) provides one-time direct Economic Impact Payments for non-tax dependents with a work-eligible social security number of up to $1,200 for single filers or heads of households. Married couples filing jointly can receive up to $2,400. An additional payment of up to $500 is available for each qualifying child under age 17.
Economic Impact Payments are subject to phaseout thresholds based on adjusted gross income (AGI). The phaseouts begin at $75,000 for singles, $112,500 for heads of household and $150,000 for married couples.
The payments are phased out by $5 for every $100 of AGI above the thresholds. For example, the payment for a married couple with no children is completely phased out when AGI exceeds $198,000. The payment for a head of household with one child is completely phased out when AGI exceeds $146,500. And, for a single filer, it’s completely phased out when AGI exceeds $99,000.
Individuals who filed a 2018 or 2019 federal income tax return will receive their rebate automatically. For those who have not filed a return, the IRS may identify recipients based on information in their 2019 Social Security Benefit Statements. The Act authorizes the IRS to disburse advance refunds electronically to any account the payee has authorized for direct deposit of a tax refund or other federal payment since January 1, 2018.
Individuals who claim the standard deduction in 2020 will be allowed an above-the-line deduction of up to $300 for cash charitable contributions, except for contributions to donor advised funds and Section 509(a)(3) supporting organizations.
For individuals who itemize, the CARES Act suspends the 50% limitation for “qualified contributions” made in 2020. Thus, individuals who itemize can generally deduct qualified contributions up to the amount of their income, less other deductible contributions. A “qualified contribution” is any cash contribution paid to a charitable organization, other than donor-advised funds and Section 509(a)(3) supporting organizations, if the taxpayer elects to treat the contribution as a qualified contribution.
For corporations, the deduction limitation for qualified contributions is increased from 10% to 25% of taxable income, less other deductible contributions.
The percentage limitation for donations of food inventory is increased from 15% to 25%.
The CARES Act (Sec. 2202) waives the 10% early withdrawal penalty for coronavirus-related distributions up to $100,000 made from qualified retirement accounts in 2020. The income attributable to the distribution is subject to tax ratably over three years, unless the taxpayer elects to include the entire amount in income in 2020. The taxpayer may recontribute the funds to any eligible retirement plan as a “rollover” within three years, without regard to that year’s cap on contributions. The provision also provides flexibility for loans from certain retirement plans for coronavirus-related relief.
A “coronavirus-related distribution” is any distribution made in 2020 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 to be described in regulations.
For 2020, the Sec. 2203 of the CARES Act also provides a temporary waiver of retirement plan minimum distribution rules for certain defined contribution plans and IRAs.
The Sec. 2206 of the CARES Act allows an exclusion of up to $5,250 from an employee’s income for amounts paid by an employer toward the principal or interest on the employee’s qualified student loans. The $5,250 cap applies to the combined amount of the student loan repayment and other educational assistance provided by the employer. In general, the payment must be made between March 27 and December 31, 2020.
As a reoccurring theme regarding the CARES Act benefits, to prevent a double benefit, the tax deduction for student loan interest is NOT allowed for any amount the exclusion is allowable.