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On March 27, 2020, President Trump signed the Coronavirus Aid, Relief, and Economic Security Act or the “CARES Act”, into law. The CARES Act will provide significant financial relief to individuals and small businesses, especially those businesses in certain sectors of the U.S. economy that have been hit hardest by the COVID-19 pandemic, by providing $2 trillion in stimulus to the U.S. economy.
A significant portion of the CARES Act focuses on supporting American workers, families and businesses through a combination of unemployment provisions, tax rebates, retirement plan changes and modifications to the Internal Revenue Code of 1986, as amended (the “Code”). This Quick Study focuses on the business tax changes included in the CARES Act. Please note that Locke Lord has separate QuickStudies that review the CARES Act’s provisions related to the Employee Benefits Changes, Executive Compensation Limits, Charitable Contributions, and Expanded Unemployment Benefits.
For more CARES Act information please see: Saving Our Small Businesses: CARES Act Expands Economic Injury Disaster Loan Program to Provide Additional Financial Relief to Small Businesses, Saving Our Small Businesses: Lender Considerations for Participating in the New Forgivable Paycheck Protection Program Loans to Small Businesses, Saving Our Small Businesses: Congress Reaches Agreement on New Forgivable Paycheck Protection Loans to Small Businesses, Saving Our Small Businesses: “Phase Three” Economic Recovery Proposal Includes New Forgivable SBA Loans for Small Businesses Impacted and Saving Our Small Businesses: SBA Disaster Assistance Loans for Small Businesses Impacted by COVID-19.
Modifications for Net Operating Losses
The CARES Act has temporarily removed limitations on net operating losses (“NOLs”) put in place by the Tax Cuts and Jobs Act (“TCJA”). In the TCJA, NOLs of a corporation could no longer be carried back to earlier tax years and any carryforward of losses was limited to only 80% of a taxpayer’s taxable income. Under Section 2303 of the CARES Act, NOLs arising in tax years 2018, 2019 or 2020 can now be carried back five years and, as carried back or forward, are no longer limited to 80% of a corporate taxpayer’s taxable income for tax years beginning before January 1, 2021, allowing corporations to fully offset taxable income by such carrybacks and carryforwards relating to such tax years. These changes will allow corporations to obtain immediate and critical cash flow by utilizing NOLs resulting from this COVID-19 crisis (or the preceding two years) through amendments to prior year tax returns to get tax refunds. Additionally, these changes allow a corporation to carryback NOLs to years in which the corporate tax rate was 35%, increasing the value of such NOL carrybacks. The CARES Act also includes special timing rules for the carrybacks arising in 2018 and certain short and fiscal tax years.
Note, however, that a Real Estate Investment Trust would not be permitted to carry back any of its NOLs. Additionally, these NOL carrybacks would not be able to offset income includible to corporate taxpayers under Code Section 965 – the deemed repatriation provision enacted in the TCJA that imposed a transition tax on previously untaxed foreign earnings and profits owned by US corporate shareholders. A corporation, however, may make an election to exclude all such tax years subject to Code Section 965 from the carryback period.
Merger and acquisition agreements frequently include covenants related to the use of NOLs and transaction tax deductions with the buyer paying the seller for any tax benefits derived from such tax attributes. Corporations that are involved in such mergers and acquisitions involving NOLs relating to the years indicated should consider whether such merger and acquisition agreements should be adjusted to account for these changes initiated by the CARES Act.
Delay of Payment of Employer Payroll Taxes
Section 2302 of the CARES Act provides short-term payroll tax payment relief for some employers. In general, employers pay 6.2% of employee compensation in Social Security taxes for each employee on a monthly or quarterly basis. Under Section 2302, an employer’s Social Security payroll taxes for which deposits are due to be made during the period beginning on March 27, 2020, and ending before January 1, 2021, may be deferred, with 50% payable no later than December 31, 2021, and the remaining 50% payable no later than December 31, 2022.
In considering this provision, there are a couple of items to note:
- The Medicare portion of an employer’s payroll tax obligations are not included in this relief.
- If an employer obtains a loan under the CARES Act’s Paycheck Protection Program and later has the indebtedness forgiven under such Program, it may not take advantage of the payroll tax deferral provision. As a result, employers need to carefully consider their alternatives when determining which program may be most beneficial.
Advance Refunding of Credits
The Code imposes on every employer certain excise taxes on wages and other compensation paid by such employer, including an excise tax equal to 6.2% of wages paid (Code Section 3111(a) also known as Social Security taxes) and an excise tax equal to an applicable percentage of compensation paid during any calendar year (Code Section 3221(a)) by such employer subject to certain credits. The Families First Coronavirus Response Act (the “FFCRA”) provides for certain credits against such employer excise taxes for “qualified sick leave wages” and “qualified family leave wages” paid by such employer with respect to each calendar quarter with certain limitations. According to the FFCRA, the credits allowed with respect to any calendar quarter are not to exceed the tax imposed by Code Section 3111(a) or 3221(a). The FFCRA further provides that any excess of such credits over the limit described in the immediately preceding sentence may be treated as a refundable overpayment.
Section 3606 of the CARES Act amends the FFCRA to include an ability in anticipation of such credits to advance such credits, including the refundable portion, rather than relying on a refund. Any such credit advance will be limited to the credit otherwise calculated by the FFCRA subject to the limits provided therein and will be according to forms and instructions to be provided by the Secretary of the Treasury. The CARES Act also provides for the waiver of certain penalties relating to a failure to make a deposit of tax imposed by Code Section 3111(a) or 3221(a) to the extent the Secretary determines that such failure was due to the anticipation of the credits described above. It should be noted that the Secretary has discretion to determine how such advances will apply and when a waiver of penalties will be allowed. The Treasury Department has issued initial guidance to carry out the purposes described above, as described in our IRS Guidance Regarding Waiver of Penalties and Acquiring Advance Payments for Payroll Tax Credits alert, and is expected to issue additional guidance on this matter in the future.
Employee Retention Credit for Employers Subject to Closure Due to COVID-19
Section 2301 of the CARES Act provides a refundable payroll tax credit (the “Retention Credit”) to eligible employers for 50% of qualified wages paid by employers to employees during the COVID-19 crisis. The Retention Credit is designed to incentivize employers to retain employees during suspended or declining business operations due to COVID-19. The Retention Credit is provided for wages paid or incurred from March 13, 2020 through December 31, 2020.
Eligible Employers. The Retention Credit is available to employers whose:
- Operations were fully or partially suspended due to a COVID-19-related shut-down order, or
- Gross receipts for a calendar quarter decline by more than 50% when compared to the same quarter in the prior year. Once the employer’s gross receipts go above 80% of a comparable quarter in the prior year, they no longer qualify as an eligible employer at the end of that quarter.
Qualified Wages. 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 qualify for the Retention Credit, regardless of whether the employee worked or not.
Amounts paid by an eligible employer to provide and maintain a group health plan are included in qualified wages. The amount of qualified wages (including such health plan costs) that may be taken into account with respect to any employee cannot exceed $10,000.
Limitations and Refundability. If, during any calendar quarter, the amount of the Retention Credit exceeds the applicable employment taxes during such calendar quarter, the excess will be treated as an overpayment and refunded to the eligible employer.
Special Rules. An eligible employer may not include any employee for which the eligible employer is allowed a Work Opportunity Credit. Furthermore, any wages taken into account for purposes of the payroll tax credit for required paid sick leave or paid family leave as provided in the Families First Coronavirus Response Act cannot be taken into account for purposes of determining the Retention Credit.
An employer is not eligible for the Retention Credit if the employer receives a covered loan under the Small Business Act, as added by Section 1102 of the CARES Act.
Modification of Limitation on Business Interest
Section 2306 of the CARES Act provides new rules applicable for taxable years beginning in 2019 and 2020 under revised Code Section 163(j)(10) that generally increase the amount of the business interest deduction limitation in several ways. Under current law, Code Section 163(j) limits the ability of certain taxpayers to deduct business interest in a given taxable year. Business interest includes all “interest paid or accrued on indebtedness properly allocable to a trade or business” and for non-corporate taxpayers does not include investment interest or interest that is investment income. The limitation is generally equal to the sum of (i) the business interest income of the taxpayer for such taxable year, and (ii) 30% of the adjusted taxable income of the taxpayer for such taxable year. Adjusted taxable income is typically the largest component of the limitation. It is defined in a manner similar to EBITDA for taxable years through 2021, and then EBIT thereafter. Disallowed business interest can generally be carried over indefinitely to the succeeding taxable year, with special rules for pass-through taxpayers, discussed below.
First, 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. As discussed in greater detail below, for partnerships this rule only applies for tax years beginning in 2020 but other beneficial provisions apply.
Second, 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, resulting in a higher amount of business interest such taxpayer can deduct for taxpayers with higher adjusted taxable income in 2019 than in 2020. Due to current economic conditions and their adverse impact on 2020 adjusted taxable income for many taxpayers, this election could be very beneficial.
Special Rules for Partnerships and S Corporations
As noted above, special rules apply for disallowed business interest for pass-through entities under the generally applicable provisions of Code Section 163(j). For a partnership, Code Section 163(j) generally applies at the partnership level but instead of being carried forward, if a partnership’s business interest for a taxable year exceeds the business interest deduction limitation under Code Section 163(j), such “excess business interest” is allocated among the partners. However, a partner’s ability to take excess business interest into account is generally limited to the excess taxable income allocated to such partner from the partnership, with any excess carried over to the succeeding taxable year.
As noted above, under the CARES Act, the increase in the share of “adjusted taxable income” taken into account in calculating the business interest deduction only applies to taxable years beginning in 2020. However, for excess business interest of the partnership allocated to a partner in a taxable year beginning in 2019, the excess taxable income limitation does not apply to 50% of such excess business interest carried forward to the 2020 taxable year.
Note, although Code Section 163 provides that rules similar to the partnership business interest deductions limitation provisions apply for S corporations, excess business interest of an S corporation does not flow through to the owners but is carried over at the S corporation level. As such, it is not clear based on the CARES Act as currently drafted how its provisions would apply to an S corporation.
Changes Regarding Qualified Improvement Property
The TCJA, in revising depreciable lives for various types of property, replaced the three former categories of qualified real property — qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property — with one category: “qualified improvement property.” Qualified improvement property means any improvement to an interior portion of a building which is nonresidential real property if such improvement is placed in service after the date such building was first placed in service. Congress intended that a single 15-year recovery period would apply to all qualified improvement property but due to a drafting error, qualified improvement property was not listed as 15-year property in the current version of Code Section 168. Many taxpayers have hoped that Congress would fix this drafting error in a technical corrections bill.
Section 2307 of the CARES Act fixes this drafting error and also modifies the definition of qualified improvement property. Qualified improvement property is now explicitly a subset of 15-year property pursuant to new proposed Code Section 168(e)(3)(E)(vii) and is therefore eligible for the 15-year recovery period for depreciation, instead of the longer 39-year recovery period that previously applied. Further, this technical correction is effective as if it had been included in the TCJA, i.e., it is effective for property placed in service beginning after December 31, 2017. The definition of qualified improvement property was also revised to now mean (emphasis added) “any improvement made by the taxpayer to an interior portion of a building which is nonresidential real property if such improvement is placed in service after the date such building was first placed in service.”
Modification of Limitation on Losses for Taxpayers other than Corporations
Section 2304 of the CARES Act is designed to allow pass-through businesses and sole proprietors to utilize certain business losses so that they can access critical cash flow to maintain operations and payroll for employees during the Coronavirus crisis by temporarily removing the limitation on the use of “excess business losses” of non-corporate taxpayers for all taxable years beginning before January 1, 2021. “Excess business losses” are defined as the excess of a taxpayer’s aggregated business deductions for the year over the sum of the taxpayer’s aggregate business gross income or gain for the year, plus $250,000 (or $500,000, in the case of a joint return), which, prior to the CARES Act, applied to tax years beginning after December 31, 2017.
Section 2304 of the CARES Act also makes certain technical amendments to the TCJA relating to the definition of “excess business losses”. Namely, “excess business losses” will now be determined without regard to net operating loss deductions or the deduction for qualified business income. Furthermore, “excess business losses” will now be determined without regard to deductions, gross income, or gains attributable to any trade or business in which the taxpayer performs services as an employee. Section 2304 of the CARES Act also adds that deductions for capital losses will not be taken into account when determining “excess business losses,” and only a limited amount of capital gains will now be taken into account.
Accelerated Refunds for Existing Corporate Alternative Minimum Tax Credits
Prior to the 2017 enactment of the TCJA, corporations were required to pay the higher of their federal alternative minimum tax (“AMT”) or their regular federal income tax (“regular tax”) for a taxable year, but generally could indefinitely carry forward the excess of the AMT paid over their regular tax liabilities (“AMT Credits”) and use these credits against future regular tax liabilities. The TCJA repealed the corporate AMT, but corporations had continued use of AMT Credits and were entitled to receive a refund of 50% of the unused AMT Credit amount for taxable years 2018 through 2020, with any remaining balance being fully refundable in 2021.
Under the CARES Act, these corporate AMT Credits are no longer subject to the 50% limitation noted above for tax years beginning in 2019, making them fully refundable. The CARES Act also includes provisions permitting an election to take the entire credit for the taxable year beginning in 2018 and claiming any resulting refund on a tentative or “quick” refund basis.
Temporary Exception from Excise Tax for Alcohol Used to Produce Hand Sanitizer
In general, distillers and importers of distilled spirits are liable for federal excise taxes on all distilled spirits produced in or imported into the United States. The federal excise tax on distilled spirits is generally $13.50 on each proof gallon; provided that “distilled spirits operations” enjoy a reduced tax rate through December 31, 2020, equal to $2.70 per proof gallon on the first 100,000 proof gallons, $13.34 per proof gallon in excess of 100,000 but below 22,130,000 proof gallons, and $13.50 per proof gallon for all additional amounts. The term ”distilled spirits” means that substance known as ethyl alcohol, ethanol, or spirits of wine in any form (including all dilutions and mixtures thereof from whatever source or by whatever process produced). Persons liable for this federal excise tax may be relieved of the tax in certain circumstances set forth in Code Section 5214(a) upon the withdrawal of distilled spirits from a bonded premises.
Section 2308 of the CARES Act amends Code Section 5214(a) to add an exception from federal excise tax for distilled spirits removed from a bonded premises for use in or contained in hand sanitizer produced and distributed in a manner consistent with guidance issued by the Food and Drug Administration. This exception applies to distilled spirits removed after December 31, 2019, and before January 1, 2021. Further, such distilled spirits are not subject to any requirements related to labeling or bulk sales under – (1) section 105 or 106 of the Federal Alcohol Administration Act (27
U.S.C. 205, 206); or (2) section 204 of the Alcoholic Beverage Labeling Act of 1988 (27 U.S.C. 215).
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