On Friday, March 27, 2020, the House used a procedural measure to pass the most recent Congressional legislation, the Coronavirus Aid, Relief, and Economic Security Act, H.R. 748, (the “CARES” Act or the “Act”), by a unanimous voice consent vote. The House passage followed the Senate’s passing of the legislation by a 96-0 vote on Wednesday, March 25, 2020. The President signed the legislation into law right after the House vote. The CARES Act includes more than $2.2 trillion in emergency relief, including the expansion of small business loan programs and unemployment insurance, assistance for impacted industries, such as transportation, and tax relief for individuals and businesses. This FGMK Tax Alert focuses on individual and business tax provisions provided by the legislation.
Individual Tax Provisions
Section 2201. Recovery Rebates for Individuals.
One of the more publicized tax elements of the legislation concerns rebate payments to American taxpayers. While the provision is structured as a refundable income tax credit, the reality is that the United States government will be issuing advanced rebate payments to qualified taxpayers as soon as possible. If a payment is not received due to issues with locating an eligible individual, such individual can claim an income tax credit of the allowed amount on the 2020 income tax return.
Those taxpayers who receive payments during 2020 will report the receipt of payment on their 2020 income tax returns. If the taxpayer calculates a credit on the 2020 tax return that is greater than the advanced rebate, the taxpayer can claim the balance as a credit. Alternatively, if the advanced rebate is greater than the calculated credit to which the taxpayer is entitled, the CARES Act only requires the taxpayer to reduce the credit amount to zero, and thus there appears to be no recapture of the excess advanced rebate.
An eligible individual is defined by exclusion, as it means an individual other than a non-resident alien, an individual claimed as a dependent on another’s return, estate, or trust. Eligible individual taxpayers may receive a tax credit of up to $1,200. The maximum credit for those married and filing a joint return is $2,400. Additionally, taxpayers may receive a credit of $500 for each qualifying child. Notably, “qualifying child” is defined pursuant to the Child Tax Credit provision, which in part, defines a “qualifying child” as one who has not yet attained age 17.
The tax credit is subject to limitations based on taxpayers’ adjustable gross income (“AGI”). The credit is reduced by 5 percent of the amount that a taxpayer’s AGI exceeds the taxpayer’s applicable AGI limit. The reduction computation utilizes a taxpayer’s 2019 tax year AGI. However, if a taxpayer has not filed a 2019 tax return, then the Secretary of Treasury may utilize a taxpayer’s 2018 AGI for the computation. Taxpayers who anticipate lower AGI for the 2019 tax year and have not yet filed their 2019 income tax return may want to consider filing as soon as possible if the AGI limit will affect the credit computation. The following provides an overview of the phase-out effects of the AGI limits.
AGI Limit for Maximum Credit
AGI When Credit Fully Phased-Out***
Head of Household**
Married Filing Jointly*
* Assumes no children
** Assumes one child
*** Each qualified child can create an additional $10,000 of AGI phase-out. For example, a couple married filing jointly with 2 kids could have a maximum credit of $3,400. Their AGI phase-out would there be $218,000.
Section 2202. Special Rules for Use of Retirement Funds.
The CARES Act modifies various provisions applicable to eligible retirement plans. Eligible retirement plans are defined as those under IRC Section 402(c)(8)(B), which includes Individual Retirement Accounts (“IRAs”), individual retirement annuities under Section 408(b), qualified trusts, Section 403(a) annuity plans Section 403(b) annuity contracts, and Section 457(b) deferred compensation plans.
Hardship Distribution – Coronavirus-Related Distribution
Eligible individuals under the hardship distribution exception has been expanded to include an individual:
The distribution received under these circumstances is referred to as a “coronavirus-related distribution”.
Individuals who receive a coronavirus-related distribution made during the period of January 1, 2020 through December 31, 2020 would qualify for a waiver of the 10 percent early withdrawal penalty on withdrawals up to $100,000 from an eligible retirement plan account. Further, the amount withdrawn may be recontributed to a retirement account within three years, without being subject to the usual annual contribution caps. A withdrawn amount not recontributed would be taxed over a three-year period.
The maximum allowed loan is increased to $100,000 or 100 percent of the participant’s vested account balance. Participants with repayments due from the date of the enactment of the CARES Act through December 31, 2020 can also delay their loan repayments for up to one year.
Plan Amendment Adopting CARES Act Provisions
Plan documents will need to be amended to adopt these provisions; however, plan sponsors are able to operate with these provisions so long as the plan is amended by the last day of the plan year beginning on or after January 1, 2020.
Limited Single-Employer Defined Benefit Plan
For employer obligations due within calendar year 2020, the due date is extended to January 1, 2021. The payments would be due with interest. The CARES Act also allows plans some flexibility in regard to the funding status and its limitation of benefits resulting from the extension.
Section 2203. Temporary Waiver of Required Minimum Distributions.
The CARES Act provides a temporary waiver for required minimum distributions (“RMDs”) due in the 2020 calendar year for IRAs, defined contribution employer plans, e.g., 401(k), profit sharing plans, as well as 403(b) and 457(b) plans. The CARES Act does not provide a similar waiver for RMDs from defined benefit plans.
Section 2204. Above the Line Charitable Deduction Contribution (Non-Itemizers).
To help facilitate charitable giving, the CARES Act provides for an above-the-line charitable deduction for individual taxpayers up to a maximum deduction of $300. This reduces AGI for applicable taxpayers.
This deduction is only allowed to taxpayers that do not itemize, i.e. only applies to taxpayers who claim the standard deduction. It is available with respect to any cash contribution made in 2020 to a public charity, governmental unit, or private operating foundation, i.e. those charities for which the standard 60 percent of the taxpayer’s charitable base deduction are available ( “Qualified Contribution”).
Section 2205. Modification of Limitations on Charitable Contributions During 2020.
In addition to the above-the-line charitable deduction described above, the CARES Act modifies the limitation on charitable giving deductions, at the taxpayer’s election. Stated simply, an individual taxpayer may elect to deduct certain charitable contributions up to 100 percent of his or her “charitable base”, which is defined as the taxpayer’s AGI without regard to any net operating loss carrybacks.
Specifically, with respect to any cash contributions, an individual will be permitted to deduct the charitable contribution up to 100 percent of his or her charitable base, less other deductible contributions made in 2020 which are not qualified contributions. Qualified contributions do not include cash payments made to a donor advised fund or to an organization which is classified as a supporting organization. Qualified contributions made in excess of 100 percent of the taxpayer’s charitable base will be carried forward for the succeeding five taxable years, subject to normal limitations. For partnerships and S-Corporations, the election to deduct up to 100 percent of the charitable base must be made by each individual partner or shareholder.
The charitable base for qualified contributions made by a C-corporation is increased from 10 percent of the corporation’s taxable income to 25 percent of the corporation’s taxable income, with similar rules for carryforward amounts.
Finally, with respect to charitable contributions of food made in 2020, the available deduction limitation is increased from 15 percent of the taxpayer’s taxable income to 25 percent of the taxpayer’s taxable income.
Section 2206. Exclusion for Certain Employer Payments of Student Loans.
Perhaps one of the more intriguing aspects of the tax provisions in the CARES Act is the modification of the employer deduction for educational expenses of an employee. The CARES Act allows employers to include payments of principal and interest on any qualified education loan (as defined under Internal revenue Code 221(d)(1)), so long as the payments by the employer are made prior to January 1, 2021. The CARES Act also adds a conforming change to IRC Section 221(e) denying a deduction to the employee for any payment of principal or interest paid for and deducted by the employer.
The effect of this provision is that an employer may provide an employee increase compensation in 2020 via the educational coverage up to $5,250 that is not only tax-free to the employee but is fully deductible by the employer.
Business Payroll Tax Assistance
As part of the Congressional response to the COVID-19 crisis, the President has previously enacted the Families First Coronavirus Response Act (“FFCRA”). The FFCRA is intended to provide emergency paid sick leave and paid family and medical leave temporarily, applying only to a public health emergency due to the COVID-19 outbreak. Specifically, it provided two weeks of paid sick leave along with up to 10 additional weeks of family and medical leave. Since this represents an additional cost for small businesses, the FFCRA also provided certain tax credits for employers paying sick leave and family and medical leave. These credits have been explained previously in prior FGMK guidance but generally, these tax credits are applied against an employer’s payroll tax liability.
Apart from the income tax and payroll tax withholdings imposed on an employee’s pay, an employer faces its own share of payroll tax liability, consisting of Social Security (6.2 percent), Medicare (1.9 percent), FUTA (most often, 0.6 percent) and SUTA (varies depending on employee pay and number of former employee state unemployment claims; for example, the Illinois SUTA rate ranges from 0.525 percent to 6.925 percent). Previously, there was discussion about temporarily waiving employer’s payroll tax liabilities entirely. That proposal did not gain footing; rather, the FFCRA provided a refundable credit only as to paid sick leave and paid family and medical leave.
Section 2301. Employee Retention Tax Credit.
The Act includes another new refundable credit in 2020 against employers’ Social Security payroll taxes (i.e., 6.2 percent) for employers who continue to pay employees during the COVID-19 crisis. Beyond retaining its employees, a business must demonstrate one of two elements to be eligible:
1) Business operations are fully or partially suspended during a calendar quarter due to a COVID-19 shut-down order; OR
2) If the business remains open, its gross receipts for any quarter in 2020 were less than 50 percent of what gross receipts were for the corresponding 2019 quarter. The business will remain eligible for the credit until its gross receipts in any given quarter recovering to 80 percent of what they were in the corresponding 2019 quarter.
Example: Acme, Inc. historically has quarterly gross receipts of $10,000,000 for each quarter in calendar year 2019. Acme remains open during 2020, but for the period April 1, 2020 through June 30, 2020, its gross receipts are $3,000,000. For the period July 1, 2020 through September 30, 2020, its gross receipts are $7,900,000. For the period October 1, 2020 through December 31, 2020, its gross receipts are $8,100,000. Acme is eligible to claim the new credit for qualified wages paid during the second and third quarters.
For all businesses, the credit terminates at the end of the fourth calendar quarter of 2020.
For each quarter in which an employer is eligible, the credit is equal to 50 percent of the “qualified wages” paid to each employee during the quarter. However, it is important at the outset to note that in computing the credit, the term “qualified wages” paid to each employee only includes the first $10,000 of wages paid (which can include qualified health plan expenses).
Beyond this cap, the new bill also contains specific rules for determining the “qualified wages” of an employee dependent upon how many employees a business has. If a business had less than 100 employees during 2019, qualified wages include all wages paid for each eligible quarter (i.e., as described in 2) above). If a business had more than 100 employees in 2019, then its “qualified wages” are limited to ONLY those wages paid by the employer while the business was suspended.
The credit is a refundable credit; if it exceeds the employer’s payroll tax liability, any excess is paid as a refund to the employer. In light of this credit as well as the payroll tax credits for family medical leave or paid sick leave, as provided in the FFCRA, it is likely that many businesses may receive a refund related to this credit.
Further, speaking of the family medical leave and paid sick leave payroll tax credits available under the FFCRA, any wages used in determining those payroll tax credits may not be considered in determining qualified wages for purposes of the employee retention payroll tax credit.
As an additional item of interest, the CARES Act amends the FFCRA to provide that credits available thereunder may be received as advanced refunds. Treasury will have to provide forms and instructions for such treatment. Moreover, if a taxpayer withholds a payroll deposit in anticipation of paid leave credit, Treasury shall waive any penalty for any failure to make a deposit in such a situation.
Example: Acme, Inc. employed 60 employees in 2019. Due to the impact of COVID-19, Acme’s gross receipts for the period of April 1, 2020 - June 30, 2020 (Q2) are $3,000,000, compared to $8,000,000 for the same period in 2019. Gross receipts for July 31, 2020 – September 30, 2020 return to a level that is 85 percent of the gross receipts for the same period in 2019. Therefore, Acme is eligible to claim the employee retention credit for Q2 of 2020.
ACME’s total payroll during Q2 is $660,000 for compensation of the 55 employees working during that period. As a result, ACME’s 6.2 percent Social Security tax share for Q2 is $40,920. ACME’s total payroll tax liability due for Q2 is $232,980. ACME has claimed an advanced credit of $60,000 against its payroll tax based on the paid leave compensation. Due to a $10,000 cap on eligible wages, only $550,000 constitute qualified wages for the credit computation (note that $60,000 paid to employees on leave is excluded), which generates a credit of $275,000. Since all these payroll credits are refundable, the combined credit of $335,000 not only eliminates any employer share of Social Security tax but generates a refund of $102,020.
Lastly, employers will have to carefully weigh the benefits of a payroll protection loan, including any allowable forgiveness, against the benefit associated with this credit. If an employer takes out a paycheck protection loan under Section 7(a) of the Small Business Act, referred to as the paycheck protection program, this credit is not available to the employer.
Section 2302. Deferral of Certain Payroll Taxes.
The Congressional response to the COVID-19 crisis includes deferring payment of the employer’s share of Social Security taxes that would otherwise be due in 2020. Specifically, payment of 50 percent of any amount of an employer’s share of the 6.2 percent Social Security payroll tax that otherwise would be due from the date of enactment through December 31, 2020 can be deferred until December 31, 2021 with the remaining 50 percent due December 31, 2022.
Just as a self-employed individual is eligible for the payroll tax credits under the FFCRA (i.e., those available for paid sick leave and paid family and medical leave), a self-employed individual can also defer payment of 50 percent of his or her self-employment tax in a manner similar to that of an employer. In other words, a self-employed individual would be required to pay 50 percent of his or her self-employment tax as normally due, but the remaining 50 percent could be deferred into two installments: one through December 31, 2021 and the remaining due December 31, 2022.
Importantly, like the employee retention credit, there is an exception to an employer’s ability to claim the payroll tax deferral benefit. If a taxpayer obtains a loan forgiveness amount for a loan obtained under the paycheck protection program, it may not take advantage of the payroll deferral benefit. Please note that while the receipt of a loan under the paycheck protection program precludes the claim of a payroll retention credit, a taxpayer is only precluded from claiming the payroll deferral benefit if it obtains a loan under the paycheck protection program AND receives loan forgiveness under that program.
Changes to the Rules on Use of Losses
Section 2303. Modifications for Net Operating Losses.
Under current law, the net operating losses of a business or individual may only be carried forward and can only be used to offset 80 percent of current year taxable income. The Act temporarily suspends these rules and provides the following:
Example: For the 2017 tax year, ACME Inc. had taxable income of $5,000,000 which resulted in a $1,700,000 income tax liability. ACME experienced a down cycle in business in 2018, and thus generated a net operating loss (“NOL”) of $1,000,000, which it carried forward to the 2019 tax year, as the Tax Cuts and Jobs Act of 2017 eliminated the carryback of NOLs. ACME will again have an NOL for the 2019 tax year and plans to file its 2019 income tax return in July of 2020. Under the CARES Act, ACME can now carry back its 2018 loss to 2017 (as NOLs can be carried back 5 tax years). Setting aside certain intricacies of the NOL computation rules, ACME carries back the 2018 NOL to the 2017 tax year which reduces 2017 taxable income to $4,000,000. Based on the adjusted taxable income amount, ACME’s 2017 income tax liability is reduced to $1,360,000. As a result, ACME files an amended 2017 tax return and claims a refund of $340,000. Note that ACME not only benefits from the NOL carryback but is able to use the carryback in a tax year that had a higher corporate income tax rate than the current flat 21 percent corporate rate.
There are special rules that apply to REITs, life insurance companies and those taxpayers with so-called Sec. 965(a) income inclusions related to earnings and profits of certain foreign corporations.
Section 2304. Modifications of limitations on losses for taxpayers other than corporations.
Under current law, an individual’s ability to claim a loss from a business is constrained by several limitations, including a taxpayer’s basis, a taxpayer’s amount at risk, whether the taxpayer is actively involved in the business and the final limitation known as the excess business loss limitation. Specifically, the excess business loss limitation prevents a taxpayer from deducting a net business loss in excess of $250,000 ($500,000 in the case of married filing jointly). Any loss in excess of this amount is converted into a net operating loss that can be carried forward indefinitely, to be used in future years subject to the NOL limitations discussed above.
The Act temporarily suspends this limitation for the 2018, 2019 and 2020 tax years. This means that if a taxpayer previously had a 2018 loss that was limited, that taxpayer should consider filing an amended return to claim a refund.
The Act also clarifies that in computing a net business loss, wages are not considered business income. In other words, losses incurred in a business cannot be used to offset wages received by a taxpayer. As a result, when the excess business loss limitation returns in the 2021 tax year, it is likely that more losses will be limited.
The Act also adds a new provision that provides deductions resulting from losses from sales or exchanges of capital assets are not allocable to a trade or business for purpose of the limitation computation. However, gains from such transactions are allocable to a trade or business to the extent such gains do not exceed the lesser of capital gain net income attributable to a trade or business or net capital gain income.
Example: Yosemite Sam is a member of ACME, LLC. In 2018, ACME, had a $4,000,000 loss of which $2,000,000 was allocable to Sam. His only other income consisted of $1,300,000 of income allocated to him from a passive investment. On his 2018 income tax return (married filing jointly), Sam was only able to use $500,000 of his allocable loss from ACME to offset income due to the excess business loss rule. The remaining $1,500,000 of loss carried forward as an NOL to the 2019 tax year. Sam has filed an extension for the 2019 tax year and plans to file by October 15, 2020. However, he would like to obtain an immediate tax benefit. Therefore, Sam can file an amended 2018 tax return and use all of his allocable $2,000,000 loss (assuming no other restrictions) to eliminate his tax liability and generate a tax refund based on his resulting overpayment of tax in 2018 as a result of the retroactive postponement of the excess business loss rule to the 2021. Note that Sam can carry the loss back for 5 tax years. Therefore, his analysis should include an analysis of years prior to 2018 when the income tax rates were higher.
Additional Modifications and Technical Correction
Section 2305. Modification of Credit for Prior Year Minimum Tax Liability of Corporations.
For corporate taxpayers that had carry over credits related to prior year payment of the corporate alternative minimum tax that was repealed beginning in 2018, current law requires corporate taxpayers to claim such credits over a period of years ending in 2021. The Act accelerates the recognition of these refundable credits into 2018 and 2019, providing a taxpayer the ability to elect to accelerate all refundable corporate minimum tax credits in 2018. This will permit corporate taxpayers to claim refunds related to 2018 and 2019, improving cash flow positions.
Section 2306. Modifications of Limitation on Business Interest.
The Act temporarily increases the limitation on the use of business interest expense from 30% to 50% of adjusted taxable income, with any excess interest expense carried forward. The increase applies to the 2019 and 2020 tax years. Perhaps more profoundly, as many businesses may not have adjusted taxable income in 2020, a business can elect to use its 2019 adjusted taxable income in computing its 2020 limitation. Interestingly, if a business were to have a loss in 2020, by electing to apply its 2019 adjusted taxable income, its 2020 net operating loss could be increased and then carried back into 2019, potentially creating a refund, and more cash flow for 2020.
The application of these modifications is different for partnerships. Specifically, the 2019 limitation is not adjusted to 50 percent. Instead, any interest disallowed at the partnership level is allocated to its partners, and suspended at the partner level until 2020, when 50 percent of the suspended interest is released (i.e., fully deductible). The remaining 50 percent is suspended until the partnership allocates excess taxable income or excess interest income to the partner.
Section 2307. Technical Amendments Regarding Qualified Improvement Property.
The Act contains an important and welcomed technical correction regarding improvements made to the interior portion of a nonresidential building (including hotels), i.e., qualified improvement property, any time after the building was placed in service. Under current law, and due to a drafting error in prior legislation, the recovery period for such improvements was 39 years. The Act corrects this by clarifying the recovery period for such improvements is 15 years. What’s more, the change is retroactive to January 1, 2018. A such, any taxpayer having made qualified improvement in 2018 and 2019 should be entitled to file amended returns to claim the benefits associated with the accelerated recovery period, including the ability to deduct 100 percent of the adjusted basis of such property via bonus depreciation. Alternatively, the IRS and Treasury may provide future relief that would allow a taxpayer to file a Form 3115 to change accounting methods and make a Section 481 adjustment to claim the deduction, which would eliminate the need to file an amended return to claim the additional depreciation deduction.
However, some real estate entities may have made an irrevocable election in prior tax years to be treated as an electing real property trade or business not subject to the interest deduction limitation rules. Such an election required these entities to depreciate nonresidential real property, residential rental property, and qualified improvement property under the alternative depreciation system, and thus such property was not eligible for bonus depreciation. Hopefully, the IRS and Treasury will provide relief to taxpayers who may have opted against the electing real property election if qualified improvement property had been bonus eligible at the time of prior tax years’ return filings. Recent news suggested that Treasury had received final regulations and newly proposed regulations governing the interest deduction limitation provision from the White House. While unknown, Treasury could use these regulations as an avenue of providing such relief.
Section 2308. Temporary Exception from Excise Tax for Alcohol Used to Produce Hand Sanitizer.
Several distillers have converted their operations to produce hand sanitizer. For these distillers, the Act temporarily suspends the federal excise tax imposed in the 2020 calendar tax year on any distilled spirits used for or contained in hand sanitizer that is produced and distributed in a manner consistent with guidance issued by the Food and Drug Administration.
The summary information in this document is being provided for education purposes only. Recipients may not rely on this summary other than for the purpose intended, and the contents should not be construed as accounting, tax, investment, or legal advice. Taxpayers' positions may vary. We encourage any recipients to contact the authors for any inquiries regarding the contents. FGMK (and its related entities and partners) shall not be responsible for any loss incurred by any person that relies on this publication.
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