The Coronavirus Aid, Relief, and Economic Security Act (H.R. 748; the CARES Act) includes several tax-related provisions, including tax rebates, modifications to the Tax Cuts and Jobs Act (TCJA), hiring and paid leave incentives, and increased deductions for charitable contributions.
These tax-related provisions are just a part of the CARES Act’s $2 trillion stimulus package, designed to stimulate the U.S. economy in light of the ongoing coronavirus crisis.
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Recovery Rebates for Individuals
Under the CARES Act, individuals are allowed a credit against income taxes they owe for 2020 equal to $1,200 (or $2,400 in the case of a joint return), not to exceed the tax liability for the year. However, if a taxpayer has (i) “qualifying” income (the sum of earned income, social security benefits and pension income) of at least $2,500, (ii) taxable income greater than zero and (iii) gross income greater than the basic standard deduction, then the taxpayer is entitled to a credit of at least $600 (or $1,200 in the case of a joint return) plus $500 per qualifying child (generally, a child that can be claimed as a dependent).
This credit is phased out (reduced) by 5 percent of adjusted gross income above $75,000 (or $150,000 in the case of a joint return).
The credits are refundable, meaning that if the income tax liability of an individual or married couple is less than the credit, the difference will be paid in cash. These credits are not available to nonresident aliens or taxpayers who are claimed as a dependent by another.
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Employee Retention Credits
The CARES Act creates a fully-refundable payroll tax credit for employers equal to 50 percent of the “qualified wages” paid by employers between March 13, 2020 and December 31, 2020. To be eligible for the employee retention credit, a business must (i) be fully or partially suspended due to an order from a governmental authority limiting travel, commerce or meetings during the applicable calendar quarter or (ii) suffer a significant decline in gross receipts—i.e., a reduction in gross receipts of 50 percent or more during a calendar quarter when compared to the same quarter during the previous year.
The period during which qualified wages may be paid begins in the first calendar quarter during which either of the above conditions occurs (i.e., a business suspension or significant decline in gross receipts) and continues until the first calendar quarter following (i) the lifting of full or partial business suspension or (ii) the calendar quarter that the gross receipts of the employer are greater than 80 percent of the gross receipts for the same calendar quarter in the prior year. For organizations that are exempt from tax under Section 501(c)(3), all wages paid between March 13, 2020 and December 31, 2020 can be qualified wages (subject to the rules described below).
For employers with more than 100 full-time employees, qualified wages include only wages paid to employees who—at the time the wages are paid—are not performing services due to the business suspension or significant decline in gross receipts. (The CARES Act does not provide guidance on how to determine whether such an absence from work is due to one of those two circumstances.) For employers with 100 or fewer full-time employees, all employee wages paid during the qualifying period are deemed to be qualifying wages.
50 percent of the first $10,000 of compensation paid to an eligible employee during a quarterly period is eligible for a credit against the employer portion of FICA tax liability for the applicable period. Although the credit is in the form of a payroll tax credit, it is not limited to FICA taxes attributable to the qualified wages but is equal to 50 percent of the qualified wages and can be applied against all of an employer’s FICA taxes.
The credits also are refundable; to the extent that an employer’s allowable credits exceed its payroll tax liability for the applicable period, the employer can obtain a cash refund. Additionally, the CARES Act directs Treasury and the IRS to develop rules allowing for the credits to be advanced – i.e., claimed in cash prior to the due date for the employer’s payroll taxes by allowing an employer to retain amounts withheld from employees.
The qualified wages cannot exceed the amount an employee would have been paid for working an equivalent duration during the 30 days immediately preceding the period during which qualified wages can be paid. Employer contributions to a qualified group health care plan can be included in qualified wages to the extent that such contributions are properly allocable to the qualified family leave wages (under guidance to be issued by Treasury).
Employers that are part of a controlled or affiliated group are treated as a single employer for purposes of the credit.
Employers are not eligible for the credit if they receive a small business loan pursuant to the CARES Act. Likewise, employers may not claim credits for (i) any amounts used to determine such an employer’s credit under Internal Revenue Code Section 45S, which allows employers to claim a tax credit for family leave wages if the employer has a written family leave policy in place that meets certain requirements or (ii) any employee for whom a work opportunity credit, which provides a credit to employers who hire individuals who are members of targeted groups, is claimed.
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Delay of Payment for Employer Payroll Taxes
FICA taxes are imposed on both employers and employees on employees’ wages at a rate of 6.2 percent for the Social Security Tax and 1.45 percent for the Medicare Tax. Self-employed individuals pay self-employment tax equal to 12.4 percent Social Security Tax and 2.9 percent Medicare Tax. The CARES Act allows an employer to defer payments of the employer portion of the Social Security Tax and allows a self-employed individual to defer 50 percent of their Social Security tax. The deferred taxes must be paid over the following two years, with 50 percent to be paid by December 31, 2021 and the other 50 percent by December 31, 2022. Employers that are granted loan forgiveness under the Small Business Act loan program created by the CARES Act are not eligible for this deferral.
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Advancement of FFCRA Tax Credits for Paid Sick Leave and Family Leave
As described in our alert available here, the Families First Coronavirus Response Act (FFCRA) provides federal payroll tax credits for paid sick leave and family leave required by the FFCRA for employers with 500 or fewer employees and paid between March 20, 2020 and December 31, 2020. Those credits (subject to limitations described in our earlier alert) are available to employers who pay wages to individuals who are unable to work because of their own coronavirus related health reasons or because they are forced to care for family members.
The CARES Act amends the FFCRA to expressly allow Treasury and the IRS to provide rules for the credits to be advanced—i.e., claimed in cash prior to the due date for the employer’s payroll taxes by allowing an employer to retain amounts withheld from employees. Although such an advance was not expressly allowed by the FFCRA, this authorization is consistent with guidance published last week by Treasury, the IRS, and the Department of Labor. We expect more specific guidance before April 30, 2020, the date by which employers are required to file their quarterly employment tax returns for the first quarter of 2020.
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Increased Incentives for Charitable Contributions of Cash During 2020
The CARES Act includes incentives designed to get money into the hands of charities quickly by encouraging charitable contributions by individuals and businesses during 2020, allowing individuals to claim an above-the-line deduction for cash contributions of up to $300 and allowing both individuals and businesses to claim increased deductions for all cash contributions.
Charitable contributions generally are a “below-the-line” deduction and therefore are deductible only by individuals who itemize deductions, not by individuals who claim the standard deduction. However, under the CARES Act, for cash contributions made during 2020, individuals can claim an above-the-line deduction of up to $300, thereby decreasing their income before taking into account the standard deduction. This above-the-line deduction applies only to cash contributions to public charities (not private foundations) and does not apply to contributions to donor advised funds. Additionally, taxpayers cannot claim the above-the–line deduction for any contributions carried forward from prior years. Contributions can only be deducted once—if a contribution is deducted above-the-line, it cannot also be deducted as an itemized deduction.
Under current law, itemized deductions for cash contributions to public charities generally are subject to limitations: (1) 50 percent of adjusted gross income (AGI) for individuals; and (2) 10 percent of taxable income for corporations. For cash contributions made during 2020, these limitations are suspended. An individual may elect to take an itemized deduction for cash charitable contributions up to 100 percent of his or her gross income. A corporate taxpayer may deduct such cash contributions made during 2020 up to 25 percent of its taxable income. These increased limitations apply only to contributions to public charities (not private foundations) and do not apply to contributions to donor advised funds. With respect to contributions by a pass-through entity (i.e., a partnership or S corporation), the election to apply the special 2020 limitations is made by each partner or shareholder.
The CARES Act increases the allowable deduction for contributions of food inventory by businesses. Under current law, a business other than a C corporation can deduct such contributions up to a limit of 15 percent of such a taxpayer’s aggregate net income from the trades or businesses from which such contributions were made for such year and a C corporation can deduct such contributions subject to a limitation of 15 percent of its taxable income. For contributions of food inventory made during 2020, both of these limitations are increased to 25 percent.
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Qualified Improvement Property Fix
The TCJA allows for bonus depreciation—100 percent expensing—for qualified property subject to a phase out. Only property with a MACRS life of 20 years or less is eligible for 100 percent expensing.
When it passed the TCJA, Congress intended for qualified improvement property (QIP)1 to be eligible for 100 percent expensing, subject to an election by a taxpayer that is a real estate trade or business to deduct 100 percent of its interest expenses. However, Congress forgot to assign the intended MACRS life of 15 years to QIP (resulting in QIP having a 39 year MACRS life), leading to what has become known as the “retail glitch.”
The CARES Act fixes the retail glitch by assigning a 15-year MACRS life to QIP and a 20-year ADS life to QIP, effective as if these changes were enacted as part of the TCJA. This means that the 15-year MACRS life applies to QIP acquired and placed in service after September 27, 2017, and the change in ADS life applies to QIP placed in services after December 31, 2017.
This fix also impacts real estate trades or businesses that elect to deduct all of their interest expenses. A taxpayer who makes such an election is required to use the ADS life to depreciate QIP with respect to which the election is made. Before this fix, the ADS life for QIP was 40 years. The CARES Act makes the ADS life 20 years, effective for QIP placed in service after December 31, 2017.
Treasury likely will announce rules explaining how taxpayers may claim these benefits with respect to returns that already have been filed for 2017, 2018 and 2019.
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Reduction of Business Interest Deduction Limitations
The TCJA imposed a limitation on the deduction of business interest. Specifically, Section 163(j) provides that the deduction for business interest for any tax year is limited to 30 percent of the taxpayer’s adjusted taxable income for the tax year. Interest disallowed under this provision can be carried over indefinitely. The CARES Act increases the allowable interest deduction to help businesses increase liquidity if they have debt or must take on more debt during the coronavirus crisis.
The CARES Act increases the amount of interest that may be deducted under Code Section 163(j) for 2019 and 2020 by raising the limitation on deductions of business interests from 30 percent of adjusted taxable income to 50 percent of adjusted taxable income. A taxpayer may also elect for any tax year beginning in 2020 to substitute the adjusted taxable income beginning in 2019 so that it may increase the base to which the 50 percent limit applies.
The limitation remains 30% for a partnership; however, 50 percent of the excess business interest allocated to a partner is deductible and the other 50 percent is suspended until the partnership allocates sufficient business income to the partner for the partner to deduct such suspended interest.
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Net Operating Loss Changes
For tax years ending after 2017, the TCJA eliminated the ability of a taxpayer to carryback net operating losses (NOLs); NOLs only may be carried forward (indefinitely). In addition, only 80 percent of income may be offset by NOL carryovers.
For NOLs arising in tax years beginning before January 1, 2021, the CARES Act once again allows losses to be carried back, and those carrybacks may offset 100 percent of income for the prior five years (2013 through 2017). An amended return may be filed to claim the benefit back to 2013.
The CARES Act also allows NOLs arising in tax years beginning after December 31, 2020, to offset 100 percent of income going forward rather than 80 percent as allowed under the TCJA.
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Modification of Excess Business Loss Deduction Limit
Under the Tax Cuts and Jobs Act, for tax years beginning before January 1, 2026, Section 461(l) disallows the “excess business loss” of an individual taxpayer. An excess business loss for a tax year is the excess of aggregate deductions of the individual taxpayer attributable to its trades or businesses, over the sum of aggregate gross income or gain of the taxpayer plus a threshold amount. Losses disallowed by Section 461(l) generally are carried forward and treated as part of the taxpayer’s net operating loss carryforward in subsequent tax years.
The CARES Act turns off this excess loss disallowance for 2018, 2019, and 2020 and modifies these limitations going forward. Individual taxpayers who had losses disallowed in 2018 and 2019 will be able to obtain refunds. The modifications applicable to tax years beginning on or after January 1, 2021 include prohibiting individual taxpayers from counting wages as business income thus further limiting the losses that will currently deductible.
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Corporate Minimum Tax Credit
The alternative minimum tax for corporations was eliminated by the TCJA for tax years after 2017, and corporations could continue to claim the refundable portion of any unused minimum tax credits through 2021. Under the TCJA, the amount of the refundable credit is limited to 50 percent of any excess minimum tax in 2018 through 2020, and any remaining credit is fully refundable in 2021. The CARES Act accelerates the year for which a fully refundable minimum tax credit can be claimed to 2019, and it also allows corporations to elect to claim the fully refundable minimum tax credits in 2018.
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Cancellation of Indebtedness Income
If debt is forgiven or cancelled, subject to specified exceptions, the amount forgiven or cancelled is ordinary income that is taxable. Debt can be cancelled for tax purposes if the lender forgives all or part of the outstanding balance but also in the case of certain modifications of the debt. Exceptions to income recognition when debt is cancelled or forgiven include: the taxpayer is insolvent, the discharge of the debt occurs in a Chapter 11 bankruptcy case, or the debt is qualified real property business indebtedness. In such cases, the taxpayer must reduce tax attributes, such as the tax basis for depreciable property, net operating losses, etc.
The CARES Act includes provisions allowing for forgiveness of certain loans guaranteed by the Small Business Administration and it provides that any such forgiveness is not income to the borrower. (The CARES Act that not include provisions that would require the borrower to reduce tax attributes.)
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Loans Made by Treasury Under the CARES Act
The CARES Act allows Treasury to provide up to $500 billion in loans, loan guarantees and other investments in support of (i) eligible businesses, including airlines, cargo air carriers and business necessary for maintaining national security and (ii) state and local governments. Loans made or guaranteed by Treasury under this program will be treated as indebtedness for federal income tax purposes. Thus, such loans will not be includable in taxable income of the borrower when received and interest payments with respect to such loans will generate tax deductions for the borrower when paid, subject to the interest disallowance rules in the Code.
Loans under this program generally will bear interest at a rate determined by Treasury based on the risk and the current average yield on outstanding marketable obligations of the U.S. of comparable maturity. With respect to loans made to airlines, cargo carriers, and businesses critical to maintaining national security, to the extent practicable, the interest rate will not be less than an interest rate based on market conditions for comparable obligations prevalent prior to the outbreak of COVID-19. Any loan made under this program will be treated as issued for its stated principal amount, and the stated interest on such loan will be treated as qualified stated interest, such that the original issue discount provisions under the Code will not be applicable to such loans.
The CARES Act also gives Treasury the authority to issue regulations or guidance to carry out the purposes of this program, including guidance providing that the acquisition of warrants, stock options, common or preferred stock, or other equity under this program does not result in an ownership change for purposes of the net operating loss limitations of Section 382 of the Code. This rule will prevent corporations from being subject to a limit on the net operating losses they would otherwise be allowed to use to offset taxable income in a subsequent tax year.
Please contact any member of the Ballard Spahr's Tax Group if you have any questions about the tax provisions of the CARE Act or any other tax matters.
1: QIP is any improvement to the interior of nonresidential real property if such improvement is placed in service after the date the building is placed in service other than (i) an enlargement of a building, (ii) an elevator or escalator, or (iii) internal structural framework of a building.