CARES Act Provides Important Tax Benefits to Businesses
Kelley Drye Client Advisory
The Coronavirus Aid, Relief, and Economic Security Act or “CARES Act,” which was enacted on March 27, 2020, contains several tax provisions that are intended to alleviate business cash-flow problems and stimulate the economy. A key provision is a tax credit that can, under some circumstances, partially reimburse an employer for wages paid to employees where the employer’s business experiences a government-mandated COVID-19 shutdown or a revenue reduction that exceeds certain thresholds. The tax provisions also include partial roll-backs of certain deduction limitations introduced by the 2017 Tax Cuts and Jobs Act. In addition, the tax provisions re-introduce 5-year net operating loss (“NOL”) carrybacks – a device that was used to help businesses following the 2008 financial crisis.
We expect to supplement this advisory as more information becomes available, and we also expect to add advisories discussing other tax aspects of the CARES Act, as well as tax aspects of the Families First Coronavirus Response Act, so please check back with us.
Credit for Retaining EmployeesSection 2301 of the CARES Act provides a potentially refundable tax credit to certain employers for up to 50% of wages that the employer continues to pay certain employees in the face of a government-mandated COVID-19 shutdown or a loss of revenue that exceeds certain thresholds. The credit is allowed against certain employment taxes, including the employer’s share of Old-Age, Survivors, and Disability Insurance (i.e., Social Security) taxes and a portion of Railroad Retirement Tax Act taxes. Employers that carry on a trade or business during 2020 are eligible for the credit during the following two periods:
- A calendar quarter during which the trade or business is fully or partially suspended due to a government order limiting commerce, travel or group meetings due to COVID-19; or
- The calendar quarters starting with the first quarter beginning after December 31, 2019 during which the employer’s gross receipts are less than 50% of its gross receipts for the same quarter in the prior year and ending with the quarter following the first quarter for which the employer’s gross receipts exceed 80% of its gross receipts for the same quarter in the prior year.
Employers potentially eligible for the credit include tax-exempt organizations described under Section 501(c) of the Internal Revenue Code, but only for periods during which they are subject to a government-mandated shutdown as described above. Governments are generally not eligible for the credit.
In general, wages (including “qualified health plan expenses” allocable to such wages) potentially trigger the credit if they are paid after March 12, 2020 and before January 1, 2021 and:
- In the case of an eligible employer with, on average, more than 100 full-time employees during 2019, the wages are paid to employees who are not providing services due to a government-mandated business suspension described above or during a quarter meeting the revenue reduction thresholds described above, or
- In the case of an eligible employer with, on average, 100 or fewer full-time employees during 2019, the wages are paid to employees during a government-mandated business suspension described above or during a quarter meeting the revenue reduction thresholds described above, regardless of whether the employees are still providing services.
There are a number of limitations on wages that must be taken into account in calculating the credit:
- Wages are not taken into account in calculating the credit if they also trigger credits for paid leave under Section 7001 or Section 7003 of the Families First Coronavirus Response Act;
- In the case of an eligible employer with, on average, more than 100 full-time employees during 2019, wages are not taken into account to the extent they exceed the amount the employee would have been paid for working an equivalent duration during the 30 days immediately preceding the triggering period; and
- The amount of the wages that may be taken into account in calculating the credit is limited to $10,000 in the aggregate per employee, for all quarters. The credit is therefore effectively capped at $5,000 per employee.
There are a number of other limitations to eligibility for the credit, including:
- Employees are not taken into account for periods during which the employer is allowed a credit under Section 51 of the Internal Revenue Code with respect to the employee; and
- Employers that have received certain loans under the Small Business Act are not eligible for the credit.
In addition, wages taken into account in calculating the credit under Section 2301 are not taken into account for purposes of determining the credit otherwise allowed under Section 45S of the Internal Revenue Code.
Expanded Availability of Net Operating Losses, Including 5-Year CarrybacksPrior to the 2008 financial crisis, taxpayers were generally able to carry NOLs back for two years and forward for 20 years. As a result of the 2008 financial crisis, some taxpayers were temporarily allowed to carry NOLs back for as many as five years. The Tax Cuts and Jobs Act, however, severely curtailed the use of NOLs, including by eliminating the ability to carry back NOLs arising in taxable years ending after December 31, 2017 and by generally limiting the use of NOLs arising in tax years beginning after December 31, 2017 to 80% of a taxpayer’s taxable income.
Section 2303 of the CARES Act significantly expands the ability of certain taxpayers to utilize both NOL carryforwards and also carrybacks. In particular:
- NOLs arising in tax years beginning after December 31, 2017 and beginning before January 1, 2021 may generally be carried back for five years. Thus, in the case of a calendar-year taxpayer, NOLs arising in 2018, 2019, and 2020 may generally be carried back for as many as five years.
- In the case of tax years beginning before January 1, 2021, the 80% limitation on the use of NOLs (whether carrybacks or carryforwards) has been lifted.
- In the case of tax years beginning after December 31, 2020, the 80% limitation continues to apply, in a modified fashion.
- NOL carrybacks, however, are still generally unavailable for REITs.
- Taxpayers with a Code Section 965 transition tax inclusion are deemed to make a Code Section 965(n) election and may elect to exclude years with a Code Section 965 inclusion from the NOL carryback period.
Increase in Interest Deduction LimitationPrior to the enactment of the CARES Act, under Section 163(j) of the Internal Revenue Code, taxpayers with average annual gross receipts of more than $25 million were generally subject to a limit on the amount of “business interest” that they could deduct. For most such taxpayers, the limit was the sum of the taxpayer’s business interest income for the tax year and 30% of the taxpayer’s “adjusted taxable income” for the tax year. Adjusted taxable income is roughly equal to EBITDA for tax years beginning before January 1, 2022, and roughly equal to EBIT for tax years beginning on or after January 1, 2022.
Section 2306 of the CARES Act increased the percentage of adjusted taxable income described above from 30% to 50% for tax years beginning in 2019 or 2020. The increase in the limit operates differently in the case of partnerships. Taxpayers may elect to use their adjusted taxable income for their tax year beginning in 2019 for their tax year beginning in 2020. Such an election could be beneficial to taxpayers that have less income in 2020 than in 2019.
Deferral of Certain Employment Tax PaymentsSection 2302 of the CARES Act provides for the deferral of certain employment taxes for the applicable period, which begins on March 27, 2020 and ends before January 1, 2021. Employers are, with some exceptions, permitted to defer the payment of their share of Social Security taxes and a portion of Railroad Retirement Tax Act taxes for the applicable period. 50% of such deferred amounts is due on December 31, 2021, and the remaining 50% is due on December 31, 2022. In addition, self-employed individuals may defer 25% of their Social Security taxes for the applicable period until December 31, 2021 and 25% of such taxes until December 31, 2022. The Section 2302 tax deferral is not available to taxpayers that have had certain indebtedness forgiven under Section 1106 or Section 1109 of the Act.
The CARES Act does not defer Hospital Insurance (i.e., Medicare) taxes or the employee’s share of Social Security taxes.
Correction of Qualified Improvement Property Cost Recovery PeriodSection 13204 of the Tax Cuts and Jobs Act combined three types of property – qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property – into a single class of property called qualified improvement property. Apparently, when this change was made, it was intended that qualified improvement property would have a 15-year cost recovery period under the modified accelerated cost recovery system (MACRS). Due to a drafting error, however, Section 13204 failed to identify qualified improvement property as 15-year property, so qualified improvement property was therefore inadvertently treated as 39-year property.
Section 2307 of the CARES Act corrected the error made in Section 13204 of the Tax Cuts and Jobs Act and made it clear that qualified improvement property is to be classified as 15-year property under MACRS. As a result, under certain circumstances, such property may be subject to full-expensing.