The CARES Act is the third phase of Congress’s response to the economic damage resulting from the 2020 Covid-19 pandemic. The act is the largest stimulus package in U.S. history, far larger than the package created after the great recession of 2009. This whitepaper addresses the key tax provisions in the act and the Paycheck Protection Loan Program.
Recovery Rebates for Individuals
The Act provides a refundable credit of up to $1,200 for single filers and $2,400 for married taxpayers filing jointly plus $500 for each child. These amounts are phased out at a rate of 5% for AGI in excess of $150,000 for a joint return and $75,000 for single filers. Thus, for example, if joint filers with no children have AGI of $170,000, the reduction is .05 x $20,000 = $1,000, leaving a credit of $1,400. No action is required by the taxpayer to claim the credit. The IRS will treat the taxpayer as having made a payment in the amount of the credit that would have applied to the taxpayer’s 2019 tax return and send this amount to the taxpayer as a refund.
Partial Above the Line Charitable Deduction
Historically, the charitable deduction was a below-the-line deduction available only to taxpayers who itemized their deductions. The Tax Cuts and Jobs Act (TCJA) nearly doubled the standard deduction, which is set at $24,800 in 2020. As a result, only 10% of taxpayers itemized their deductions, down from 30% before the TCJA was enacted. This is believed to have significantly reduced small charitable contributions. To address this concern, the CARES Act allows individuals who don’t itemize to deduct up to $300 of cash contributions above-the-line, provided they are made to Section 501(c)(3) public charities. The donations can’t be made to non-operating private foundations, support organizations or donor advised funds and excess charitable deductions carried forward from prior years aren’t eligible.
Changes in Percentage Limitations for Charitable Contributions
The CARES Act temporarily modifies the charitable contribution limitations for individuals and corporations. Following the TCJA, individuals who itemized their deductions could deduct contributions only up to 60% of their adjusted gross income (AGI). Any contributions in excess of this amount had to be carried forward and deducted during the next five years. For 2020 only, the Act allows individuals to deduct up to 100% of AGI, but the increased percentage doesn’t apply to contributions to supporting organizations or donor advised funds.
Under prior law, annual charitable contributions by corporations were generally limited to 10%, with a special 15% limitation for contributions of food. The Act increases both limitations to 25%. In the case of a partnership or S corporation, the election must be made separately by each partner or shareholder.
Employee Retention Credit
The Act creates a new credit against the FICA (Social Security) tax for employers who continue to pay their employees even though their business operations have been fully or partially suspended. To be an eligible business, an employer must have been carrying on a trade or business during 2020 and satisfy one of the following tests:
1. Business operations were fully or partially suspended during any quarter of 2020 pursuant to a government order related to COVID -19, or
2. The business remained open during any quarter of 2020 but, experienced a decline of at least 50% in gross receipts from the same quarter in 2019.
The credit is available to corporations as well as pass-through entities like LLCs, S corporations and partnerships, and sole proprietorships. It is also available to tax-exempt organizations.
The credit is equal to 50 percent of the qualified wages paid by the employer with respect to each employee, subject to limitations explained below and is refundable so employers who owe no taxes can still get the full amount. As long as the requirements for the credit are met, the employer doesn’t have to repay the credit or any resulting refunds.
The definition of qualified wages differs depending on the size of the business.
Employers with more than 100 full-time employees. Qualified wages include wages paid to employees when they are not providing services due to a governmental order related to COVID-19. If an employee is performing services on a reduced schedule, employers will receive a credit for the difference between the total wages paid to the employee and the amount the employer would have paid for the reduced hours or services actually provided by the employee.
Employers with 100 or fewer full-time employees. All employee wages qualify for the credit, whether or not the employee is providing services to the employer.
Regardless of business size, qualified wages include certain healthcare costs paid by an employer to maintain a group health plan. For purposes of determining the number of employees, certain aggregation and affiliation rules apply.
The amount of qualified wages with respect to any employee for all calendar quarters in 2020 can’t exceed $10,000 so there is a $5,000 total cap on the credit per employee for the 2020 tax year. The credit is also limited to the “applicable employment taxes” paid with respect to all employees for such calendar quarter, reduced by any credits under the Families First Coronavirus Response Act (FFCRA). The term “Applicable employment taxes” means the employer’s 6.2% portion of the Social Security tax. If the amount of the credit exceeds this limit for any calendar quarter, the excess is treated as a refundable overpayment. Finally, employers aren’t eligible for this credit if they receive any small business interruption loan pursuant to section 1102 of the CARES Act.
The credit is available for qualified wages paid from March 13, 2020 through December 31, 2020.
The Cares Act allows employers to delay payment of the employer share of the Social Security taxes (6.2%). The delay applies to Social Security taxes due on wages paid between March 27 and January 1, 2021. Deferred amounts are payable over the next two years with half due December 31, 2021 and the rest due December 31, 2022. Self-employed individuals can defer 50% of the Social Security portion of the Self-employed Contributions Act (SECA) tax under the same payment schedule.
Prior to 2018, taxpayers were allowed to carry back losses two years and carry forward losses 20 years. The 2017 TCJA eliminated the carryback period, but allowed losses to be carried forward indefinitely, limited to 80% of the taxpayer’s income.
Many business owners are expected to suffer large losses in 2020 as a result of the COVID-19 pandemic. To help these taxpayers, the CARES Act amends IRC section 172 to allow taxpayers to carry back losses sustained in 2018, 2019 or 2020 for 5 years, creating refunds for taxes paid in these carryback years. No election is required to carry back these NOLs. The NOL is first carried back to the earliest tax year of the 5-year carryback period, then to the next succeeding tax year and so on.
Taxpayers expecting to have a 2020 NOL should consider accelerating deductions into the 2020 tax year to include such deductions with their 2020 NOL carryback to increase the prior year tax refund. Note that if the taxpayer is a C corporation, a deduction carried back to 2015 or 2016 will be more favorable than a deduction carried back to a later year because it will offset income taxed at 35% instead of 21%.
The CARES Act also retroactively removes the 80% income limitation for NOL Carryforwards from taxable years beginning before 2021. The 80% limitation comes back for tax years beginning after 2021. Taxpayers who were subject to the 80% limitation should consider amending returns to take advantage of the new rule.
The 2017 TCJA disallowed the deduction of “excess business losses” for the tax years 2018 through 2026. Excess business losses are the amount by which net losses from all trades or businesses exceed $500,000 for married taxpayers filing jointly and $250,000 for single filers. The CARES Act modifies this limitation so it applies only to losses arising after 2020.
Prior to the CARES Act, IRC section 163(j) limited the amount of business interest expense that could be deducted in a tax year to the sum of—
(1) the taxpayer's business interest income for the year;
(2) 30% of the taxpayer's adjusted taxable income (ATI) for the year; and
(3) the taxpayer's floor plan financing interest expense for the year.
The CARES Act increases the ATI component of the calculation from 30% to 50% for tax years that begin in 2019 and 2020 and includes a special election that allows a taxpayer to use its 2019 ATI in lieu of its 2020 ATI on its 2020 tax return. Given the likely economic recession in 2020, many taxpayers may have higher ATI in 2019, making the election to use 2019 ATI more favorable. The additional interest expense deduction may also increase an NOL for 2020, which can now be carried back five years.
The TCJA modified IRC section 168 to consolidate qualified leasehold, qualified restaurant, and qualified retail improvement property into a new classification called qualified improvement property (QIP). QIP is defined as improvements to the inside of a non-residential building if the improvement is made after the building was first placed in service, other than improvements involving enlargement of the building, elevators or escalators, or the internal structural framework of the building.
Congress presumably intended QIP to be assigned a 15-year recovery period so it qualified for bonus depreciation, but due to an apparent drafting error the property was assigned a 39-year tax life. This error was referred to as the “retail glitch.” The CARES Act corrects the drafting error by assigning a 15-year depreciable life to QIP, making it eligible for bonus depreciation. The correction is retroactive to the effective date of the TCJA.
The Act postpones corporate estimated tax payments due after the date of enactment until October 15, 2020.
Small business owners in all U.S. states, Washington D.C., and territories may be eligible to apply for an Economic Injury Disaster Loan because of the COVID-19 pandemic. The loan is made by the Small Business Administration directly and a $10,000 advance on the loan can be requested as well. This loan advance will not have to be repaid. Details of the loan are as follows--
· Maximum amount of $2,000,000
· Proceeds must be used for working capital needs such as fixed debt and payroll
· Interest rate of 3.75% for businesses and 2.75% for nonprofits
· Loan term of up to 30 years, depending on the needs of the borrower
· Automatic one-year deferment on repayment so the first payment is not due for a full year
· Applicant must be adversely impacted by the COVID-19 pandemic
· Applicant must generally be a small business with 500 or fewer employees, but businesses in certain heavily impacted areas may also be eligible even if they have more than 500 employees
· Also, businesses in certain industries may have more than 500 employees if they meet the SBA’s size standards for those industries.
· Sole proprietorships, independent contractors, self-employed persons, private non-profit organization or 501(c)(19) veterans organizations affected by COVID-19 can apply.
The Paycheck Protection Program is the most important provision of the Cares Act for most small businesses. It originally provided $349 billion in government-backed loans and this amount was later increased by $310 billion. The loans don’t have to be paid back to the extent they are used for approved purposes.
Subject to certain exceptions listed below, all businesses with 500 or fewer employees can apply. This includes nonprofits, veterans organizations, Tribal business concerns, sole proprietorships, self-employed individuals, and independent contractors. Businesses in certain industries can have more than 500 employees if they meet applicable SBA employee-based size standards for those industries or an alternative size standard (average net income of not more than $5 million and tangible net worth of not more than $15 million). Businesses in the accommodation and food industry qualify if they have more than one physical location and have less than 500 employees per location as do franchises assigned a franchise identifier code by the SBA.
Some businesses aren’t eligible even if they meet the above requirements. Exceptions are made for—
· Businesses engaged in illegal activities;
· Household employers;
· Businesses in which a 20% or greater owner is incarcerated, on probation or on parole, and
· Businesses whose owners have delinquent SBA loans.
The maximum loan amount is the lesser of $10 million or 2.5 times the business’s average monthly payroll costs over the one-year period before the loan is made, plus the amount of any COVID-19 EIDL loan that is refinanced with the PPP loan. For purposes of the 2.5 test, any amount paid to an employee in excess of $100,000 is excluded, but this exclusion applies only to cash compensation above $100,000 and not to non-cash benefits like healthcare benefits, insurance premiums, retirement plan contributions and state and local taxes).
Example: A business has an annual payroll of $1,500,000, $300,000 of which represents excess salary income. It also has an outstanding EIDL loan of $10,000.
1. Subtract excess salary ($1,500,000 - $300,000)……………….$1,200,000
2. Average monthly qualifying payroll ($1,200,000/12)…….…..$100,000
3. Multiply by 2.5………………………………….…………..……..…………$250,000
4. Plus EIDL loan ($10,000)………………………………….......…..……$260,000
The following expenditures qualify as payroll costs for purposes of calculating the maximum loan amount—
· Payments to employees in the form of salary, wages, commissions or similar compensation
· Cash tips or the equivalent
· Payment for vacation, parental, family, medical or sick leave
· Allowance for separation or dismissal
· Group health care coverage, including insurance premiums
· Payment of state and local taxes assessed on compensation of employees
For an independent contractor or sole proprietor, payroll costs include wage, commissions, income, or net earnings from self-employment or similar compensation.
Expressly excluded from compensation are—
· Compensation of an employee whose principal residence is outside the U.S.
· Compensation of an individual employee in excess of an annual salary of $100,000, prorated as necessary
· Federal employment taxes imposed or withheld between February 15, 2020 and June 30, 2020, including the employer’s and employee’s share of FICA and Railroad Retirement Act taxes and income required to be withheld from employees
· Qualified and family leave wages for which a credit is allowed under the FFCRA
· Amounts paid to independent contractors
The Paycheck Protection Program offer two-year loans with an interest rate of one percent on a first-come, first-served basis. Borrowers won’t have to make any payments for six months following issuance of the loan, but interest will continue to accrue on the loan during this six-month deferral period. No eligible borrower can receive more than one PPP loan. The SBA ordinarily requires businesses to try to obtain loans from other sources before they can apply for an SBA loan, but this requirement is waived for PPP loans.
Loan proceeds may be used by small businesses for—
· payroll costs (excluding individual employee compensation over $100,000)
· group healthcare benefits
· mortgage interest payments
· interest on other debt incurred prior to the covered period.
The principal of the loan can be forgiven to the extent used for--
· payroll costs (excluding costs for any compensation above $100,000 annually),
· mortgage interest payments,
· rent payments and
· utility payments.
However, at least 75% must be used for payroll. The maximum amount that can be used for mortgage interest, rent and utility costs is 25%. Amounts paid to independent contractors aren’t counted as payroll costs.
Business owners must provide appropriate documentation to show that the funds were used for eligible purposes and the amount forgiven can’t exceed the amount of the loan. Amounts forgiven will be treated as non-taxable cancelled indebtedness for tax purposes.
If the business meets the above requirements, the full amount of the loan will be forgiven. The amount forgiven will be ratably reduced, however, if the average number of full-time equivalent employees is reduced during the eight-week period following loan origination compared with the average number for the period January 1, 2020 to February 29, 2020, or if the employer chooses, the period from January 1, 2019 to February 28, 2019. The amount of forgiveness will also be reduced to the extent the reduction in salaries of employees earning under $100,000/year exceeds 25% of the employee’s salary during the most recent full quarter preceding the forgiveness period.
Businesses that have furloughed or laid off employees due to COVID-19 or have reduced salaries can still qualify for full loan forgiveness if the reductions are eliminated by June 30, 2020.
Loans are originated by private lenders rather than the SBA. Borrowers can apply for a PPP loan through any of the 1,800 participating SBA approved lenders or through any participating federally insured depository institution, federally insured credit union, or Farm Credit System institution. Lenders are accepting applications from small businesses now and will continue until June 30, 2020. They are required to issue a decision on the application within 60 days. Lenders will also process loan forgiveness applications directly, and the SBA is required to purchase the forgiven loan from the lender within 90 days of forgiveness.
On the PPP application, an authorized representative of the applicant must certify in good faith to all of the following:
· The applicant was in operation on February 15, 2020 and had employees to whom it paid salaries and payroll taxes or paid independent contractors, as reported on a Form 1099-MISC.
· Current economic uncertainty makes the loan request necessary to support the ongoing operations of the applicant.
· The funds will be used to retain workers and maintain payroll or make mortgage interest payments, lease payments and utility payments
· During the period beginning on February 15, 2020 and ending on December 31, 2020, the applicant won’t receive another loan under the program.
Robert Keebler, CPA/PFS, MST, AEP® (Distinguished) is a partner with Keebler & Associates, LLP, and a recipient of the prestigious Accredited Estate Planners (Distinguished) award from the National Association of Estate Planners & Councils. He frequently represents clients before the IRS in the private letter ruling process and in estate, gift and income tax examinations and appeals, and has received more than 250 favorable private letter rulings including several key rulings of “first impression.” Keebler has been speaking at national estate planning and tax seminars for over 20 years and is a frequent presenter for New York Life's advisor webinars and company training conferences.
This writing is provided for informational purposes only. New York Life Insurance Company, its agents, and employees may not provide tax, legal or accounting advice, and none is intended nor should be inferred from the foregoing comments and observations. Clients should consult their own tax, accounting and legal advisors who must form their own independent opinions on these matters based upon independent knowledge and research.
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