Many aspects of the CARES Act have been covered in prior GKH emails and website posts. This article addresses the key tax provisions of the CARES Act as they relate to businesses. Certain topics, such as the Paycheck Protection Program, are not covered here because they are limited primarily to business loan programs and do not involve changes to the Internal Revenue Code.
Employee Retention Credit
The CARES Act allows eligible employers to take a credit against applicable employment taxes for each calendar quarter equal to 50 percent of the qualified wages with respect to each employee for the calendar quarter. The employee retention credit applies to wages paid after March 12, 2020, and before January 1, 2021. For purposes of determining the credit, the amount of qualified wages with respect to any employee that may be taken into account for all calendar quarters is limited to $10,000. An “eligible employer” is any employer that was carrying on a trade or business during calendar year 2020 and whose operation is fully or partially suspended during the calendar quarter due to orders by a government authority due to the COVID-19 pandemic, or for which the calendar quarter is within a period of “significant decline in gross receipts.” A period of significant decline in gross receipts means a period beginning with the first calendar quarter beginning in 2020 for which gross receipts for the quarter are less than 50 percent of gross receipts for the same quarter in the prior year, and ending with the first calendar quarter in which gross receipts are greater than 80 percent of the gross receipts for the same calendar quarter in the prior year. This provision is expected to keep $55 billion circulating in the economy. It is important to note that an employer cannot receive both a loan under the Paycheck Protection Program and an Employee Retention Credit.
Extension of Time to Pay Employment Taxes
Under the CARES Act, a business can delay payment of the employer portion of Social Security taxes for the period beginning on March 27, 2020, and ending before January 1, 2021 (i.e., the payroll tax deferral period). Generally, under this provision, an employer will be treated as having timely made all deposits of applicable employment taxes that would otherwise be required during the payroll tax deferral period if all such deposits are made not later than the “applicable date,” which is defined as (i) December 31, 2021, with respect to 50 percent of the amounts due, and (ii) December 31, 2022, with respect to the remaining amounts. In addition, self-employed taxpayers are able to defer 50 percent of the self-employment Social Security taxes for the payroll tax deferral period until the applicable date. For purposes of applying the penalty for underpayment of estimated income taxes to any tax year which includes any part of the payroll tax deferral period, 50 percent of the self-employment taxes for the payroll tax deferral period will not be treated as taxes to which that penalty applies. This provision is expected to keep $352 billion circulating in the economy.
Carryback of Net Operating Losses (NOLs) to Reduce Prior Year Income
The CARES Act modifies the limitation on deducting NOLs, as well as the rules relating to NOL carrybacks. Thus, a business that was not able to obtain the full benefit of deducting an NOL due to the Tax Cuts and Jobs Act, may now be able to do so by amending tax returns. In general, for any NOL arising from 2018 through 2020, the loss is an NOL carryback to each of the five tax years preceding the tax year in which the loss occurred. In addition, the provisions limiting the carrybacks of farming losses do not apply. For tax years beginning after 2020, the new law allows NOLs that were incurred before 2018 to be deducted, along with the lesser of (i) NOLs generated in tax years beginning in 2018 or (ii) 80 percent of taxable income after reduction for pre-2018 NOLs and without regard to certain deductions (e.g., IRC § 199A). In considering whether to amend tax returns in an effort to maximize an NOL carryback, it is necessary to evaluate the interaction of several Internal Revenue Code sections; the final decision, therefore, must be determined on a case-by-case basis.
Elimination of the Deduction Limitation on Excess Farm and Business Losses
Under current law, the deduction for business losses for non-corporate taxpayers is subject to an annual limitation, and losses in excess of that amount may be carried forward. Under the CARES Act, excess business losses, which were previously disallowed for tax years 2018 through 2025, are now allowed for tax years beginning at any time after 2017 and before 2021. In addition, for any tax year between 2018 and 2025, the deduction limitation on excess farm losses of certain taxpayers does not apply.
Alternative Minimum Tax Credit
The CARES Act modifies the rules for the minimum tax credit for alternative minimum tax (AMT) incurred by a corporation in a prior tax year. Under the CARES Act, the limitation will not apply to a corporation’s 2020 and 2021 tax years and the AMT refundable credit amount is 100 percent, rather than 50 percent, of the amount determined for tax years beginning in 2019.
Increase in Deductible Business Interest Expense
The Tax Cuts and Jobs Act limited the deduction of business interest to, among other factors, 30 percent of the adjusted taxable income of the taxpayer for the tax year in question. Under the CARES Act, for tax years beginning in 2019 or 2020, 50 percent of the taxpayer’s adjusted taxable income, rather than 30 percent, is used to determine the business interest expense limitation. A special rule is provided for partnerships, though guidance on the application to tiered partnership structures has not yet been issued. The definition of adjusted taxable income starts with the taxable income of the business, but is then reduced by several items, including business interest, NOLs, IRC § 199A deductions, and deductions allowable for depreciation, amortization, or depletion.
Qualified Improvement Property
The CARES Act fixes the so-called “retail glitch” that resulted from a drafting error in the Tax Cuts and Jobs Act. The error meant that the 15-year recovery periods that were available for qualified leasehold improvements, qualified restaurant property, and qualified retail improvement property (i.e., qualified improvement property) that was placed in service before 2018 no longer existed for such property placed in service after 2017. Instead, the depreciation period was 39 years. The CARES Act fixes this mistake so that such property now has a 15-year depreciation life and meets the criteria for taking a bonus depreciation deduction. Importantly, this correction is effective for tax years beginning in 2018. Therefore, taxpayers with qualified improvement property who filed a 2018 or 2019 return using a 39-year recovery period should consider amending their tax returns to see if they are entitled to a refund.
Excise Tax for Alcohol Used in Hand Sanitizer
For 2020, the CARES Act eliminates the excise tax on distilled spirits that are used in or contained in hand sanitizer produced and distributed in accordance with Food and Drug Administration guidance regarding the COVID-19 pandemic.
Charitable Contribution Deductions for Corporations
As noted in a prior GKH post, the CARES Act suspends the adjusted gross income limitation on charitable contributions made by individuals in 2020. Under prior law, the deduction allowed to a corporation for charitable contributions was limited to 10 percent of the corporation’s taxable income. Under the CARES Act, that limitation is increased to 25 percent of the corporation’s taxable income. Excess contributions may be carried forward for five years, subject to certain requirements. To qualify for a deduction, charitable contributions must be in cash and made in 2020. As is the case for individuals, the 15 percent net income limitation that usually applies to contributions of food inventory has been raised to 25 percent.
Further updates will be provided as developments are confirmed. Businesses with net operating losses or qualified improvement property are reminded to consider whether amending their tax return would result in a tax refund.
This update was prepared by attorney Doug Smith, who practices in the areas of estate planning, estate administration, tax law, and business and non-profit planning. It does not constitute legal advice and has been prepared for informational purposes only. Please contact Doug directly with questions about how these provisions affect you.