Tax savings opportunities from the CARES Act

By John Werlhof, CPA

PHOTO BY JOHANNES EISELE/GETTY IMAGES
PHOTO BY JOHANNES EISELE/GETTY IMAGES
 

EXECUTIVE
SUMMARY

 
  • The Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136, contains important tax changes designed to deliver speedy relief to businesses and individuals struggling due to the COVID-19 pandemic.
  • For businesses, net operating losses from the 2018, 2019, and 2020 tax years can now be carried back. The excess business loss rules have been suspended temporarily for individuals.
  • The limitation on business interest has been modified to allow more business interest to be deducted. The adjusted taxable income limit of 30% for the limitation is raised to 50% for 2019 and 2020.
  • Qualified improvement property is now eligible for 100% bonus depreciation, retroactive to property acquired and placed in service after 2017.
  • The employer portion of Social Security tax is deferred. Also, the employee retention credit provided by the CARES Act allows eligible employers a refundable payroll tax credit equal to 50% of qualified wages paid to employees.
  • In addition, the CARES Act generally removes the 10% penalty on an early withdrawal from retirement accounts if the withdrawal is coronavirus-related, gives employers a temporary incentive to help employees pay down their student loans, and provides certain favorable rules for 2020 cash charitable contributions, among other things.

On March 27, President Donald Trump signed the Coronavirus Aid, Relief, and Economic Security (CARES) Act,1 the third phase of legislation aimed at fighting the COVID-19 pandemic and mitigating the related economic harm for families, workers, and businesses. It is the largest stimulus package in history with an estimated cost of $2.2 trillion. The CARES Act, among other things, provides "recovery rebates" to individuals, expands and enhances unemployment benefits, extends loans and loan guarantees to eligible businesses, offers funding for the health care and education systems, and provides tax relief for businesses and individuals. This article discusses business and individual tax provisions of the CARES Act.

Business provisions
Deferral of employer Social Security tax

The employer share of the 6.2% Social Security tax on wages paid from March 27, 2020, through Dec. 31, 2020, is deferred, with 50% due on Dec. 31, 2021, and 50% due on Dec. 31, 2022.2 A similar rule applies to 50% of self-employment tax liability of partners and sole proprietors.

Originally, employers that take advantage of loan forgiveness under the Paycheck Protection Program (PPP) (a CARES Act program involving certain loans for payroll and specified other expenses that is administered by the U.S. Small Business Administration) were not eligible to defer the deposit and payment of the employer share of Social Security tax, but that prohibition was repealed in June.3

Employee retention credit

The CARES Act added a refundable payroll tax credit equal to 50% of qualified wages (wages, including qualified health plan expenses allocable to the wages) paid by eligible employers from March 13, 2020, to Dec. 31, 2020.4 An eligible employer is one whose:

  • Operations were fully or partially suspended due to a COVID-19-related shutdown order; or
  • Gross receipts declined by more than 50% when compared with the same quarter in the prior year (the employer remains an eligible employer in subsequent quarters until its gross receipts exceed 80% of gross receipts compared with the same quarter for the prior year).

If the employer has more than 100 employees, qualified wages include only wages paid to employees who are not working as a result of a COVID-19-related shutdown order or the significant decline in gross receipts. For employers with 100 or fewer employees, qualified wages paid during the period when the operations were fully or partially suspended or during a quarter in which gross receipts have significantly declined are eligible for the credit, even if paid to an employee who is still working.

The credit is limited to the first $10,000 of qualified wages paid to a particular worker. The credit is not available for wages taken into account in computing the sick leave or family medical leave credits under the Families First Coronavirus Response Act (FFCRA).5 Similarly, the credit is not available to employers who receive a small business interruption loan under the PPP.

Example 1: E Inc. is an electrical contractor whose operations are partially suspended from March 20 through April 14 as a result of a COVID-19-related shutdown order. A few of E's employees are able to work from home during the shutdown, but most are not. E continues to pay all its employees, regardless of whether they are able to work. Assume for purposes of this example that E is not eligible to claim the sick leave or family medical leave credits under the FFCRA. E's second-quarter gross receipts decline by 25% relative to the same quarter in the previous year and then pick back up in the third quarter.

If E has more than 100 employees, it can claim the retention credit with respect to the portion of qualified wages paid from March 20 to April 14 to employees unable to work. The credit is not available for qualified wages paid to employees for work actually performed.

If E has 100 or fewer employees, it can claim the retention credit with respect to all qualified wages paid from March 20 to April 14 — even wages paid to employees for time they are working.

Reinstatement of NOL carrybacks

Following the passage of the law known as the Tax Cuts and Jobs Act (TCJA),6 net operating losses (NOLs) generated in tax years beginning in 2018 and later years cannot be carried back and can only offset up to 80% of taxable income in carryover years.7 The CARES Act permits NOLs from the 2018, 2019, and 2020 tax years to be carried back to the previous five tax years (beginning with the earliest year first) and suspends the 80%-of-taxable-income limitation through the 2020 tax year.8

Taxpayers can elect to waive the loss carryback.9 For losses generated during the 2018 and 2019 tax years, the waiver is made by attaching an election statement to a timely filed return for the first tax year ending after March 27, 2020.10 For example, a calendar-year corporation with an NOL in 2018 would waive the carryback for the 2018 year by attaching a waiver election to its timely filed 2020 tax return. Taxpayers cannot elect a reduced carryback period (e.g., there is no election to use a two-year carryback in lieu of the five-year carryback).

Aside from the cash flow benefits, NOL carrybacks present an opportunity to secure permanent tax savings by using losses to offset income generated prior to the TCJA when the tax rates were higher. For example, a corporate NOL from 2020 can be carried back to offset income from 2015 that may have been subject to a 35% tax rate rather than carried over to 2021 when income is subject to a 21% tax rate. In some cases, however, income in future years will be subject to higher tax rates than income in the carryback period, and the taxpayer may prefer to waive the carryback.

Depending on the taxpayer's situation, it may be beneficial to pursue planning measures to accelerate deductions and defer income to increase the NOL available to be carried back. If 2019 was profitable but the taxpayer anticipates a loss for 2020, the planning may focus on accelerating income into 2019 and deferring deductions to 2020 to maximize the NOL for 2020.

Example 2: B Inc., an accrual-method C corporation, anticipates having $2 million of taxable income in 2019 and $0 taxable income in 2020. B's projections assume it will defer recognizing income associated with a one-time prepayment of $1 million received in 2019 for services to be performed in 2020 under the deferral method of Sec. 451(c). If B uses the full inclusion method instead, B will have $3 million of taxable income in 2019 (subject to tax at a 21% rate) and a $1 million NOL in 2020 that can be carried back to offset income in 2015 (subject to tax at a 35% rate). While it is counterintuitive to accelerate income, doing so creates an NOL in 2020 that can be carried back to offset income subject to higher rates in earlier years, resulting in permanent tax savings of $140,000. The additional tax for the 2019 calendar tax year is generally due by July 15, and the refund for carrying back the 2020 loss will not be available until 2021, so taxpayers that need cash to keep their business afloat may not be in a position to take advantage of this planning opportunity.

The CARES Act also made a few technical corrections to the TCJA's NOL rules. For example, NOLs generated in a year beginning in 2017 and ending in 2018 can now be carried back two years. As another example, for tax years after 2020, the 80%-of-taxable-income limitation is computed by increasing taxable income for deductions under Secs. 199A and 250 and is reduced for NOL carryovers from pre-2018 tax years.11

Temporary suspension of excess business loss rules

The TCJA limited individuals from using more than $250,000 ($500,000 for married filing jointly (MFJ) taxpayers) of business losses to offset nonbusiness income.12 The CARES Act repeals the limitation for years beginning before Jan. 1, 2021.13 The repeal is nonelective, so it appears that any taxpayer with an excess business loss in 2018 or 2019 will need to amend their return to claim that loss, regardless of whether doing so is favorable.

Example 3: A is a single individual whose only items of income and loss for 2018 were a $3 million business loss from his S corporation construction business and a $4 million long-term capital gain from the sale of marketable securities. A used only $250,000 of the business loss against the long-term capital gain in 2018 due to the excess business loss rules. He was planning to carry over the $2,750,000 excess loss to 2019 to offset ordinary income from the business.

A appears to be required to amend his 2018 tax return to use the ordinary loss to offset the long-term capital gain income otherwise taxed at preferential capital gains rates. A cannot use the 2018 loss to offset any of his 2019 ordinary income. The repeal of the excess business loss rules increased A's total 2018 and 2019 tax liability.

The CARES Act also made several adjustments to the computation of the excess business loss that will apply beginning in 2021, such as treating wage income as nonbusiness income.

Corporate credit for prior-year AMT

The TCJA repealed the corporate alternative minimum tax (AMT)14 and provided an opportunity for corporations to claim a refund of minimum tax credit carryovers during 2018-2021.15 The CARES Act makes any remaining minimum tax credit carryovers fully refundable in 2019.16 Alternatively, corporations can elect to claim a refund for the unused carryovers in 2018.17

Modification of business interest limitation

The business interest limitation was added by the TCJA and generally limits the deduction for business interest expense to the sum of (1) business interest income; (2) 30% of adjusted taxable income (ATI); and (3) floor plan financing interest.18 Certain small taxpayers are exempt from the limit.19

The CARES Act increases the limit to 50% of ATI for 2019 and 2020,20 potentially increasing interest expense deductions and thereby reducing taxable income (or creating an NOL that can be carried back). Taxpayers can elect to use their 2019 ATI in computing the 2020 limit, providing relief to those whose income declines in 2020.21 Taxpayers can elect to apply the more restrictive 30%-of-ATI limit if desired.22

A special rule applies to partnerships in 2019. Instead of increasing the limit from 30% of ATI to 50% of ATI, half of the excess business interest of a partnership allocated to a partner is treated as business interest of the partner in 2020 and is not subject to the business interest limit at the partner level.23 The other half of the excess business interest expense is subject to the normal rules for excess business interest. Partners can elect out of this relief provision if desired. The 50%-of-ATI limit applies to partnerships in 2020.

Example 4: P Partnership incurred $50 of business interest expense and has ATI of $100 in 2019. P does not have any business interest income or floor plan financing interest. P's business interest limitation is $30 (30% × $100 ATI), so $30 of its interest is currently deductible and $20 is allocated to the partners as excess business interest. Y is a 50% partner and is allocated $10 of the excess business interest.

In 2020, Y will be able to deduct half of the 2019 excess business interest expense from P (50% × $10 excess business interest from 2019 = $5). The other half of Y's excess business interest expense is subject to the normal business interest rules. Specifically, the excess business interest is treated as business interest paid by Y (and then subjected to Y's personal business interest limit) to the extent Y is allocated excess taxable income from P in a subsequent year.24

The change presents an amended return opportunity for taxpayers who have already filed their 2019 tax returns with a restrictive business interest limit. The special rule for partnerships eliminates the burdens of filing an administrative adjustment request for those partnerships that have already filed their 2019 tax returns.

Bonus depreciation for qualified improvement property

Under the TCJA, qualified improvement property (QIP) was supposed to have a 15-year cost recovery period and be eligible for 100% bonus depreciation. A drafting error, however, caused QIP to have a 39-year cost recovery period and be ineligible for bonus depreciation. The CARES Act retroactively corrects the drafting error for QIP acquired and placed in service on or after Jan. 1, 2018.25

The retroactive fix presents an opportunity for many taxpayers to accelerate depreciation, either by filing a Form 3115, Application for Change in Accounting Method, or, in some cases, by filing an amended tax return.26 Taxpayers that are required to use the alternative depreciation system (ADS) — including those who elected out of the business interest limitations — are ineligible for bonus depreciation on QIP.27

In some cases, a taxpayer may wish to change a depreciation-related election for a previously filed return (e.g., to revoke an election out of the business interest limitation or to elect not to claim the 100% bonus depreciation). The IRS has granted relief that may permit this to be done.28

Individual provisions
 
Recovery rebates

U.S. resident individuals who are not dependents of another taxpayer will receive a "recovery rebate" of $1,200 ($2,400 for MFJ taxpayers) plus an additional $500 per qualifying child.29 The rebate begins phasing out for incomes over $75,000 ($112,500 for a head of household; $150,000 for MFJ taxpayers) and is reduced by $5 for every $100 that the taxpayer's income exceeds the threshold. The rebate is available only for individuals and qualifying children who have a Social Security number.

The IRS began direct depositing the rebate in April for individuals who are eligible based on the income reported on their 2018 tax return (or 2019 return if they had already filed). If a taxpayer receives a rebate but their 2020 income makes them ineligible for the rebate, there is no requirement for the taxpayer to repay the rebate. On the other hand, if an individual was not eligible for the rebate based on their 2018 or 2019 income but they would be eligible based on their 2020 income, they can claim the rebate as a credit on their 2020 tax return.

Waiver of early-withdrawal penalty

The 10% penalty on an early withdrawal from a retirement account is waived for up to $100,000 of distributions for coronavirus-related purposes made on or after Jan. 1, 2020.30 A distribution is coronavirus-related if made to an individual:

  • Who is diagnosed with SARS-CoV-2 or with COVID-19 by a test approved by the Centers for Disease Control and Prevention;
  • Whose spouse or dependent is diagnosed with SARS-CoV-2 or COVID-19; or
  • Who experiences, due to SARS-CoV-2 or COVID-19, adverse financial consequences because of being quarantined, being furloughed or laid off, having work hours reduced, or being unable to work due to lack of child care or the closing or reducing hours of a business the individual owns or operates.

A taxpayer who takes a coronavirus-related distribution can either report the distribution as ordinary income ratably over a three-year period beginning in 2020 or can recontribute the funds to a retirement plan within three years to avoid tax on the withdrawal altogether.

Waiver of required minimum distributions (RMDs) for 2020

The CARES Act waives the RMD rules for certain defined contribution plans and IRAs during 2020.31 The waiver does not apply to defined benefit plans (i.e., pensions).

Example 5: D has a traditional IRA and turned 70 on May 1, 2019. D did not receive her RMD on or before Jan. 1, 2020. D does not have to take an RMD in 2020.

Charitable contribution provisions

The following favorable rules apply to cash contributions made during 2020 to certain charities:

  • Individuals who do not itemize can claim an above-the-line deduction of up to $300 for such contributions;32
  • Individuals who itemize can deduct such contributions up to 100% of adjusted gross income;33 and
  • C corporations can deduct such contributions up to 25% of taxable income.34

Contributions made to donor-advised funds are not eligible for the incentives.

The business deduction limit for contributions of food inventory is increased from 15% to 25% of the business taxable income.35

Exclusion for student loan repayment

Employees can exclude up to $5,250 from income for student loan repayments made by an employer after March 27, 2020, and on or before Dec. 31, 2020.36 The exclusion is subject to the same restrictions as an educational assistance program (e.g., the payments need to be available on a nondiscriminatory basis to employees who meet criteria established by the employer, cannot be in lieu of other taxable compensation, etc.). The exclusion appears to be available regardless of whether the student loan repayment has any connection to COVID-19.

Seize the opportunities

The CARES Act provides timely cash tax savings for businesses and individuals to help them get through the COVID-19 pandemic and position themselves for success as the economy emerges from the pandemic. Amended return opportunities are available for the following changes brought by the CARES Act, among others:

  • Five-year NOL carryback for losses generated in the 2018 and 2019 tax years;
  • Two-year NOL carryback for losses generated in a year beginning in 2017 and ending in 2018;
  • Repeal of the excess business loss rules for 2018 or 2019;
  • Apply the 50%-of-ATI limit instead of the 30%-of-ATI limit in computing the business interest limitation for 2019;
  • Suspension of the 80% of taxable income limitation on using NOL carryovers generated in 2018; and
  • Apply 100% bonus depreciation to QIP placed in service in 2018 or 2019.

There are still several areas with unanswered questions. The IRS will inevitably continue to release guidance over the coming weeks and months. In addition, Congress may modify certain rules in upcoming COVID-19 legislation. State conformity will evolve over the coming months as state legislatures take action to respond to the pandemic.

Footnotes

1Coronavirus Aid, Relief, and Economic Security Act, P.L. 116-136.

2CARES Act §2302.

3Paycheck Protection Program Flexibility Act of 2020, H.R. 7010, §4.

4CARES Act §2301.

5Families First Coronavirus Response Act, P.L. 116-127.

6P.L. 115-97.

7Secs. 172(a)(2) and (b), as amended by P.L. 115-97.

8Secs. 172(a) and (b), as amended by the CARES Act.

9Sec. 172(b)(3).

10Rev. Proc. 2020-24 provides guidance on the NOL carryback procedures.

11Sec. 172(a)(2)(B)(ii).

12Sec. 461(l), as amended by P.L. 115-97.

13CARES Act §2304.

14P.L. 115-97, §12001, amending Sec. 55(a).

15Sec. 53(e).

16Sec. 53(e)(2), as amended by CARES Act §2305.

17Sec. 53(e)(5), as amended by CARES Act §2305. For information regarding the process to claim the minimum tax credit refund in 2018, see the IRS's FAQs regarding the temporary procedures to fax certain Forms 1139 and 1045 due to COVID-19, available at www.irs.gov.

18Sec. 163(j).

19Sec. 163(j)(3).

20Sec. 163(j)(10), as added by CARES Act §2306.

21Sec. 163(j)(10)(B)(i), as added by CARES Act §2306.

22Sec. 163(j)(10)(A)(iii), as added by CARES Act §2306.

23Sec. 163(j)(10)(A)(ii).

24Sec. 163(j)(4)(B)(ii).

25CARES Act §2307, amending Sec. 168(e)(3)(E).

26Rev. Proc. 2020-25, §3.02(3).

27Sec. 168(k)(2)(D).

28Rev. Proc. 2020-25; Rev. Proc. 2020-22.

29Sec. 6428, added by CARES Act §2201.

30CARES Act §2202.

31Sec. 401(a)(9)(I), as added by CARES Act §2203.

32Sec. 62(a)(22).

33CARES Act §2205.

34Id.

35Id.

36Sec. 127(c)(1)(B).

 

Contributor

John Werlhof, CPA, is a principal in CliftonLarsonAllen LLP's National Tax Office in Roseville, Calif. For more information about this article, contact thetaxadviser@aicpa.org.

 

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