In the midst of the Corona Virus epidemic, Congress is poised to pass a massive $2 trillion relief package known as the Coronavirus Aid, Relief and Economic Security Act — or CARES Act. The CARES Act is aimed at helping individuals, and in particular, business owners and their employees who are facing severe economic consequences as a result of the Corona Virus pandemic.
The Act is a massive injection of cash into the economy, certain individuals, and businesses, derived from rebate checks, low cost loans, debt forgiveness, employment credits and a whole host of other benefits.
This summary will predominantly focus on the tax aspects of the legislation. For technical employment related questions you can visit my partner’s articles here, here and here.
The “Paycheck Protection” Loans—And Related Forgiveness
By far, the most exciting and beneficial provision of the CARES Act for employers is the new “paycheck protection” loan program administered through the SBA. The point of these loans is to enable small businesses to “weather the storm” and to keep paying its employees, even in the face of an economic downturn.
The loans are generally only available to businesses with less than 500 employees and are to be used for payroll costs, healthcare, rent, utilities, and other debts incurred by the business. Generally the amount that a business can borrow is equal to the business’s average monthly payroll costs during the prior year, times 2.5 (but in no event more than $10MM).
The standard SBA loan fees are supposed to be waived and no requirement that the loans be personally guaranteed. The last day to apply for these loans is June 30, 2020.
While the loan seems helpful, the most exciting aspect of the CARES Act is that it will allow the forgiveness of a large portion of this loan on a tax-free basis! This is remarkable and results in a tax-free transfer of cash to struggling businesses.
Generally, the amount of the debt that will be forgiven is equal to the amount of certain payroll costs, rent, utilities and interest paid by the business during an eight-week period after origination of the loan. (Notably wages in excess of $100,000 per employee are not considered).
The amount of debt forgiveness, however, will be reduced if the business reduces its workforce or reduces an employee’s wages by more than 25% during the 8-week period. Fortunately, the law allows businesses to re-hire laid off staff or increase their reduced salaries and not have their loan forgiveness reduced.
In addition, the loan forgiveness appears to be reduced by the amount of the $10,000 grant received under the Economic Injury Disaster Loan program discussed below.
Economic Injury Disaster Loan (and Related $10,000 Grant)
Another interesting aspect of the CARES Act are SBA loans paid under the Economic Injury Disaster Loan program. Under this program, a loan applicant can receive an advance of up to $10,000 on the loan to pay for certain overhead expenses. Surprisingly, the applicants would NOT have to repay the $10,000 grant even if they are denied the loan. The grants are awarded on a first-come, first serve basis until the $10 billion fund is exhausted.
Notably, any grant received under this program appears to reduce the amount of loan forgiveness allowed under the paycheck protection loans mentioned above.
Employee Retention Tax Credit
The CARES Act also provides a new tax credit called the “employee retention tax credit.” Unfortunately, this tax credit is NOT available to businesses that receive the generous small business “paycheck protection” loans previously discussed. So businesses will need to calculate their benefits under both programs and pick the one they think works best for them.
The tax credit provides businesses with a refundable payroll tax credit for 50% of the wages paid by businesses during the COVID-19 pandemic and applies to wages paid between March 13, 2020 and the end of the year. The tax credit is provided for the first $10,000 of compensation paid to an employee.
A business is eligible if: i) its operations were fully or partially suspended due to a COVID-19 related “shut-down order” during any calendar quarter during 2020 or, ii) the business’s gross receipts in any 2020 quarter declined by more than 50% compared to the same quarter in a prior year.
For each eligible quarter, the business will receive a credit against its 6.2% share of Social Security payroll taxes equal to 50% of the “qualified wages” paid to each employee for that quarter, ending on December 31, 2020.
The “qualified wages” is a function of the size of the business. If there were more than 100 employees during 2019, the qualified wages are limited to those wages that were paid by the business during the quarter for the period of time the business was shut down. If there were 100 or fewer employees for, however, “qualified wages” include wages paid to employees during a shut-down, but also wages paid for each quarter that the business has suffered a sharp decline in receipts.
But again, in either case, “qualified wages” for each employee for all quarters cannot exceed $10,000.
Payroll Tax (and Self Employment Tax) Payment Delays
In addition to the new payroll tax credits created by the CARES Act (and the Corona Virus Relief Act) this law seeks to lift the burden on businesses struggling to make payroll by allowing employers and self-employed individuals to defer payment of the employer share of the Social Security tax (and 50% of a person’s self-employment tax if self-employed) until Dec. 31, 2020. The amounts deferred would be paid over the following two years, with half required to be paid at the end of 2021 and the other half paid by the end of 2021.
It is important to note, however, that this deferral is NOT available to any business that receives a payroll protection loan discussed previously in this Article.
Changes to Net Operating Loss Rules and Qualified Improvement Property Fixes
This act also makes some technical “corrections” to the 2017 Tax Cut and Jobs Act that were oversights. This act will allow losses from 2018-2020 to be carried back for up to five years, or to be carried forward.
In addition, this act fixes a glitch in prior law and will now allow for “qualified improvement property” (generally defined as any improvement made to the interior portion of a nonresidential building) to be deducted over 15 years (and thus available for 100% bonus depreciation), rather than 39 years. This change is made retroactive to January 1, 2018 and so businesses should be able to file amended returns for 2018 and 2019 to get the benefit of this increased depreciation.
Use of Retirement Funds for COVID-19 Costs
Generally, if you take money too early out of a qualified retirement plan (before age 59 ½), you are subject to the Section 72(t) 10% penalty tax on early withdrawal.
The CARES Act adds an additional exception that would enable taxpayers to make early withdrawals related to the corona virus of up to $100,000 in 2020, free of any penalty. While the distribution escapes the 10% penalty, it does not escape the income tax; however the Act, allows the taxpayer to spread the income over a 3-year period beginning with 2020. The taxpayer also has the choice to avoid any income recognition by repaying the distribution to the retirement plan within three years.
In addition, for those required to withdraw a “required minimum distribution” from their retirement plan in 2020, the CARES Act temporary waives the requirement for this year only.
Exclusion from Income of Employer Payment of Employee Student Loan Debt
Under the CARES Act, a business can pay up to $5,250 of an employee’s student loan obligation on a tax-free basis. This provision modifies existing Section 127, which permits an employer to pay up to $5,250 of an employee’s qualified educational expenses with the payment being tax-free to the employee.
This is now a combined limit of $5,250. To the extent an employee’s student loan is paid on a tax-free basis under this new Section 127 by his or her employer, the employee cannot deduct the interest on the student loan under Section 221.
Temporary Retroactive Changes Section 461(l):
The Act will temporarily remove the Section 461(l) limitations that limited an individual’s ability to use losses from a business. Thus, a taxpayer whose loss was limited by old Section 451(l) can file an amended return to claim a refund for 2018 and 2019.
Unfortunately, however, the relief is short-live and the Act provides that when the provisions apply again 2021 and beyond, wages will not be considered business income. This will, in many cases, result in significantly more loss being limited.
Relief from the Interest Limitation Rules
The TCJA limited a business’s ability to deduct its interest expense to 30% of “adjusted taxable income,” with any excess interest expense carried forward.
The CARES Act would increase that limit to 50% of adjusted taxable income for 2019 and 2020, and then allow the business can elect to use its 2019 income in computing its 2020 limitation. So a business with negative income this year but positive income in 2019 could deduct more of their interest expense, generate larger losses, and then use the new carryback provisions to amend 2019 returns and recover taxes paid that year.
The Individual Rebate
Perhaps the most well-known provision of the CARE Act stems from the one-time federal income tax rebate for eligible individuals. The rebate amount would be $1,200 for individual tax filers and $2,400 for those filing a joint return. In addition, a rebate of $500 is available for each child. The amount of the rebate, however, will be reduced for single filers making more than $75,000 and joint filers earning in excess of $150,000. Once above those thresholds, an individual will lose $5 of the rebate payment for every $100 the person’s AGI exceeds the applicable threshold.
Conclusion
The CARES Act has some pretty major benefits for small businesses and their employees and will put cash in hands right now as well as providing additional benefits as 2020 tax returns are filed.
Disclaimer: This article is meant for educational and illustration purposes only and is not intended to constitute legal advice for any particular fact situation.