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Law360 (April 1, 2020, 3:47 PM EDT )
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| Sean Tevel |
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| Gregory Bauer |
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| Alan Schwartz |
Irrespective of whether portfolio companies are able to qualify for some of the other economic stimulus provisions established by the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act,[1] (including the small business loan and loan forgiveness programs), the legislation implements several important tax provisions that should provide relief to impacted businesses.
The provisions discussed below can provide benefits in terms of short-term liquidity and longer-term tax savings.
Tax Provisions That Can Provide Immediate Liquidity — Payroll Tax Deferral and Relief
The CARES Act enables employers to defer payment of the employer portion of Social Security payroll taxes (i.e., FICA taxes but not Medicare taxes) attributable to wages paid during 2020 (after the enactment of the CARES Act).
This can free up funds from employment tax deposits to be used for other pressing needs of portfolio companies. Deferred tax payments are due 50% at the end of December 2021 and 50% at the end of December 2022.
The CARES Act implements the "employee retention credit," through which employers may be allowed a credit against their employment tax liability equal to 50% of the first $10,000 in wages per employee (including the value of health plan benefits).
For employers with more than 100 employees, this benefit is available with respect to employees that are not providing services to the business but remain employed. For employers with less than 100 employees, qualified wages of all employees are eligible.
To qualify for this credit, the employer must have had their business fully or partially suspended due to a government order, or the employer must have experienced a greater than 50% reduction in its gross receipts for a calendar quarter when compared to the same quarter in the prior calendar year. The credit applies to wages paid after March 12 and before Jan. 1, 2021.
Prior to applying any of these payroll tax benefits, private equity funds should consider that limitations apply on the combination of these relief measures with the loan program and certain other benefits provided under the CARES Act.
Tax Provisions That May Result in Prior-Year Refunds
The limitations on net operating loss, or NOL, carrybacks and carryforwards imposed by the 2017 Tax Cuts and Jobs Act[2] are relaxed by suspending the 80% of taxable income limit on NOL carryforwards until 2021, and permitting NOLs arising in 2018, 2019 and 2020 to be carried back for five years.
These measures should result not only in significant tax refunds for portfolio companies that expect to experience losses during 2020 but may also provide a current benefit for companies that generated losses in 2018 or 2019.
For example, a C corporation that generated NOLs in 2018 or 2019 may be eligible for a tax refund because of the newly allowed carrybacks. This benefit is significant in that the NOLs may be carried back to tax years when the maximum corporate tax rate was 35% (prior to 2018) rather than the current 21% rate.
The NOL carryback provision may also offer significant benefits in respect of C corporation portfolio companies that were acquired during the 2018 or 2019 taxable years. Generally, transaction costs and bonus payouts may create operating losses for C corporations in the year of sale. As these losses are now eligible to be carried back, transaction documents should be reviewed to determine whether the buyer or seller retained the right to preclosing tax refunds that may now be available.
The CARES Act clarified that certain improvements to nonresidential real property, or "qualified improvement property," that were made after Dec. 31, 2017, are eligible for 100% bonus depreciation (i.e., immediate expensing) by assigning a 15-year depreciable life to such improvements (instead of the 39-year life assigned to nonresidential real property).
This should result in tax refunds for portfolio companies that made qualifying improvements to their offices, facilities, restaurants and stores during 2018. This provision should reduce tax burdens for improvements made during 2019 and in future years.
The CARES Act measures may also provide prior-year tax refunds to C corporations that have outstanding alternative minimum tax, or AMT, credits. The TCJA repealed the corporate AMT and offered a refundable credit for AMT paid in prior tax years which was to be used against a corporation's tax liabilities in taxable years 2018, 2019, 2020 and 2021.
Under the CARES Act, C corporations may accelerate these credits to tax years 2018 and 2019, thus resulting in a potential tax refund for 2018 taxes paid. Corporations may also elect to take the entire refundable credit amount in 2018.
Tax Provisions That Can Reduce Tax Burden for 2019 Taxable Year and Potentially Result in Refunds of Overestimated Tax Payments
Many portfolio companies and private funds made estimated tax payments for the 2019 taxable year. Accordingly, any reduction in a portfolio company's or private equity fund's 2019 tax liability can lead to a tax refund with respect to any overpayment of the estimated tax liability.
The CARES Act retroactively relaxes the limits on the deductibility of interest payments. For 2019 and 2020, the limitation under Internal Revenue Code Section 163(j)[3] on business interest deductions is increased from 30% of adjusted taxable income (which is similar to earnings before interest, tax, depreciation and amortization) to 50% of adjusted taxable income. This may create additional deductions in 2019 at the fund and portfolio company level.
Taxpayers may also elect to use their 2019 adjusted taxable income when they calculate their interest deduction limitation in 2020. These changes may result in a lower tax burden for 2019 and possibly a refund of any overpayment of fund level or portfolio company level estimated taxes for the 2019 taxable year.
The additional interest deductions may also create NOLs that can be carried back under the legislation to obtain tax refunds in respect of prior years.
Application of Changes to 2019 and 2020 Tax Years
In addition to the cash-flow benefits resulting from tax refunds in respect of previous years' tax liabilities, the provisions described above will offer significant benefits with respect to the 2019 and 2020 tax burdens. Perhaps most significant is the ability to carry back losses realized in the 2020 taxable to prior tax years in which many portfolio companies were profitable, thus generating additional tax refunds.
The other tax changes described above (e.g., with respect to qualified improvement property and the limitation on business interest deductions) will further increase tax benefits generated in 2019 and 2020.
Additional Tax Benefits
In addition to changes to the Internal Revenue Code under the CARES Act, the Internal Revenue Service extended the due date for filing individual and corporate federal income tax returns and for the payment of any income taxes due from April 15 to July 15. Under this provision, no additional forms are required.
There is no limitation on the amount of payments that may be postponed and no interest, penalties or additions to tax with respect to such returns or payments that will accrue during such postponement.
Funds and portfolio companies that are considering issuing payments to employees to alleviate the COVID-related financial impact should consider the application of Code Section 139,[4] which may enable these payments to be deductible while not being treated as taxable income to the recipients.
Section 139 may be utilized as a result of President Donald Trump's declaration under the Stafford Act resulting in COVID-19 being qualified disaster for Section 139 purposes.
Qualified disaster relief payments may include amounts paid to reimburse or pay reasonable and necessary personal, family, living or funeral expenses (not otherwise compensated for by insurance), but may not include payments treated as income replacement. As a best practice, employers should consider establishing a program or adopting an administrative system that validates that such payments meet the Section 139 requirements.
Sean Tevel, Gregory Bauer and Alan J. Schwartz are partners at Holland & Knight LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] 116 P.L. 136
.[2] 115 P.L. 97.
[3] Internal Revenue Code Section 163(j).
[4] Internal Revenue Code Section 139
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