By George Callas

Law360 (July 6, 2020, 4:17 PM EDT )

George Callas

With the enactment of the Families First Coronavirus Response Act[1] and the Coronavirus Aid, Relief and Economic Security, or CARES, Act[2] this March, Congress provided substantial tax relief to American employers struggling with liquidity and cash-flow problems resulting from the governmental and societal responses to the COVID-19 pandemic.

At the time of the enactment of the CARES Act, however, a consensus existed that additional legislation, including additional tax relief, would be necessary to provide support to an artificially depressed economy, including support to households, private sector (including nonprofit) employers and governmental entities.

With the expiration of the CARES Act's enhanced unemployment benefits scheduled to go into effect after July 31,[3] pressure is mounting to enact additional economic relief and recovery legislation into law by the end of this month.

While many broad-based tax relief proposals have received extensive coverage — including a payroll tax cut, increased deductibility of meal and entertainment expenses, and a second round of tax rebates, to name just a few — there are numerous more targeted proposals that either would improve business cash flow temporarily or provide incentives for longer-term economic recovery, usually at a fraction of the cost of the higher-profile provisions being discussed.

Some of these proposals are described below.

1. Debt Restructuring and Cancellation of Debt Income

In the current economic crisis, employers of all sizes are being forced to take on additional debt while their earnings collapse. In fact, the federal government's primary solution to this government-induced economic collapse has been to provide additional leverage in the form of direct loans, loan guarantees and the creation of secondary markets.

Congress recognized this squeeze — low or negative earnings combined with higher debt service costs — when it enacted the CARES Act by temporarily raising the limit on net business interest expense to 50% of adjusted taxable income rather than 30%.[4] Some of these new loan programs, however, such as the Federal Reserve's Main Street program, impose limitations on leverage based on a multiple of earnings.[5]

In response, many debt holders and borrowers are seeking to restructure existing debt to help debtors remain solvent while qualifying for more favorable terms on government loans and loan guarantees. But those restructuring efforts come at a high tax cost, because under general tax principles any amount of debt that is discharged by a creditor is included in income and therefore subject to federal income tax.[6]

In the case of related-party debt, double taxation can even result, because Internal Revenue Code Section 267 often denies the holder of the debt a corresponding deduction.[7] This tax penalty makes it more difficult for distressed companies to restructure their debt so that they might obtain greater liquidity.

Like it did in 2009, Congress should look at options to alleviate this barrier to debt restructuring, either through providing a temporary exclusion from gross income for cancellation of debt income resulting from attempts to restructure debt, or otherwise by modifying the rules governing exchanges of debt instruments to prevent cancellation of debt income recognition.[8]

2. Full Access to Net Operating Losses

The CARES Act recently provided a five-year carryback of net operating losses to allow taxpayers to get refunds of prior year tax payments quickly, thus providing near-term liquidity.[9] Congress, however, did not account for certain interactions with other Code provisions that limit the ability of many taxpayers to access their NOLs and thus undermine the purpose of the NOL carryback provision.

For instance, despite NOLs representing domestic losses, IRC Section 172 requires taxpayers to determine and to utilize their NOL carrybacks before their section 250 deduction — both for the year in which the NOL arises and for the carryback year — meaning that every dollar of NOL carryback reduces the section 250 deduction by 37.5 cents in the case of foreign-derived intangible income, and by 50 cents in the case of global intangible low-taxed income, or GILTI.[10]

In addition, because taxpayers must apply NOLs to foreign-source income, U.S. tax on that foreign income, such as GILTI, can be wiped out by domestic losses, and foreign tax credits are permanently lost.

Similarly, taxpayers with overall domestic losses, or ODLs, must allocate a portion of those ODLs to foreign-source income, thus permanently reducing the availability of foreign tax credits.[11] Taxpayers suffering NOLs and ODLs because of the current crisis should not lose other tax attributes as a result.

3. Technical Corrections

On March 19, Sen. Mitch McConnell, R-Ky., and several Senate committee chairmen released their first version of draft text for the CARES Act. This version included two technical corrections that they later dropped from the legislation.

The first is the restoration of the pre-Tax Cuts And Jobs Act limitation on the downward attribution of stock ownership in applying the constructive ownership rules to determine whether a U.S. investor is a 10% U.S. shareholder in a controlled foreign corporation. This technical correction would clarify the limited circumstances in which downward attribution of ownership from a foreign person to a U.S. person in which the foreign person has an ownership interest would apply, rather than capturing a broad swath of American companies.

The second is a glitch in the election to spread out payment of the Section 965 deemed-repatriation tax over eight years, where if a company makes an overpayment on a current installment the IRS — contrary to congressional intent — will not refund the money and instead applies it to future tax liability.

Efforts to fix these drafting errors have stalled not because of objections to the fixes themselves, but because the provisions have become entangled in larger partisan political battles. Enacting these technical corrections could allow many employers to recover tax payments they made on their 2018 and 2019 returns that they should never have been required to make in the first place, thus freeing up much-needed cash flow.

4. Temporarily Liberalized Tentative Refund Rules

Under current law, taxpayers who have filed claims for refund in excess of $2 million ($5 million for C corporations) may have to wait months or even years as the Internal Revenue Service conducts an audit and the refund determination is sent to the Joint Committee on Taxation for review.[12]

With current IRS operations hampered by the COVID-19 pandemic, the process likely will take even longer. In the interim, the amounts claimed essentially remain on deposit with the IRS, instead of providing needed cash flow to taxpayers during the economic emergency.

Section 6411 provides for tentative, so-called quick refunds in cases where the refund claim results from net operating losses, general business credits or capital loss carrybacks.[13] But some cash-strapped taxpayers with valid refund claims might not be able to obtain a quick refund.

For example, their refund claims might derive from foreign tax credit carrybacks, which are not covered by Section 6411. In addition, a taxpayer generally may apply for a quick refund only within 12 months after the end of the taxable year in question.

Congress could provide liquidity to taxpayers by accelerating tax refunds, in whole or in part, currently stuck in the bureaucratic process. This would have the effect of moving money to employers rapidly to alleviate cash flow problems.

Moreover, because the proposal results in a refund of money already paid into the U.S. Department of the Treasury, it neither requires new spending nor provides new tax relief. Congress should adopt reasonable guard rails to ensure that any active audits are not prejudiced and that the final determination of tax due is paid in full.

5. U.S. Possessions and Location of Supply Chains

Finally, the American people and their elected officials are starting to have a conversation about the potential consequences of critical goods being produced in global supply chains that inject geopolitical risk into our ability to manage a crisis. The economic case for free and open trade is strong, but COVID-19 has led many to ask whether, when other actors in the global economy are not free and open, theoretical views about economic efficiency can put the public's health at risk.

With that said, carrots are far preferable to sticks, and any legislation addressing supply chains in critical industries should focus on incentives rather than mandates.

As part of any such effort, tax incentives to move supply chains to the U.S. should recognize that U.S. possessions such as Puerto Rico, the U.S. Virgin Islands, Guam, American Samoa and the Northern Mariana Islands are part of the U.S. The people who reside in these jurisdictions are either U.S. nationals or citizens, and tend to live in economically depressed areas.

The Internal Revenue Code, however, deviates from general U.S. law in that it treats U.S. possessions as foreign jurisdictions for tax purposes,[14] and thus many U.S. businesses operate in those locations through controlled foreign corporations. Because controlled foreign corporations are not domestic corporations generally subject to U.S. income tax,[15] incentives limited to U.S. taxpayers that file U.S. tax returns do not benefit them.

Any new tax regime based on the rationale that it is in our national interest for certain supply chains to move back to the U.S. must accommodate the structures used by U.S. businesses operating in U.S. possessions, to ensure U.S. possessions are viewed as an attractive option for locating production.

Conclusion

These ideas are not exhaustive with respect to business tax relief measures narrowly targeted to provide liquidity or encourage economic recovery. They should score high, however, on the bang-for-the-buck test in that they tend to focus budgetary resources on activities and circumstances that are connected to the crisis at hand. As Congress negotiates another package to deal with the pandemic and associated economic slowdown, it should consider legislating in these areas.

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George Callas is a managing director of the government affairs and public policy, and tax groups at Steptoe & Johnson LLP. He served as senior tax counsel to former House Speaker Paul Ryan. He is a regular contributor to Tax Authority Law360.

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] Pub. L. No. 116-127 . https://www.congress.gov/116/plaws/publ127/PLAW-116publ127.pdf.

[2] Pub. L. No. 116-136 . https://www.congress.gov/bill/116th-congress/house-bill/748?q=%7B%22search%22%3A%5B%22hr748%22%5D%7D&s=2&r=1.

[3] See id., Section 2104.

[4] Id., Section 2306.

[5] https://www.federalreserve.gov/monetarypolicy/mainstreetlending.htm#term-sheet.

[6] See I.R.C. Section 61 .

[7] I.R.C. Section 267 .

[8] For example, section 3412 of H.R. 1 (113th Cong.), the Tax Reform Act of 2014, as introduced by then-chairman of the House Ways and Means Committee, Dave Camp, R-Mich., provided that the issue price of a new debt instrument exchanged for an existing debt instrument (including significant modifications) of the same issuer would be the least of: (1) the adjusted issue price of the existing debt instrument, (2) the stated principal amount of the new debt instrument, or (3) the imputed principal amount of the new debt instrument. https://www.congress.gov/bill/113th-congress/house-bill/1/text. "Thus, if the principal amount of the debt does not change and there is adequate stated interest, the exchange does not cause the issuer to recognize COD income." https://www.jct.gov/publications.html?func=startdown&id=4556.

[9] Pub. L. No. 116-136, Section 2303.

[10] See I.R.C. Section 172(d)(9) .

[11] I.R.C. Section 904(g) .

[12] See I.R.C. Section 6405(a) .

[13] I.R.C. Section 6411 .

[14] I.R.C. Section 7701(a)(9) .

[15] I.R.C. Section 7701(a)(5) .

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