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Law360 (April 2, 2020, 5:39 PM EDT) --
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Taylor Kiessig |
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Wes Sheumaker |
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Michael Resnick |
The CARES Act is the largest stimulus package in U.S. history, providing direct financial assistance to distressed businesses, significantly expanding unemployment assistance and providing rebates directly to taxpayers (so-called stimulus checks, with eligible taxpayers receiving up to $1,200 — $2,400 if married — and an additional $500 per child under age 17).
In addition, the CARES Act includes several taxpayer-favorable changes to core federal tax provisions that were enacted or revised by the Tax Cuts and Jobs Act.[2]
The CARES Act establishes a new employee retention payroll tax credit, permits employers to defer the payment of payroll taxes, modifies the net operating loss, or NOL, provisions under Internal Revenue Code Section 172,[3] the excess business loss limitation provisions under Code Section 461(l), the corporate alternative minimum tax, or AMT, provisions under Code Section 53(e), the business interest limitation provisions of Code Section 163(j)[4] and the bonus depreciation provisions of Code Section 168(k).[5]
Employee Retention Tax Credit
The CARES Act provides a refundable payroll tax credit for 50% of certain qualified wages paid by employers to employees during the COVID-19 crisis.[6] The credit would be available to employers whose: (1) operations were fully or partially suspended due to a COVID-19-related shutdown order, or (2) gross receipts declined by more than 50% when compared to the same quarter in the prior year.
The credit would be provided for up to the first $10,000 of compensation, including health benefits, paid to an eligible employee. The credit would be provided for wages paid or incurred from March 13 through Dec. 31.
Payroll Tax Deferral
The CARES Act allows employers and self-employed individuals to defer payment of the employer share of the Social Security tax due for 2020, paying half of such amount by Dec. 31, 2021, and the other half by Dec. 31, 2022.[7]
Modifications for Net Operating Losses
The CARES Act modifies the NOL provisions in a number of taxpayer-favorable ways to provide businesses with relief.[8] Significantly, the section modifies the rules relating to carrybacks to allow carrybacks of up to five years for losses arising in 2018, 2019 or 2020, and temporarily repeals the 80% taxable income limitation.
Under Code Section 172[9] as revised by the TCJA, for most taxpayers, NOLs arising in taxable years beginning after Dec. 31, 2017, generally were not allowed to be carried back to prior taxable years. Most taxpayers were allowed only to carry forward such losses to future taxable years.
In addition, under the TCJA, taxpayers carrying forward such NOLs were only allowed to deduct such NOLs to the extent of 80% of their taxable income in such taxable year.
The CARES Act generally provides that NOLs arising in 2018, 2019 or 2020 are to be carried back five years, and eliminates the 80% taxable income limitation for taxable years beginning before 2021. Taxpayers generally have at least 120 days following enactment of the CARES Act either to carry back their 2018 NOLs or to relinquish the carryback period and carry such amounts forward.
NOLs from taxable years beginning after Dec. 31, 2017, and before Dec. 31, that are carried forward to taxable years beginning after Dec. 31, will be subject to the 80% limitation that was enacted as part of TCJA.
Further, the NOL provisions under the CARES Act include the following:
- For the 2018, 2019 and 2020 taxable years, the TCJA two-year limitations on certain insurance loss carrybacks do not apply;
- Real estate investment trusts are not allowed to carry back NOLs, and former REITs are not allowed to carry back losses to REIT taxable years; and
- With respect to taxpayers subject to the Section 965 transition tax, if the five-year NOL carryback allowed by the CARES Act would result in a carryback to any taxable year in which the taxpayer has an income inclusion under Code Section 965(a),[10] the taxpayer is treated as having made the election under Section 965(n)[11] with respect to each such taxable year (which election generally allows the taxpayer to forgo some of the NOL deduction in such year, so that its ability to use foreign tax credits related to the transition tax inclusion is not restricted by the NOL deduction); alternatively, the taxpayer can elect to exclude from the carryback period each taxable year in which it has an income inclusion under Section 965(a).
As a result of the COVID-19 crisis, many businesses have been forced to close, or are experiencing decreased revenue, which may result in significant NOLs for the 2020 taxable year. The CARES Act temporarily repeals the 80% taxable income NOL limitation for taxable years beginning before Jan. 1, 2021. Thus, businesses will not be limited in their ability to use losses arising during this economic crisis to offset current (and past) taxable income.
Furthermore, the CARES Act provides businesses with immediate relief by allowing NOLs generated in 2018, 2019 or 2020 to be carried back up to five taxable years. Businesses with such NOLs may be able to amend prior-year returns and seek a cash refund of taxes previously paid.
Taxpayers considering carrying back NOLs should model the consequences of such carryback, among other things, taking into account the impact on the taxpayer's global intangible low-taxed income, or GILTI, calculation and ability to utilize foreign tax credits in the taxable years to which the NOLs would be carried.
Modification of Excess Business Loss Limitation
The CARES Act makes certain amendments to Section 461(l),[12] which was enacted as part of the TCJA and limits the ability of noncorporate taxpayers to deduct excess business losses.[13]
A taxpayer's excess business loss for a taxable year generally is the amount by which the taxpayer's aggregate deductions attributable to trades or businesses exceed the sum of the taxpayer's aggregate gross income or gain attributable to such trades or businesses, plus $500,000 for married couples filing jointly or $250,000 for other individuals (in each case as adjusted for inflation).
In the case of a partnership or S corporation, Code Section 461(l) is applied at the partner or shareholder level, respectively. Under the TCJA, Code Section 461(l) applied to taxable years beginning after Dec. 31, 2017, and before Jan. 1, 2026. Moreover, under the TCJA, a taxpayer's excess business loss for a taxable year was treated as a NOL carryover to the following taxable year.
The CARES Act amends Section 461(l) to apply only to taxable years beginning after Dec. 31, and before Jan. 1, 2026. The act also makes certain technical corrections to Section 461(l). These corrections primarily involve the definition of excess business loss.
In this regard, the corrections provide that a taxpayer's excess business loss is computed without regard to deductions under Section 199A[14] and NOL deductions, and without regard to any deductions, gross income or gains attributable to the trade or business of being an employee.
Moreover, to clarify the interaction of Code Section 461(l) with capital loss limitation rules, the corrections provide that, for purposes of computing the taxpayer's excess business loss, capital losses attributable to a trade or business are disregarded.
Further, capital gains attributable to a trade or business are taken into account in the calculation, but only to the extent of the lesser of the taxpayer's capital gain net income — i.e., the excess of the taxpayer's capital gains over capital losses — or the taxpayer's capital gain net income attributable to trades or businesses.
The corrections also provide that an excess business loss is treated as a NOL for purposes of determining any NOL carryover to subsequent taxable years (as opposed to only the following taxable year).
The inapplicability of Code Section 461(l) for 2018, 2019 and 2020 may allow a noncorporate taxpayer to utilize business losses to offset nonbusiness income for such years (subject to other potentially applicable loss limitation rules). Taxpayers who have filed 2018 and 2019 tax returns reflecting an excess business loss under Code Section 461(l) may now be entitled to seek a refund of taxes for such years.
Further, taxpayers recognizing nonbusiness income in 2020 — for example, on account of gains from sales of securities — may now be permitted to shelter that income with 2020 business losses, thereby avoiding federal income tax on the nonbusiness income.
Modification of Credit for Prior-Year Minimum Tax Liability of Corporations
The TCJA repealed the corporate AMT for taxable years beginning after Dec. 31, 2017. If a corporation had an AMT credit from an earlier taxable year, it was able to carry the unused AMT credit forward and allowed to use portions of the credit in each taxable year beginning in 2018 through 2021.[15]
The CARES Act accelerates the utilization of such credits.[16] Specifically, Code Section 53(e)[17] was revised to provide that beginning in 2018 or 2019 (as opposed to 2018, 2019, 2020 or 2021) the limitation in Code Section 53(c)[18] is increased by the AMT refundable credit amount for such year.
Further, the AMT refundable credit amount provided in Section 53(e)(2)[19] was modified to be 100% in the case of a taxable year beginning in 2019 (as opposed to 2021). This provision is particularly helpful because businesses will be able to accelerate any remaining AMT credits they have not utilized into 2019.
The CARES Act also provides taxpayers with an election under Section 53(e)(5)[20] to take the entire refundable credit amount in 2018. To permit taxpayers to take advantage of these changes to the AMT provisions, the CARES Act also provides a special rule for filing a tentative refund claim as a result of an election under Section 53(e)(5).
If a taxpayer files such a claim prior to Dec. 31, the U.S. Department of the Treasury is required to review the application, determine the appropriate amount, and apply, credit, or refund such overpayment within 90 days.
Not only do these changes provide applicable taxpayers with an immediate tax refund opportunity, but a special rule is provided to taxpayers seeking to take advantage of Code Section 53(e)(5) to take the entire refundable credit amount in 2018 and file a tentative claim for refund. It would be prudent for taxpayers to review their AMT posture and file such refund claim as soon as possible.
Modifications of Limitation on Business Interest
Permits Increased 50% Interest Expense Limitation
As amended by the TCJA, Code Section 163(j)[21] generally limits the amount of net business interest expense that may be deducted for U.S. federal income tax purposes to 30% of the taxpayer's adjusted taxable income. Any business expense in excess of this threshold is carried forward and can be deducted in a future year, subject to the application of the same limitation.
The CARES Act revises Code Section 163(j) by inserting a special rule — new Code Section 163(j)(10)[22] — providing, in the case of any taxable year beginning in 2019 or 2020, that the business interest expense limitation amount is increased from 30% of adjusted taxable income to 50% of adjusted taxable income.[23]
In the case of a partnership, the rule does not apply to any taxable year beginning in 2019. However, unless a partner elects otherwise, the partner's share of any excess business interest of the partnership — i.e., the interest expense of the partnership that is disallowed under Section 163(j) — for any taxable year beginning in 2019 is subject to a special rule pursuant to which (1) 50% of the excess business interest is treated as interest expense of the partner for the partner's 2020 taxable year and is not subject to Section 163(j), and (2) 50% of the excess business interest continues to be subject to the normal Section 163(j) rules applicable to partnerships and partners.
Importantly, taxpayers may elect not to have Section 163(j)(10) apply, retaining the application of the 30% adjustable taxable income limitation. For partnerships, this election may be made only for taxable years beginning in 2020.
Election to Use 2019 Adjusted Taxable Income
Code Section 163(j)(10) also permits taxpayers to elect to use 2019 adjusted taxable income (which may be significantly greater than what 2020 adjusted taxable income is likely to be) for taxable years beginning in 2020. In the case of a partnership, any such election is made by the partnership.
In deciding whether to elect out of the increased 50% adjusted taxable income limitation and whether to use 2019 adjusted taxable income to determine the limitation, taxpayers should consider the interaction of Code Section 163(j) with other provisions.
For example, taxpayers that are claiming deductions under Code Section 250 (the deduction for foreign derived intangible income and GILTI) could be negatively impacted by an increased current interest expense deduction.
The Code Section 250 deduction is taxable income limited (without any option to reference 2019 taxable income). If the increased Code Section 163(j) limitation causes the taxpayer to have a current year loss before taking into account income eligible for the Code Section 250 deduction, its Code Section 250 deduction would be reduced or even eliminated.
In contrast to the Code Section 250 deduction, excess interest expense under Code Section 163(j) is carried forward and may be deducted in a future year.
Like the CARES Act's changes to the NOL rules, these changes to Code Section 163(j), which generally increase the amount of interest expense businesses may deduct, are intended to provide businesses with needed liquidity.
Many advocated for Congress to modify the TCJA rule that prevents consideration of depreciation, amortization and depletion for purposes of calculating adjusted taxable income for taxable years beginning before Jan. 1, 2022, in the Code Section 163(j) calculation. Unfortunately, while there was certainly ample discussion and public commentary on such a fix, Congress ultimately decided not to include such taxpayer-favorable change.
Technical Amendments Regarding Qualified Improvement Property
The CARES Act corrects a long-noted technical error to Code Section 168(k)[24] by including any qualified improvement property, or QIP, as 15-year property, for which full expensing is available.[25] This correction was made effective back to the enactment of the TCJA in December 2017.[26]
While this technical correction to the QIP quagmire is long overdue, it could not come at a better time for businesses during this economic downturn. By including QIP as 15-year property, the CARES Act enables businesses, particularly those in the retail, restaurant and hospitality industries, to immediately expense the costs associated with improving their facilities.
This should incentivize investment as these businesses attempt to rebound from the economic losses experienced due to the COVID-19 crisis.
Beyond incentivizing investment, this change enables taxpayers to recover previously incurred QIP costs through bonus depreciation. The Treasury and the Internal Revenue Service are currently drafting administrative guidance to address this new provision and considering whether relief for previous years will be available through amended returns, accounting method changes or both.
Taylor M. Kiessig and Wes Sheumaker are partners, and Michael D. Resnick is an associate at Eversheds Sutherland.
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 informational purposes and is not intended to be and should not be taken as legal advice.
[1] 116 P.L. 136
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[2] 115 P.L. 97.
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[3] IRC Section 172
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[4] IRC Section 163(j)
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[5] IRC Section 168(k)
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[6] CARES Act, Section 2301
[7] CARES Act, Section 2302. For discussion of the employee retention tax credit, payroll tax deferral and other provisions please see our recent alerts on the CARES Act in relation to employer tax relief, https://us.eversheds-sutherland.com/NewsCommentary/Legal-Alerts/230380/Legal-Alert-Congress-delivers-a-CARES-package-to-employers-and-other-recent-developments, and on employer-sponsored group health plans, https://us.eversheds-sutherland.com/NewsCommentary/Legal-Alerts/230378/Legal-Alert-Employer-sponsored-group-health-plansCOVID-19-guidance-and-legislation.
[8] CARES Act, Section 2303.
[9] IRC Section 172
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[10] IRC Section 965(a).
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[11] IRC Section 965(n)
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[12] IRC section 461(l)
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[13] CARES Act, Section 2204.
[14] IRC Section 199A
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[15] The IRS initially took the position that the refundable AMT credits under Code Section 168(k) and Code Section 53(e) were subject to sequestration under the budget provisions, which had the effect of reducing the refundable amount by approximately 6%. The Office of Management and Budget subsequently determined that this credit was not subject to sequestration. In January 2020, the IRS announced that it would refund any amount sequestered in prior years.
[16] CARES Act, Section 2305.
[17] IRC Section 53(e)
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[18] IRC Section 53(c)
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[19] IRC Section 53(e)(2)
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[20] IRC Section 53(e)(5)
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[21] IRC Section 163(j).
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[22] IRC 163(j)(10)
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[23] CARES Act, Section 2306.
[24] IRC Section 168(k)
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[25] CARES Act, Section 2307.
[26] A fuller discussion of this can be found in our recent alert, https://us.eversheds-sutherland.com/NewsCommentary/Legal-Alerts/230548/Legal-Alert-A-day-late-but-not-a-dollar-too-shortCongress-uses-CARES-Act-to-finally-provide-technical-corrections-to-QIP-quagmire.
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