CARES Act – Tax Provisions

By Greg Yoder

Congress has passed the CARES Act, the giant stimulus bill meant to ameliorate the effects of the COVID-19 virus on individuals and businesses. (The House passed the bill earlier this afternoon and the President recently signed it, making the bill a law. See also:

Some of these changes will affect only 2020, but others will continue to have effects in future years and/or will affect past years and may impact 2019 returns as well as creating the opportunity to amend earlier year returns. The details are, as usual, complicated, and the situation is highly fluid, but here’s a summary of what we know so far.

Provisions primarily for individuals

Many individuals will be receiving rebate checks. The amounts are $1,200 for an unmarried individual and $2,400 for a married couple. In addition, there is an additional $500 for each dependent child under the age of 17. As rebates, these amounts are generally not taxable, but they are subject to phase out at relatively modest income levels. Phaseouts begin at an AGI of $75K (single) or $150K (MFJ) and are fully phased out at AGIs of $99K/$198K. The payments in most cases will be made automatically, and taxpayers who provided direct deposit information on a recent tax return may receive a direct deposit into the same account. Since in many cases, the payments will be based on information from 2018 returns, some taxpayers may receive either more or less than they’re entitled to under the new law, and may have modest adjustments to make when they file their 2020 tax returns next year.

Individuals will be eligible to take early retirement plan distributions for “coronavirus-related purposes.” These distributions will not be subject to the normal 10% early withdrawal penalty, and the regular tax associated with the distributions will be payable over three years, rather than all in the year of distributions. A “coronavirus-related distribution” is available where an individual a) is diagnosed with COVID-19, b) has a spouse or dependent diagnosed with COVID-19, OR c) “experiences adverse financial consequences as a result of being quarantined, furloughed, laid off, having work hours reduced, being unable to work due to lack of child care due to COVID-19, closing or reducing hours of a business owned or operated by the individual due to COVID-19, or other factors determined by the Treasury Secretary.” In addition, taxpayers who take a coronavirus-related distribution will have up to three years to recontribute that amount to an eligible plan, regardless of that year’s contributions cap.

The required minimum distribution (RMD) rules for 2020 are being waived for certain IRAs and defined contribution plans. Normally taxpayers who have reached a certain age (currently 72, previously 70 1/2) are required to take a distribution every year. That requirement’s being suspended for 2020 only.

Taxpayers who do not itemize their deductions (a much more common occurrence after the changes in the tax law under TCJA, the major tax legislation from the end of 2017) will be allowed to deduct up to $300 of charitable contributions above the line on their 2020 returns, regardless of whether they itemize.

For 2020 only, the 60% of AGI limitation on charitable contributions is being eliminated for individuals. For corporations, the usual 10% of taxable income limitation is being increased to 25% of taxable income. This will greatly increase the amount of contributions that many taxpayers can deduct and will create some planning opportunities around the timing of contributions.

For 2020 only, employers may make payments towards employees’ student loan balances on a tax-free basis. Under normal rules, an employer’s payment of employee student loans would be considered taxable income to the employee. The excludable amount is limited to $5,250, and any amount paid towards student loans reduces the excludable amount an employer can provide in other educational assistance.

Paycheck Protection Program (PPP)

While not technically a tax provision, the PPP can be an important benefit for many small businesses, including sole proprietorships and nonprofit organizations. Be warned that these provisions are complex, and there are additional requirements: this is an overview.

The PPP provides businesses with fewer than 500 employees with “paycheck protection loans” (PPLs) during the “covered period” which begins February 15, 2020 and continues to June 30, 2020.

Loans are fully guaranteed by the federal government through the end of this year. After that, loans in excess of $150K will be 85% guaranteed.

Loan amounts are limited to the lower of $10 Million OR the SUM of a) 2.5 times the average monthly payroll costs for the year ending on the date of the loan AND b) any disaster loan taken after January 31, 2020 that’s been refinanced into a PPL.

The definition of “payroll costs” is further complicated. In general, what’s included is fairly expansive and includes many benefits; however, once an employee’s compensation exceeds $100K none of their additional compensation is included. Also excluded is any sick or family medical leave for which an employer receives a credit under an earlier coronavirus relief act.

Interest rates on PPLs are limited to 4%, and there is a maximum maturity of 10 years. Loan proceeds may be used for payroll, rent, utilities, mortgage payments, and other debt service requirements. No personal guarantee by the business owner is required, and some of the standard fees required by the Small Business Act will be waived.

The CARES Act also provides for partial forgiveness of PPL amounts. The amount that’s available for forgiveness is the amount of payroll costs, mortgage interest, rent, and utility payments that are made in the eight weeks beginning with the loan date. While debt forgiveness is generally considered taxable income under the tax code, any PPL amounts forgiven under this program are excluded from a business owner’s taxable income.

There are substantial documentation requirements associated with the loan forgiveness, and the amount available to be forgiven may be reduced if an employer either reduces the wages of employees or reduces the number of employees during the eight-week period. (Wages of employees making more than $100K/year may be reduced without penalty.)

Tax provisions primarily for businesses

Employers whose operations were affected by a COVID-19-related shutdown order are eligible for a refundable payroll tax credit for 50% of wages paid to employees during the crisis. This provision also applies to an employer whose gross receipts fell by more than 50% when compared to the same quarter in 2019. For large employers (greater than 100 full-time employees), the credit applies to wages paid when the employees are not working due to COVID-19-related events. For employers with 100 or fewer full-time employees, all employee wages qualify, regardless of whether the employer is open for business. The credit is limited to the first $10,000 of compensation paid to an eligible employee between March 13, and December 31, 2020. “Compensation” for these purposes includes health benefits paid on employees’ behalf.

Employers may defer payment of the employer share of Social Security taxes paid on behalf of their employees. This tax is generally 6.2% of eligible wages. The deferred taxes must be paid within the following two years: half by the end of 2021, and the remainder by the end of 2022. This provision also applies to part of the self-employment tax paid by self-employed individuals.

Net operating loss carrybacks are being reinstated and the limitations are being relaxed. TCJA only allowed NOLs to be carried forward, not back, in most cases, but under the CARES Act, NOLs arising in 2018 through 2020 tax years are eligible for a five-year carryback. These same NOLs will not be subject to the normal taxable income limitation so that they may fully offset income. This provision will also apply to individuals who have an NOL due to losses from pass-through entities and/or from a sole proprietorship.

One of the more difficult to implement provisions of TCJA was the cap on the deductibility of business interest for large businesses (and many smaller businesses with losses). CARES does not eliminate this provision, but it temporarily raises the limit on deductibility from 30% of adjusted taxable income to 50% of adjusted taxable income. This change is effective for tax years beginning in 2019 and 2020. Additionally, businesses may elect to use their 2019 income in determining their 2020 limitation. This provision will keep an ordinarily profitable business from losing its interest expense deduction due to a bad year.

Another unpopular feature of TCJA was a technical drafting error which limited depreciation on qualified improvement property (QIP). CARES fixes that error so that QIP will now be subject to immediate expensing under the bonus depreciation rules rather than having to be depreciated on a straight-line basis over 39 years. This change is retroactive to January 1, 2018, which may give some businesses the opportunity to file amended returns and claim refunds.

As with all large legislative packages, there are a number of other provisions that apply only to specified industries, and many of the above provisions have exceptions and limitations that are too detailed to discuss in an overview. We are continuing to monitor the situation and will update advice as appropriate. In the meanwhile, if you have questions about specific provisions of the CARES Act, please get in touch with us.

Additional Resources:

To read about previously enacted provisions related to COVID-19, click here.

To learn about the financial resources for businesses affected by COVID–19 in the Washington Metropolitan area, click here.

To get the most recent developments on state tax filings related to COVID-19, click here.