Rebates for Individuals (Section 2020 of the CARES Act)
The CARES Act provides individuals who have a Social Security number (other than non-resident alien individuals, individuals claimed as dependents by another taxpayer and estates or trusts) with a tax credit for the 2020 taxable year in the form of a rebate check. The determination of whether the individual is eligible for the tax credit will be based on the individual’s status as reflected on the individual’s 2019 tax return. If the individual’s 2019 tax return has yet to be filed, the individual’s status will be determined based on the individual’s 2018 tax return or Social Security administration benefit information.
Eligible individuals will receive up to $1,200 ($2,400 for taxpayers filing jointly) plus an additional $500 for each child for whom the individual is entitled to the child tax credit under Section 24 of the Internal Revenue Code (the Code). The amount of the credit is reduced by $5 for each $100 of the individual’s gross income that exceeds $75,000 in the case of single filers, $112,500 in the case of head of household filers and $150,000 in the case of joint filers. The credit phases out entirely at $99,000 for single filers, $146,500 for head of household filers with one child and $198,000 for joint filers.
An eligible individual will be treated as having made a tax payment in respect of 2019 in an amount equal to the allowable credit. The resulting overpayment will allow the eligible individual to claim an advance refund prior to the end of 2020. No advance refund or credit will be allowed after December 31, 2020, in which case the credit can be claimed on the eligible individual’s 2020 tax return.
Charitable Deductions (Sections 2204 and 2205 of the CARES Act)
Individuals who do not elect to itemize deductions generally will be entitled to a deduction for up to $300 of cash contributions made in their 2020 taxable year to certain charitable organizations (including churches and other religious organizations).
In addition, the CARES Act increases the limitation on deductions for charitable contributions by individuals and corporations. For individuals who itemize deductions and elect to apply this provision of the CARES Act, the existing limit on deductions (generally, 50 percent of adjusted gross income) is suspended for contributions paid in cash during the 2020 calendar year, and the limit for those cash contributions is the excess of the taxpayer’s adjusted gross income over the amount of other allowed charitable contributions. However, the provision does not apply to contributions made to certain private foundations or to donor-advised funds. In the case of partnerships or S corporations, the election to apply this provision is made separately by each partner or shareholder. For corporations, the charitable deduction limit for contributions paid in cash during the 2020 calendar year is increased from 10 percent to 25 percent of the excess of the corporation’s taxable income over the amount of other allowed charitable contributions. Finally, the percentage used to calculate the limitations on the deduction for food inventory contributions made in 2020 increases from 15 percent to 25 percent.1
Employee Retention Credits (Section 2301 of the CARES Act)
The CARES Act provides “eligible employers” with a refundable employment tax credit for each calendar quarter equal to 50 percent of “qualified wages” paid to employees during such quarter. Only wages paid after March 12, 2020, and before January 1, 2021, qualify for the credit, and the maximum wages (including qualified health plan expenses described below) that can be taken into account with respect to any employee for all applicable calendar quarters is $10,000.
“Eligible employer” status is determined each quarter. An eligible employer is defined as any employer operating a trade or business in 2020 if either (i) that trade or business is fully or partially suspended in the relevant calendar quarter due to a governmental order relating to COVID-19 or (ii) the relevant calendar quarter falls within a period beginning with the first calendar quarter in which such employer suffers a decline of more than 50 percent in gross receipts compared with the same calendar quarter in the 2019 and ending with the first quarter in which gross receipts are greater than 80 percent of the gross receipts for the same calendar quarter in the prior year. A tax-exempt organization may constitute an eligible employer, but only if the operation of its relevant trade or business is suspended by governmental order. Government employers and employers receiving covered loans under Section 1102 of the CARES Act are not eligible for the credit.
“Qualified wages” include wages paid either (i) during periods in which operation of the employer’s trade or business is suspended due to a COVID-19- related governmental order or (ii) during any quarter in which the employer qualifies as an eligible employer by reason of reduced gross receipts. In the case of large employers2 (i.e., employers with an average number of full-time employees during 2019 greater than 100), qualified wages include only wages paid to employees not providing services during the relevant period. Qualified wages are increased by “qualified health plan expenses” allocable to such wages in a manner to be prescribed by the Department of the Treasury (Treasury). Qualified health plan expenses are generally amounts paid by an eligible employer to provide and maintain a group health plan, but only to the extent such amounts are excluded from the employee’s income. Qualified wages do not include mandatory sick leave and mandatory Family and Medical Leave Act (FMLA) wages payable by certain employers pursuant to prior COVID-19 legislation for which a separate employment tax credit is provided.3
Treasury is given broad regulatory authority under the statute, including the authority to provide for advance payments of credit amounts. In this regard, note that with respect to the credits payable on account of mandatory sick leave and FMLA wages pursuant to prior COVID-19- related legislation, Treasury announced that it intends to use analogous regulatory authority to permit taxpayers to request accelerated payment of those credit amounts. It seems likely that Treasury will permit similar requests to be made in respect of the employee retention credits.
Deferred Payment of Employer Payroll Taxes (Section 2302 of the CARES Act)
The CARES Act extends the due date for deposit of the employer’s 6.2 percent share of employment taxes (and a corresponding portion of (i) taxes payable pursuant to the Railroad Retirement Tax Act and (ii) self-employment taxes) otherwise due after the date on which the CARES Act is enacted and before January 1, 2021. The due date for 50 percent of such amounts is extended until December 31, 2021, and the due date for the remaining 50 percent of such amounts is extended until December 31, 2022.
This rule does not apply to any taxpayer if the taxpayer has benefited from forgiveness of debt under Section 1106 or Section 1109 of the CARES Act.
Net Operating Loss Modifications (Section 2303 of the CARES Act)
Following enactment of the Tax Cut and Jobs Act (the 2017 Tax Act), (i) with limited exceptions, net operating losses cannot be carried back to prior taxable years, and (ii) the net operating loss deduction for any taxable year beginning after 2017 is capped at 80 percent of the taxpayer’s taxable income for such taxable year (without regard to the net operating loss deduction).
The CARES Act modifies these rules in several respects.
First, for all relevant taxable years beginning before 2021, including taxable years for which tax returns have already been filed, the CARES Act eliminates the 80 percent taxable income cap.
Second, the CARES Act permits taxpayers other than REITs to carry back net operating losses arising in taxable years beginning in 2018, 2019 or 2020 to each of the five preceding taxable years.4
As a result of these changes, taxpayers who have loss carryforwards from 2018 or 2019 will be allowed to file amended returns and immediately carry those losses back up to five years and obtain refunds of taxes paid in those earlier years. In this regard, note that the amount of those refunds will be determined by reference to the tax rates in effect in the year to which the losses are carried back. Thus, to the extent that losses are carried back to offset taxable income in years in which the corporate tax was 35 percent, in addition to the timing benefit arising from the ability to carry back the losses, the amount of the tax benefit generated by the use of those losses will be significantly greater than it would have been in the absence of the carryback.
Taxpayers who have participated in M&A transactions should review the tax provisions in the relevant transaction documents to determine whether those provisions allow for carrybacks to years in which the target company was owned by the seller and whether they adequately and appropriately address which party will be entitled to the benefit resulting from the use of losses in light of this change in law.
In addition, the CARES Act makes technical corrections to the relevant provisions of the Code relating to the manner in which the 80 percent taxable income cap will be applied in taxable years beginning after 2020. These corrections clarify that the 80 percent taxable income cap is applied after taking into account loss carryforwards from any taxable year not subject to the cap.
Limitation on Losses for Taxpayers Other Than Corporations (Section 2304 of the CARES Act)
As a result of changes made by the 2017 Tax Act, business losses of non-corporate taxpayers arising in taxable years beginning after December 31, 2017, and before January 1, 2026, that exceed certain thresholds are not deductible but instead must be carried forward to future taxable years.
The CARES Act modifies these provisions by making this limitation inapplicable to taxable years beginning before January 1, 2021, thereby allowing taxpayers to deduct losses otherwise subject to this limitation (subject to any other applicable loss limitations). As with the net operating loss provisions described above, because these changes apply to tax years beginning after 2017, affected taxpayers can file amended returns for 2018 (and to the extent already filed, 2019) and claim immediate refunds.
Modification of Corporate AMT Credits (Section 2305 of the CARES Act)
As part of the 2017 Tax Act, the corporate alternative minimum tax was repealed, with taxpayers able to claim any unused alternative minimum tax (AMT) credits during the four-year period ending in 2021 and to claim 100 percent of any amount not previously claimed in 2021.
The CARES Act permits taxpayers to claim the full amount of the unused AMT credits on its 2019 tax return and contemplates that taxpayers will be entitled to file an application for a tentative refund in a form and manner to be determined by Treasury.
Modifications of Business Interest Limitation (Section 2306 of the CARES Act)
The 2017 Tax Act added new Section 163(j), which places limits on the amount of business interest that taxpayers can deduct in a particular taxable year. In general, under those provisions, a taxpayer’s interest deduction for a particular year is limited to the sum of (1) 30 percent of the taxpayer’s adjusted taxable income (generally, an amount equivalent to EBITDA for taxable years beginning before 2022 and an amount equivalent to EBIT for taxable years beginning in 2022 and after), plus (2) the taxpayer’s business interest income plus (3) the taxpayer’s floor plan financing interest. In the case of partnerships, the Section 163(j) limitation is determined at the partnership level. Business interest expense in excess of the Section 163(j) limitation can be carried forward and used in subsequent years. Any business interest expense of a partnership in excess of the Section 163(j) limitation is allocated to the partners as a carryforward item that the partners can use only to the extent they are allocated “excess taxable income” or excess business interest income by the partnership in future years.
The CARES Act modifies these provisions in a manner intended to allow taxpayers to deduct more of their business interest expense in 2019 and 2020.
First, in the absence of an election to the contrary, for any taxable year beginning in 2019 or 2020, the taxpayer’s Section 163(j) limitation takes into account 50 percent rather than 30 percent of the taxpayer’s adjusted taxable income.5
Second, in the case of taxable years beginning in 2020, taxpayers can elect to apply Section 163(j) by substituting the taxpayer’s (presumably higher) adjusted taxable income for the taxable year beginning in 2019 for the taxpayer’s adjusted taxable income in the taxable year beginning in 2020. In the case of a partnership, the election is made at the partnership level.
Technical Correction Fixing the “Retail Glitch” (Section 2307 of the CARES Act)6
As part of the 2017 Tax Act, Congress intended to allow the cost of qualified improvements to be immediately deductible, but due to a drafting error (commonly referred to as the “retail glitch”), those improvements were determined to be subject to a 39-year recovery period.
The CARES Act fixes the drafting error retroactive to the effective date of the 2017 Act. Accordingly, to the extent taxpayers have previously filed tax returns on which they depreciated qualified improvements using a 39-year recovery period, those taxpayers can file amended tax returns on which they are now entitled to deduct 100 percent of the cost of the qualified improvements.
1 If the amount of 2020 cash contributions exceeds the increased limitation described above for individuals or corporations, the excess will be carried over and treated as a cash contribution subject to the existing limitations applicable to such taxpayers in each of the five succeeding taxable years.
2 Employers treated as a single employer under certain other provisions of the Code will be treated as a single employer for purposes of the employee retention credit provisions. Thus, for example, separate employers that are part of a consolidated group of corporations will be treated as a single employer for determining the number of employees and, accordingly, wages that constitute “qualified wages.”
3 See Governmental Responses to COVID-19 with Significant Implications for Employers: Federal Coronavirus Response Act and Partial Suspension of California WARN Act at https://www.sidley.com/en/insights/newsupdates/2020/03/governmental-responses-to-covid-19-with-significant-implications-for-employers.
4 Special rules apply in cases where net operating losses are carried to any taxable year in which an amount is includible under Section 965(a) of the Code (relating to the deemed repatriation of offshore income). In addition, the CARES Act makes clear that the carry back of a net operating loss to a taxable year of a life insurance company beginning prior to the effective date of the 2017 Tax Act will be treated as an “operations loss carryback” for such year, following the statutory scheme for life insurance carry backs in effect for years prior to the 2017 Tax Act.
5 In the case of a partnership, this rule applies only to taxable years beginning in 2020, presumably to avoid the need for partnerships to file amended K-1s for the 2019 taxable year. In the case of partnership taxable years beginning in 2019, however, partners are allowed to use 50 percent of any excess interest expense of the partnership carried forward by the partner to 2020 without regard to the partnership’s 2020 taxable income, business interest income or business interest expense. The remaining 50 percent of the partner’s excess business interest expense carryforward remains subject to the same limitations in effect prior to amendment by the CARES Act (i.e., it can only be used to the extent the partnership generates excess taxable income or excess business interest income).
6 The Senate’s initial version of COVID-19 stimulus legislation would have made an additional technical correction, removing the rule added by the 2017 Tax Act requiring “downward attribution” of ownership for purposes of determining whether a foreign corporation is a controlled foreign corporation. That provision is not included in the CARES Act as passed by the Senate.
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