Commentary of Coronavirus Aid, Relief, and Economic Security Act (the CARES Act)
Author: Jacob Franklin
There is quite a Pangea of tax items contained in the CARES Bill recently signed into law by President Trump. There are basically four common motivations behind these items: incentivizing employers to retain and continue to pay employees, providing stimulus for the economy by reducing current tax burden, giving individuals, employers, and businesses access to cash in the form of refunds and rebates, and most entertainingly curing Congress’s various drafting mistakes from the Tax Cuts and Jobs Act that have been plaguing the tax system dating back to the 2018 filing season. Of course, the final item depends on a person’s standards for entertainment.
Let’s start first by taking a look at the individual provisions.
In a few weeks many individuals will be receiving payments from the IRS. The amount of the payments is dependent on whether the return is for a single person or a married couple and the number of dependents claimed on the return. The payment will be $1,200 per individual ($2,400 for a married couple filing jointly), plus $500 for each dependent child. Dependent children will not be eligible to receive their own payment. The payment amount will only be provided to those whose income is below certain thresholds. As a single person’s income exceeds $75,000 or a married couple’s income exceeds $150,000 the payment begins to be reduced by $5 for each $100 of income over those thresholds. So, a single person with no children, or a married couple with no children will receive no payment for incomes in excess of $99,000 and $198,000, respectively.
This payment is deemed to be an advance of a credit available on the 2020 tax return. The income amounts for determining a taxpayer’s eligibility for an advance on that credit will be based upon the 2019 tax return. If the taxpayer’s 2019 tax return has not been filed, the IRS will look to income amounts on the 2018 tax return.
When the idea of the rebate was originally released, taxpayers that paid little to no income tax in previous years were slated to get reduced amounts. This provision has been removed from the final bill. All taxpayers below the income threshold amounts will receive the full payment.
The amounts are expected to be distributed within weeks, and the payments will come in the same form as the 2019 tax refund (2018 for those who have yet to file 2019).
An additional measure congress has taken to help taxpayers have access to cash is allowing them to tap retirement funds without penalty, or giving preferential treatment for borrowing funds from retirement plans while allowing for the funds to be recontributed without tax or penalty.
Generally, taxpayers under the age of 59 ½ are subject to a 10% penalty for distributing funds out of a retirement account. Under the CARES act, taxpayers who are affected by the COVID-19 pandemic by way of being infected, having a spouse or dependent child who is infected, experiencing economic hardship due to the virus because of a layoff, reduction in hours, etc. will get this preferential treatment with respect to their retirement plans. Those taxpayers will be able to distribute up to $100,000 penalty free from their retirement accounts. While those amounts will still be subject to income tax, Congress has provided those taxpayers with the ability to tax the distribution over a three-year period.
Additionally, Congress has provided those taxpayers with the ability to redeposit those funds into the retirement plan within three years and have the distribution/contribution be treated as a qualified non-taxable rollover. This provision is quite interesting to people in the tax community as it takes an unintended loophole in the tax code and essentially just makes it bigger.
Generally, a rollover from a retirement account happens when a taxpayer leaves an employer or financial institution and needs to move funds from one retirement plan to another. Generally, the funds are transferred directly from one investment company to another. However, there is a provision that allows a taxpayer to receive a check from the retirement plan and deposit those funds into another qualified retirement plan within 60 days. If done properly, the distribution is treated as a non-taxable rollover. Knowing this provision exists, some taxpayers have used that 60-day window as an interest free bridge loan. The IRS has not been friendly to those taxpayers who have run into trouble in meeting the 60-day requirement. The IRS has gone so far as to deny additional time for recontribution to someone whose house was destroyed during Hurricane Sandy because the IRS was adamant that this provision was not intended to be a loan. Apparently, the 116th Congress does not share the IRS’s view regarding this provision as Congress is applying this provision in the exact manner to which the IRS objects. Affected taxpayers will have three years to redeposit funds into the retirement account for the transaction to be treated as a nontaxable rollover. Unfortunately, the irony of this provision is sure to be lost on all but CPAs.
Required Minimum Distributions
Qualified retirement plans allow funds to grow tax free, and like all good things, this must come to an end. Once an individual reaches the appropriate age (72 in 2020 thanks to the SECURE act passed in December of 2019), that individual is required to distribute a portion of his or her retirement account in a taxable distribution. The distribution amount is determined based on actuarial tables released by the IRS. The amount required to be distributed increases yearly with age.
For the 2020 tax year, this requirement has been suspended by the CARES act. While I welcome the provision, the logic escapes me. Perhaps Congress has seen enough stocks get sold over the previous weeks, and doesn’t want to give anyone another incentive to sell. Or perhaps Congress is hoping people apply some common logic, “You’re not lost until you run out of gas, and you didn’t lose any money unless you sell the stock.”
Historically, taxpayers have not been able to offset 100% of their income with charitable contributions. For 2020, Congress is now allowing taxpayers to do just that. Under the Tax Cuts and Jobs Act, the previous 50% limitation on cash contributions was raised to 60% until 2025. For 2020, that amount is raised to 100%. Corporations will also be afforded a higher threshold for contributions during 2020 as well (25% of 2020 taxable income versus the previous 10%).
The logic behind these provisions seems unclear at this point. Either Congress believes that taxpayers will be much more charitably inclined during 2020 (which I hope is true), or else Congress believes income will be much lower in 2020 which would otherwise restrict charitable giving (which I hope is not true).
Additionally, Congress has given us a permanent item related to charitable contributions. Thanks to the much larger standard deduction and limitation on deductibility of state and local taxes, vast numbers of taxpayers who used to itemize their deductions are now taking the much larger standard deduction. As a consolation prize, Congress is now allowing taxpayers to deduct $300 of charitable contributions without using itemized deductions.
Next let’s take a look at changes to business tax provisions. First, while the Paycheck Protection Program loans are not necessarily a tax item, it effects enough business tax provisions that it must be discussed within this article. This program was established to let small businesses, non-profits, and self-employed individuals receive loans in order to continue business operations and to continue payroll to employees. Many of these loans will be at least partially forgiven by the Federal Government. Whether or not businesses have taken these loans or had debt forgiven under these loans will impact different business tax provisions.
Delayed Payments for Payroll Taxes:
Employers withhold Social Security and Medicare tax as part of administering payroll. Additionally, employers must match this withholding when remitting payments to the IRS. Generally, this equates to a 7.65% tax on the employer’s payroll. The CARES act will allow employers to defer the payment of the employer’s match portion of these payroll taxes for the remainder of 2020. The deferred tax will be payable in two installments (December 31, 2021 & December 31, 2022).
Self-Employed Individuals are generally subject to a Self-Employment tax of 15.3% which is comprised of both the employer and employees share of Social Security and Medicare (7.65% X 2). Self-Employed Individuals would be afforded the same opportunity to defer ½ of the self-employment tax in the same manner.
It should be noted that employers and self-employed individuals who have debt forgiven under the Paycheck Protection Program will not be eligible for these deferrals.
Net Operating Losses
Before the Tax Cuts and Jobs Act of 2017 (TCJA), Net Operating Losses (NOLs) were allowed to either be carried back two years for a refund claim, or carried forward for up to 20 years to offset future income. Under the TCJA, NOLs were no longer allowed to be carried back. Now under the CARES Act, the carryback makes its grand return with style. The carryback provision was restored and it has been increased to five years from its previous two.
This change to the carryback provision is retroactive to the 2018 year, so not only will taxpayers be able to carryback 2019 Net Operating Losses, but they can also carryback any 2018 losses to potentially access refunds for future cash needs. Even better, the five-year carryback provision will allow C corporations to carry losses back to higher tax bracket years (potentially 35% versus 21% for carryforward).
Furthermore, the TCJA limited the ability for Net Operating Losses to completely wipe out future taxable income. Net Operating Losses incurred after December 31, 2017 could only offset up to 80% of taxable income in a future year. This limitation has been lifted for tax years 2018 – 2020.
Excess Business Loss Limitations
This provision may be a little more obscure, but to those who have been affected by it, they will know it well. Basically, the Excess Business Loss Limitation prohibits large business losses from offsetting other types of income (investment, rental, etc.). The limitation was $250,000 for a single taxpayer or $500,000 for a joint taxpayer. This limitation has been removed for the 2018 through 2020 tax years making this another opportunity for taxpayers to amend 2018 returns for access to cash.
Employee retention credit for employers subject to closure due to COVID-19
Congress hoped to defray some of the cost for businesses who continued to pay employees even while the business was either shut down or suffered significant revenue declines during the COVID-19 pandemic. This credit is a refundable payroll tax credit of 50 percent of wages paid to employees during the COVID-19 crisis. Qualifying employers are those whose operations were fully or partially shut-down, whose gross receipts declined by more than 50 percent compared to the same quarter in the previous year. Qualified wages only include the first $10,000 of compensation to each employee (including health benefits). The credit is for wages paid or incurred between March 13, 2020 and December 31, 2020.
If an employer had more than 100 employees, only those employees who were not working during shutdowns caused by COVID-19 will qualify. For those employers with fewer than 100 employees qualified wages include all wages paid to employees during the shutdown or significant decline
Only employers who did not receive a small business interruption loan will be eligible.
Business Interest Limitation
Starting in 2018, one of the revenue-raising items was a potential limitation on the deductibility of interest expense. This limitation was based on multiple factors including gross receipts, net income, depreciation expense, and interest expense. Even beginning to explain the mechanics of this limitation is well beyond the scope of this article. The key takeaway for this item as it relates to the CARES Act is that for 2019 and 2020 much of the bite has been removed from this limitation (2020 for partnerships).
Qualified Improvement Property
This final change is your treat for making it all the way through to the end.
Generally, commercial real estate is depreciated over 39 years. However, throughout the years there have been special carve outs that have allowed the depreciable life for commercial real estate to be reduced for specific industries. These were a patchwork of different types of property (qualified restaurant property, qualified retail property, etc.). The Tax Cuts and Jobs Act of 2017 rode in on a white horse to slash through the red tape, apply the breaks to all industries, and simplify the code by creating a single type of commercial real estate that allowed for a 15 year life and the ability to write-off in a single year the entire improvement if a taxpayer so chose. In reality what happened was a drafting error that cut through the red tape, treated all industries the same, and made everyone depreciate their property over 39 years.
The CARES Act has corrected the wrongs of the past, retroactively. If during the 2018 or 2019 tax year a taxpayer placed into service qualifying property, an amended return can be filed to claim a refund for the difference in depreciation.