The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) is expected to be enacted, as early as March 27, 2020. The CARES Act contains tax provisions intended to provide individuals and companies with liquidity as the world battles the COVID-19 pandemic. As summarized in more detail below, the CARES Act allows taxpayers: (i) to fully offset taxable income for certain years with post-2017 net operating losses (“NOLs”); (ii) to carryback certain NOLs up to five years; (iii) to immediately claim tax credits for taxes paid under the alternative minimum tax (“AMT”) in pre-2018 years; (iv) to deduct additional interest expense; (v) to claim bonus depreciation for improvements to nonresidential buildings; (vi) to claim a refundable payroll tax credit for qualified wages paid by COVID-19 impacted taxpayers; and (vii) to delay tax payments for the employer portion of certain payroll taxes. Some of these provisions only apply to corporations. In addition, the CARES Act allows individual taxpayers to take certain penalty-free withdrawals from their retirement plans and expands the ability to deduct charitable contributions. The CARES Act builds on other actions previously announced by the Treasury and the IRS to delay the filing of federal income tax returns and payment of tax from April 15 to July 15.
The CARES Act significantly increases the ability of corporations to utilize NOL carryforwards and carrybacks for NOLs generated in 2018, 2019 and 2020. The TCJA eliminated the ability to carryback most NOLs and limited a corporation’s ability to use NOL carryforwards in a taxable year to 80% of taxable income. The CARES Act temporarily suspends both of those changes by permitting a corporation to carryback NOLs generated in 2018, 2019 and 2020 to the five preceding years, which loss carrybacks were previously subject to the TCJA disallowance of NOL carrybacks. This will allow corporations to utilize current year NOLs to obtain refunds for taxes paid in prior years. In the event that a taxpayer has an NOL carryback to 2017 and such taxpayer had an income inclusion under Section 965, the taxpayer is treated as having made an election under Section 965(n) such that the NOL is not used in determining the taxpayer’s income inclusion under Section 965. Alternatively, the CARES Act provides that a taxpayer may make an election to exclude taxable years in which it had an inclusion under Section 965 from the carryback period. The CARES Act also suspends the 80% taxable income limitation to permit a corporation to offset without limitation its taxable income in 2019 or 2020 with NOL carryforwards generated in 2018 or 2019. Corporations that had NOLs in 2018 or 2019 for which they have already filed tax returns should consider filing amended tax returns for those years, even if they had previously believed that these NOLs were utilized in 2019 or 2020.
In addition, the CARES Act generally allows partnerships and businesses operated as sole proprietorships to utilize business losses, without regard to the excess business loss rules enacted by the TCJA, by delaying the application of such excess business loss limitations of Section 461(l) to tax years beginning after December 31, 2020. Taxpayers with losses that were not allowed in 2018 and 2019 as a result of the Section 461(l) limitation may file claims for refund.
The CARES Act accelerates the ability of a corporation to utilize corporate AMT credits to offset its tax liability (or possibly to receive a refund of the AMT credits). The TCJA eliminated the corporate AMT. However, many corporations had AMT credit carryforwards from pre-TCJA years. The TCJA permitted a corporation to utilize such AMT credit carryforwards to offset federal income tax payable and receive a refund for up to 50% of unused AMT credit carryforwards at the end of each of 2018, 2019 and 2020. Any remaining AMT credit carryforwards would have been refundable at the end of 2021. The CARES Act permits corporations to elect to claim an immediate refund for any remaining AMT credit carryforwards.
The TCJA amended the interest expense limitations under Section 163(j) such that taxpayers may only deduct net business interest expense up to 30% of the taxpayer’s adjusted taxable income. For interest expense incurred by a partnership, the partnership rather than the partnership’s partners apply the Section 163(j) interest expense limitation. The CARES Act increases the interest expense limitation in two ways. For 2019 and 2020, the CARES Act increases this limitation to 50% (rather than 30%) of the taxpayer’s adjusted taxable income. In addition, the CARES Act permits a taxpayer to elect to use its 2019 adjusted taxable income to determine its limitation for 2020, thereby potentially allowing a taxpayer to deduct additional interest expense in the event that the taxpayer’s adjusted taxable income during 2019 exceeds its adjusted taxable income for 2020. The CARES Act clarifies that an election to use the partnership’s 2019 adjusted taxable income will be made by the partnership rather than its partners. For a discussion of additional tax considerations with respect to structuring borrowings, see our recent perspective, Tax Planning for Multinational Borrowers During the COVID-19 Crisis.
While the CARES Act provides rules regarding how the increased interest expense limitation for 2020 works if 2020 is a short taxable year, it does not address how the rules apply in other more complicated fact patterns that may arise if, for example, a taxpayer seeking to increase its 2020 Section 163(j) limitation by reference to its 2019 income engaged in certain M&A transactions in 2019 or 2020.
The TCJA provided for 100% bonus depreciation for certain investments in depreciable property. However, as a result of a provision commonly referred to as “the retail glitch,” an investment in any improvement to any interior of a nonresidential building meeting the definition of “qualified investment property” was not eligible for bonus depreciation. The CARES Act permits taxpayers to claim bonus depreciation with respect to such improvements effective retroactively as if originally included in the TCJA, thereby enabling businesses (especially in the hospitality and retail industries) to immediately expense costs associated with improving facilities.
The CARES Act provides a refundable payroll tax credit up to 50% of eligible wages paid by employers to employees from March 13, 2020 through December 31, 2020 whose (i) operations were fully or partially suspended due to a COVID-19 related shut-down order or (ii) gross receipts declined by more than 50% compared to the same quarter in the prior year. The credit is capped at $10,000 of compensation per employee (which includes health benefits). For eligible employers with 100 or fewer employees, all employee wages paid qualify as eligible wages for the purpose of the payroll tax credit. For eligible employers with more than 100 employees, only wages paid to employees when they are not providing services due to a COVID-19 related shut-down order or a 50% reduction in gross receipts are eligible for the payroll tax credit.
The CARES Act allows employers to defer the payment of the employer portion of any Social Security payroll taxes and self-employed individuals to defer the payment of half of any self-employment taxes arising under Section 1401(a) (relating to the Social Security component of the self-employment tax), in each case, for the period between the date of enactment of the CARES Act and December 31, 2020. 50% of the deferred employment tax may be paid on December 31, 2021 and the remaining 50% on December 31, 2022.
Absent certain exemptions, individuals that take early withdrawals from qualified retirement plans are generally required to pay a 10% penalty. Consistent with previous disaster-related relief, the CARES Act waives this 10% early withdrawal penalty for distributions made in calendar year 2020 from qualified retirement accounts for COVID-19-related purposes, subject to a cap of $100,000. In addition, while the distribution would generally be taxable in the year of the distribution, under the CARES Act, a distribution for a COVID-19-related purpose would be subject to tax over a three-year period beginning with the year of the distribution. The taxpayer also may recontribute the funds to an eligible retirement plan within three years without regard to that year’s cap on contributions and, in such an event, the amount of the COVID-19-related distribution that is recontributed would not be subject to tax. The CARES Act also provides flexibility for loans from certain retirement plans for COVID-19-related relief.
Furthermore, the CARES Act temporarily waives required minimum distributions for certain qualified retirement plans for calendar year 2020.
The CARES Act permits individual taxpayers to deduct up to $300 of qualified cash charitable contributions, regardless of whether they itemize their deductions or claim a standard deduction. Under current law, an individual may generally deduct charitable contributions up to 50% of the individual’s adjusted gross income and a corporation is subject to a 10% limitation. The CARES Act suspends the limitation for individuals for 2020 and increases the limitation to 25% of taxable income for corporations.
Earlier versions of the CARES Act contained additional provisions that were not included in the final bill. An earlier version of the CARES Act would have provided relief to certain taxpayers from the unintended adverse consequences resulting from the TCJA’s repeal of Section 958(b)(4) (which had prevented “downward attribution” in certain cases). In addition, an earlier version would have permitted businesses to receive an immediate refund related to overpayments of 2017 taxes resulting from technical issues related to the TCJA’s transition tax on foreign earnings. While these provisions were not included in the final version of the CARES Act, they could re-emerge in subsequent legislation.
We will continue to provide updates as future developments and tax-related stimulus and incentives emerge.
Please contact any member of the Shearman & Sterling LLP Tax team for further information.