Late on March 25, 2020, the US Senate released the final tax of the CARES Act, the third Coronavirus related Bill and much needed stimulus package. The Bill passed the House and signed into law by the President on March 27th.
At this time, we want to stress to our clients that so far, all that has been done is the passage (eventual) of the law. We still need to get regulations issued to help define the key questions and details of the law along with guidance from Federal agencies on the mechanics of claiming these benefits. As more information is released, we will share with you and begin to help you navigate (along with your team and other providers, such as payroll processors) these waters to get the necessary assistance for you and your business.
Employee retention credit for employers
One of the major provisions for employers that are trying to weather this storm, from a tax perspective, is this Employee Retention Credit (ERC). In a broad sense, the law is providing a credit against the applicable employment taxes (6.2% Social Security Tax only!) for 50% of the qualified wages of each employee of an employer for each calendar quarter.
Qualified wages are capped at $10,000 for all quarters, on a per employee basis. At this point, there have been multiple interpretations seen in the media and in senate materials; however, our and the most common interpretation is that the cap is on wages, and the credit is for 50% of these wages, making the maximum credit $5,000.
The credit can offset applicable employment taxes (the employer’s 6.2% social security tax) in any calendar quarter in which the credit is earned. Any amount in excess of this tax is treated as an overpayment and is therefore refundable to the taxpayer.
The credit is designed to help keep employees on payroll during this shutdown and would fully cover 50% of wages (including amounts paid for insurance). Senator Toomey said this “is exactly equivalent to a 50 percent cut in their payroll. That is going to enable a lot of medium and large businesses to retain their workforce.”
The ability to claim these credits depends first on if you are an eligible employer, meaning the following:
1. The employer must have carried on a trade or business during the calendar year 2020, AND
2. For each quarter, the trade or business is either
a. Fully or partially suspended due to orders from an appropriate governmental authority limiting commerce, travel OR
b. Gross receipts are less than 50% during the same quarter in the prior year. This period continues until gross receipts for a calendar quarter are greater than 80% of gross receipts of the prior year quarter.
For eligible employers (who should be nearly everyone), the next key factor will be the number of full-time employees (determined in the same manner as ACA calculations).
Employers with less than 100 employees
For employers with less than 100 employees, all wages during any such period above are considered qualified wages, regardless of if the employee is able to provide services or not.
Employers with more than 100 employees
For employers with more than 100 employees, qualified wages are limited to wages paid to employees who were unable to provide services as a result of condition a. or b. above.
The regulations and forms for this specific credit will be crucial to understanding and confirming this interpretation of how this credit functions. They will also be very crucial in helping to understand recordkeeping requirements, documentation and certifications needed and other key issues. Until these are released, we will be in a holding pattern. As more information is released, such as regulations or forms & mechanisms used to claim these credits, we will be able to advise and act & plan on these provisions and work with payroll processors to claim these credits.
The passed law includes that any credits belong to the company itself and not to a Certified PEO, similar to credits for increasing R&D Credits. Hence, being on a PEO will not preclude any taxpayers from taking advantage of this credit.
Per the Joint Tax Committee Report, this credit is effective for wages paid after March 12, 2020 thru December 31, 2020.
It is also important to note that this credit will not be available for any taxpayer who takes any Small Business Interruption loan.
A final, and somewhat underpublicized & interesting note is that the law allows for the issuance of regulations that will allow for an advance payment of this credit. As more details on this potential advance payment become available, we will share.
Delay of payment on Employer Payroll Taxes
The CARES act provides a temporary liquidity measure by allowing for the deferral of applicable payroll taxes (the 6.2% employer Social Security liability). 50% of the amount is due on December 31, 2021 and 50% of the amount is due on December 31, 2022. There will likely be additional forms and regulations related to how to pay these forthcoming, as well as work to do with payroll processors to implement.
Employers who work via a Certified PEO relationship will also be eligible for this deferral. The business will have to direct the PEO to defer payment; the mechanism of this will likely need to be covered between you and your processor. We are sure they will be diligent on the communication of this, and we will work to assist accordingly.
Additionally, Self-employed taxpayers can defer 50% of any related Self-employment tax (SECA) due between the enactment of the CARES Act and December 31, 2020. This deferment includes the deferment of any estimated tax payment, as there will be no estimated tax penalty for this amount.
Any Trust Funds are held harmless per the statute, which should mitigate any trust fund recovery penalty concerns.
Very important to note: any taxpayer that takes out a payroll protection loan (see our information on business lending provisions here) will not be eligible for this deferral.
Modification of Net Operating Losses
The TCJA changed the rules relating to Net Operating Losses (NOLs), which eliminated the ability for taxpayers to carry back NOLs to the preceding 2 prior years and then to carry forward the loss for up to 20 years and use as an offset of 100% of taxable income. The current law does not allow for carrybacks and provides that a maximum of 80% can be used in any year as a carryforward.
The CARES Act amends Section 172 (which governs NOLs) to allow losses from 2018, 2019 and 2020 to be carried back for up to 5 years, and any losses carried to 2019 or 2020 will be allowed to offset up to 100% of income.
It is important for both individual and corporate taxpayers to use the NOL rules under Section 172, which combined with other sections, may allow for pass-through entity owners to claim NOL carrybacks.
Modification of Business Losses for Non-Corporate Taxpayers
Another TCJA change was to limit the total amount of business losses available for individual taxpayers. Under this TCJA change, a business loss was limited to $250,000 ($500,000 if married) per year, with any additional amounts treated as a Net Operating Loss going forward.
CARES Act amends this IRS Code Section to allow unlimited business losses from 2018, 2019 and 2020, which, combined with the above NOL provisions, can provide refunds for taxpayers of prior taxes. As the change is retroactive to 2018 and 2019, any losses in those years can also be used to potentially accelerate those refunds via amendments if filed or filing the current return and a claim for an NOL carryback (which will probably take some time to implement the reporting, appropriate forms and tax software updates).
Business Income Interest Limitation
A final TCJA change that has been updated is on the business interest income limitation. As part of the tax reform, businesses were limited on their interest deduction to approximately 30% of their EBITDA if they were above a certain level of gross receipts (average of $25 million) over the prior 3 years.
Under the CARES Act, this limitation is raised to 50% for 2019 and 2020 and allows for an election to use 2019 income in place of 2020 income (as 2020 may be a loss for many businesses). If your business is below the receipts level or has significant business investment income, these provisions will not provide much assistance.
Expansion of Employee Tuition Programs to Include Student Loans
Under current IRS Law, Section 127 allowed for educational assistance programs which could pay for employee’s college tuition, up to $5,250 per year, so long as it was provided to all employees and in a non-discriminatory manner. These programs are for the employee only and do not apply to the dependents of the employee.
For 2020 only, employers can make payments for employee student loans (for the education of the employee) under these programs, which are fully deductible for the employer but not considered income for tax purposes of the employee.
Technical Correction Regarding Qualified Improvement Property
As part of the 2017 Tax Reform, the TCJA changed certain classes of property into one combined class called “Qualified Improvement Property,” which is for an improvement of the interior of a nonresidential (commercial) property, so long as it is not an enlargement of the building, the internal structural framework, elevators or escalators or building systems (HVAC, fire suppression, alarms).
During the drafting of the TCJA, this property was intended to have a 15-year class life (meaning depreciated over 15 years); however, a drafting error excluded this provision. The net result was that this property was not eligible for 100% bonus depreciation but was eligible for Section 179 expensing. However, Section 179 depreciation can only be used up to certain limits and cannot create a loss above business income. As such, some taxpayers would have been better served to use bonus depreciation to reduce taxable into a loss or were otherwise ineligible to use Section 179 depreciation.
This correction updates the tax law to reflect the 15-year life effective as of January 1, 2018, as if it were always there. Any taxpayers who were unable to fully depreciate leasehold improvements should consider amending 2018 or filed 2019 returns to take advantage of this expanded depreciation.
Edward McWilliams, CPA
Ed is a Partner in the firm’s tax and business advisory practice focusing on providing services to middle market private companies across different industries as well as to early stage startups. Ed has over a decade of experience providing tax and business consulting services to these companies of different sizes and across different industries, bringing a broad and diverse knowledge base and strategic solutions to the many complex issues that businesses face.