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Initial Impressions of the Business Tax Measures in the Phase III Coronavirus (COVID-19) LegislationMarch 26, 2020
The US Senate reached agreement on the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), a $2.2 trillion economic stimulus and relief package, on March 25, 2020. Included in the CARES Act are a number of changes to the Internal Revenue Code (the “Code”) designed to provide relief and liquidity to taxpayers suffering losses and/or that are required to take on debt for liquidity purposes. The CARES Act also includes certain technical corrections to the Tax Cut and Jobs Act (“TCJA”) enacted in December, 2017.
The House is considering the CARES Act, with a vote likely imminent. This communication will be updated accordingly as specific details become clearer or changes occur. If you have any questions regarding the CARES Act or how it may affect your company, please contact the authors of this alert or your O’Melveny advisor.
A summary of the CARES Act highlights is provided below. In light of a number of these changes, taxpayers may want to assess whether they can realize near-term benefits by amending returns to generate refunds and unlocking additional net operating losses (“NOLs”) that can be carried back to prior years, among other benefits.
Employer Tax Relief Provisions:
- The CARES Act extends the payment of payroll taxes due during 2020 by allowing 50% of such taxes to be paid on or before December 31, 2021, and 50% on or before December 31, 2022.
- The CARES Act provides for advance refunds of the payroll tax credits enacted last week as part of the Families First Coronavirus Response Act, P.L. 116-127, and a waiver of penalties for taxpayers that failed to deposit payroll taxes in anticipation of the tax credit.
- The CARES Act includes an employee retention credit for businesses closed due to the coronavirus pandemic. Eligible employers are allowed a credit against employment taxes equal to 50% of qualified wages (up to $10,000 in wages) for each employee.
- To be eligible, employers must have been carrying on a trade or business in 2020, the operation of which has been fully or partially suspended due to orders from an appropriate governmental authority limiting commerce, travel, or group meetings due to the COVID-19 outbreak.
- The credit is available during the period beginning the quarter for which the employer’s gross receipts are less than 50% of its gross receipts for the same quarter in the prior year and ending the quarter for which its gross receipts exceed 80% of its gross receipts for the same calendar quarter in the prior year.
- For employers with more than 100 employees, wages eligible for the credit are wages paid to employees who are not providing services due to the suspension of the business or a drop in gross receipts. For employers with 100 or fewer employees, all wages qualify.
- The credit is provided for wages paid or incurred from March 13, 2020 through December 31, 2020.
Net Operating Loss, Excess Business Loss and Alternative Minimum Tax Credit Relief
- One of the most significant provisions in the CARES Act with respect to businesses and corporations is a new rule that enhances their ability to utilize NOLs to offset taxable income. Specifically, for the 2018, 2019, and 2020 tax years:
- NOLs may to be carried back up to five years; and
- The TCJA’s 80% limitation on a taxpayer’s ability to offset income with NOLs is removed.
- The CARES Act also repeals the TCJA’s rule that disallowed a deduction for business losses of non-corporate taxpayers in excess of $250,000 ($500,000 for married taxpayers filing jointly).
- The CARES Act accelerates the timing for corporate taxpayers to obtain refundable alternative minimum tax (“AMT”) credits. Whereas under the TCJA these credits were payable over four years from 2018-2021, under the CARES Act the entire amount is deemed refundable in 2018. Corporate taxpayers with remaining AMT credits should consider amending their 2018 federal income tax return to obtain this benefit.
Taxpayers without existing NOLs may not benefit from the new five-year NOL carryback rule or the temporary repeal of the current 80% limitation on the use of NOLs.
Because tax returns are filed on an annual basis, certain companies may not see the benefit of these new rules until next year when they actually file their 2020 tax returns.
Taxpayers with existing NOLs should examine their prior year tax returns to determine whether there is an immediate benefit available to them by filing amended returns before next year’s filing deadlines. Taxpayers able to carry NOLs back to years before 2018 will benefit from the higher pre-TCJA tax rates. For a corporate taxpayer, such a carryback will achieve a 35% tax benefit as compared to the lower 21% tax benefit for NOLs applied to offset income in later taxable years.
The timing of the receipt of any payments or benefits arising from the CARES Act may be delayed given the logistical and other processing difficulties that are certain to ensue.
Investment funds and strategic acquirers and sellers of companies that may be able to benefit from the CARES Act should examine their stock purchase agreements to determine whether they are permitted to file a claim for a refund on behalf of any such companies, and after reviewing their rights and obligations, may wish to approach counterparties where applicable to begin discussing the prospect of filing amended returns.
Modification of Interest Expense Deduction Limitation
- For the 2019 and 2020 tax years, the CARES Act increases taxpayers’ ability to deduct interest under Section 163(j) of the Code to 50% of adjusted taxable income rather than the 30% cap prescribed by the TCJA.
- For tax years beginning in 2020, taxpayers can elect to use their 2019 adjusted taxable income for purposes of computing the interest deduction cap. Given the likely adverse impact of the current coronavirus crisis on post-2019 adjusted taxable income, this election may enable taxpayers to access additional liquidity.
Airline Excise Taxes
- The CARES Act provides for a temporary suspension of certain aviation excise taxes through December 31, 2020.
Aviation excise taxes represent a meaningful percentage of the cost of any airplane ticket and the suspension of these taxes should provide airlines with additional revenue when travel begins to pick up, though they may elect to share some or all of the savings with their customers by offering more favorable fares as a means of encouraging more robust consumer and business travel as the coronavirus crisis subsides.
- The CARES Act clarifies some of the uncertain aspects of the NOL limitations enacted as part of the TCJA, specifically:
- The 80% NOL deduction limit (now applicable after 2020) does not apply to pre-TCJA NOLs, but these NOLs do reduce taxable income for purposes of determining the 80% deduction limit for post-TCJA NOLs; and
- For purposes of calculating the 80% limit, taxable income is determined without taking into account the qualified business income deduction under Section 199A of the Code, or the deduction for foreign-derived intangible income (FDII) and global intangible low-taxed income (GILTI) under Section 250.
- The CARES Act fixes the so-called “retail glitch” arising from a technical mistake in the TCJA. The TCJA inadvertently excluded interior improvements made to a building after it was placed in service (“qualified improvement property”) from the list of 15-year depreciable life properties eligible for 100% bonus depreciation under Section 168(k) of the Code. The CARES Act’s technical correction treats qualified improvement property as 15-year depreciable life property and thus amounts spent on qualified improvement property qualify for the 100% bonus depreciation deduction.
Taxpayers that filed tax returns on which they were not able to claim 100% bonus depreciation for any of their qualified improvement property due to the “retail glitch” should consider whether to amend those returns to take advantage of the 100% bonus depreciation deduction.
Withdrawals from Retirement Funds
- The CARES Act waives the 10% early withdrawal penalty for retirement fund distributions of up to $100,000 made on or after January 1, 2020 and before December 31, 2020 for individuals (or spouses/dependents) who are diagnosed with COVID-19 or who experience adverse financial consequences as a result of being quarantined. The CARES Act also temporarily waives the required minimum distribution rules for certain retirement plans and IRAs until December 31, 2020.
Other Tax Related Provisions
- Perhaps the most notable and publicized tax provision in the CARES Act is the one-time payment of $1,200 to individuals and $2,400 to couples filing joint tax returns, increased by a $500 payment for each child in the family. The amount is reduced by 5% of the taxpayer’s taxable income in excess of $75,000 for individuals and $150,000 for couples filing jointly—the payments will be fully phased out for income levels above $99,000 and $198,000 respectively. The IRS will use 2019 tax returns, if filed, or 2018 tax returns to determine whether a payment is due and the amount to be paid to eligible individual taxpayers.
- The CARES Act provides up to $150 billion for states and localities that have, like the federal government, deferred tax filing and tax payment obligations for 90 days after the current April 15th tax return filing/payment deadline.
- The CARES Act will allow employers to provide a tax-free student loan repayment benefit up to $5,250 per year per employee from the date of enactment and until December 31, 2020.
- The CARES Act also creates a temporary assistance program through December 31, 2020, which provides unemployment benefits for those who are not typically eligible for unemployment benefits, but are unable to work due to COVID-19 (e.g., self-employed individuals, independent contractors, etc.).
As stated above we will update this alert as necessary to reflect further developments.
This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Alex Anderson, an O'Melveny partner licensed to practice law in New York, Arthur V. Hazlitt, an O'Melveny partner licensed to practice law in New York, Luc Moritz, an O'Melveny partner licensed to practice law in California, and Dawn Lim, an O'Melveny associate licensed to practice law in New York, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.
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