Key Tax Provisions in the CARES Act
Key Tax Provisions in the CARES Act
April 4, 2023
On March 27, 2020, the President signed into law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The CARES Act provides economic stimuli and modest redistributions to address the effects of the COVID-19 health crisis on the economy of the United States and of its citizens. Included in the CARES Act are several key tax-related provisions, which affect both businesses and individuals. Some of these provisions modify and delay provisions in the Tax Cuts and Jobs Act (the “TCJA”) that was enacted at the end of 2017.
These income tax changes are to U.S. federal income tax law only, and will apply for state income tax purposes only as and to the extent a state incorporates them into its income tax law. California has not yet incorporated any of these provisions.
A brief summary of key tax provisions in the CARES Act relevant to our real estate clients is provided below.
Business Income Tax Provisions
Modifications for Net Operating Losses
In 2017, the TCJA placed limitations on the use of net operating losses (“NOLs”) for taxpayers. Under the TCJA, NOLs typically cannot be carried back to prior years, but can be carried forward indefinitely. However, TCJA limits the use of NOLs carried forward to 80% of taxpayer’s taxable income for the current year.
The CARES Act temporarily removes the 80% limitation, allowing certain NOLs to offset up to 100% of a taxpayer’s current taxable income. For tax years beginning before 2021, taxpayers can take an NOL deduction equal to 100% of taxable income (rather than the 80% limitation in present law). For tax years beginning after 2021, taxpayers will be able to take: (1) a 100% deduction of NOLs arising in tax years prior to 2018 (i.e., a 100% deduction for NOLs carried forward from those years), and (2) a deduction limited to 80% of modified taxable income for NOLs arising in tax years after 2017.
The CARES Act also provides for an elective five-year carryback of NOLs generated in taxable years beginning after December 31, 2017, and before January 1, 2021. This allows taxpayers to carry back NOLs arising in 2018, 2019 or 2020 to the five preceding taxable years. No election is required to carry back such NOLs. The carry back rules allow taxpayers to collect refunds in pre-TCJA years at the higher tax rates that applied in those years.
However, the CARES Act specifically carves out the application of the NOL provisions to real estate investment trusts (“REITs”). Under the Act, REITS are not able to carry back losses, and losses may not be carried back to any REIT year (regardless of whether the taxpayer incurring the loss is currently a REIT). The CARES Act also makes technical changes to address issues with the original TCJA drafting (for example, addressing NOLs for fiscal year taxpayers and addressing questions in application of the NOL carry-forward ordering rules).
Modification of Limitation on Losses for Taxpayers other than Corporations
The TCJA limited the amount a non-corporate taxpayer could deduct as “excess business losses” during tax years beginning after December 31, 2017, and before January 1, 2026. Excess business losses are the amount by which the aggregate deductions attributable to all of a taxpayer’s trades or businesses exceed such taxpayer’s total gross income and gains attributable to those trades or businesses plus $250,000 (or $500,000 for joint filers). The CARES Act amends this provision, by providing that the limitation on excess business losses shall only apply to taxable years beginning after December 31, 2020 and before January 1, 2026. Therefore, business losses from taxable years 2018, 2019, and 2020 are no longer subject to this limitation. The provision also includes technical corrections to the TCJA rules, generally clarifying certain losses and deductions that are not subject to the excess business losses provision.
Modification of Credit for Prior Year Minimum Tax Liability of Corporations
The TCJA repealed the corporate alternative minimum tax (“AMT”), but provided that corporate AMT paid in prior years could be used as refundable credits to offset corporate liability for taxable years 2018 to 2021.
The CARES Act now accelerates the ability of companies to recover 100% of those AMT credits, permitting companies to immediately claim a tentative refund of the credits in order obtain additional cash flow during the COVID-19 crisis.
Modification on Limitation of Business Interest
Under the TCJA, the amount of deductible business interest expense was limited to the sum of: (1) the taxpayer’s business interest income for the taxable year, (2) 30% of the taxpayer’s adjusted taxable income for the taxable year, and (3) the taxpayer’s floor plan financing interest expense for the taxable year. However, exceptions to this limitation were made for certain businesses, including business with average gross receipts of no greater than $25 million and electing real property trades or businesses. Special rules apply for income tax partnerships. Also, certain businesses may elect out of these rules in return for accepting less favorable “ADS” depreciation periods.
For purposes of calculating the limitation on deductible business interest expense, the CARES Act allows for a taxpayer to use 50% of its adjusted taxable income, rather than 30%. For most taxpayers, this revised calculation can be used for taxable years beginning in 2019 and in 2020. However, in the case of partnerships, the increase only applies for the taxable year beginning in 2020. Partners that are allocated excess business interest expense for taxable years beginning in 2019 can deduct 50% of that excess business interest in 2020, while the remaining 50% will subject to the normal excess business interest limitations. Taxpayers may choose to elect out of these provisions, but such election will be considered irrevocable absent the Secretary of the Treasury’s consent.
Additionally, for purposes of calculating the taxpayer’s deductible business interest expense in taxable years beginning in 2020, the taxpayer may elect to use its adjusted taxable income from its taxable year beginning in 2019, which should help businesses that have seen an income drop from 2019 to 2020.
Technical Amendments Regarding Qualified Improvement Property
The CARES Act also provides for a technical correction to the TCJA. Under the TCJA, bonus depreciation deductions (deductions of up to 100%) are allowed for “qualified property.” Qualified property includes property which has a recovery period of 20 years or less.
The CARES Act addresses what many believe is a drafting error in the TCJA, by assigning a 15-year recovery period to qualified improvement property. Qualified improvement property is any improvement to an interior portion of a building which is nonresidential real property if such improvement is placed in service after the date such building was first placed in service. This change clarifies that qualified improvement property is eligible for 100% expensing of bonus depreciation. This expensing rule does not apply to qualified improvement property subject to ADS depreciation because of a prior election out of the business interest expense limitations. As of this writing, there is no word from the IRS as to how or whether a prior election out of the business interest expense limitations might be affected by this amendment.
Employment-Related Tax Provisions
Employee Retention Credit for Employers Subject to Closure due to COVID-19
The CARES Act provides a refundable payroll tax credit to eligible employers for 50 percent of the qualified wages with respect to each employee for each calendar quarter (the “Employee Retention Credit”). The Employee Retention Credit is available to employers carrying on a trade or business in 2020 whose (1) operations were fully or partially suspended, due to the COVID-19 crisis, or (2) gross receipts declined by more than 50% when compared to the same quarter in the prior year. Because the latter condition may be uncertain at this time for many employers, there is added stress on qualifying under condition (1).
Employers with more than 100 employees are eligible for the Employee Retention Credit on wages paid to employees that are not providing services (i.e., not working) due to a COVID-19-related business suspension or the reduction in gross receipts described above. Employers with 100 or fewer employees are eligible for the Employee Retention Credit on all wages paid to their employees. However, the amount of any qualified wages (including health benefits) with respect to an employee which may be taken into account for all calendar quarters cannot exceed $10,000.
The CARES Act adds a Paycheck Protection Program made available from the Small Business Administration to provide small businesses (as defined under the program) with loans to help pay up to eight weeks of payroll costs (including beneﬁts) and other costs during the coronavirus crisis. The Employee Retention Credit is not available to employers that receive a loan under the Paycheck Protection Program.
Under the recently-enacted Families First Coronavirus Response Act (“FFCRA”), small employers (500 or fewer employees) whose employees receive paid sick or family leave required by the FFRCA are entitled to tax credits in respect of the wages paid. Wages used to qualify under the FFRCA cannot also be used to qualify for the Employee Retention Credit, although both credits are available.
Delay of Payment of Employer Payroll Tax Payments
The CARES Act provides that most employers can delay payment of the Social Security employer payroll taxes (6.2%) for the period between the date of enactment of the CARES Act and January 1, 2021. Note that this does not cover all payroll taxes (e.g., wage withholding is not covered), but a significant portion is covered nonetheless. The Act provides that 50% of the delayed payroll taxes will be due by December 31, 2021, with the remainder due by December 31, 2022. A similar delay is allowed for 50% of self-employment taxes.
However, similar to the limitation on the employee retention credit, employers that receive loan forgiveness under certain other provisions of the CARES Act (for example, the Paycheck Protection Program) are not eligible for the deferral under this provision.
Forgiveness of Cancellation of Indebtedness for Loans Under the Paycheck Protection Program
The reduction or cancellation of indebtedness generally results in taxable income to the debtor. Under the Paycheck Protection Program, loan amounts spent during the eight-week period after the loan origination date for qualified expenses up to the principal amount of the loan are eligible for forgiveness. Under the CARES Act, these forgiven amounts are subject to an exclusion from the cancellation of indebtedness rules. A loan recipient seeking forgiveness of indebtedness on a covered loan must verify that the amount for which forgiveness is requested was used to retain employees, make interest payments on a covered mortgage obligation, make payments on a covered lease obligation or to make covered utility payments.
Advance Refunding of Credits for Paid Sick Leave and Paid Family Leave
As described above, under the FFRCA, small employers whose employees receive paid sick or family leave required by the FFRCA are entitled to tax credits. The CARES Act provides for advance refunding of the tax credits for paid sick leave and paid family leave established under the FFRCA.
Existing Section 139
Section 139 was added to the Internal Revenue Code following the attacks of September 11, 2001. Section 139 (which applies to payments made after a national disaster, which now includes COVID-19), provides that if an employer reimburses employees for reasonable personal expenses due to COVID-19, the payment is deductible to the employer and non-taxable to the employee. However, this section does not apply to payments in lieu of compensation.
Provisions Related to Charitable Contributions
Allowance of Partial Above-the-Line Deduction for Charitable Contributions
The CARES Act allows taxpayers that do not itemize their deductions to take a limited above-the-line deduction for charitable contributions. Taxpayers that do not itemize may deduct up to $300 in cash contributions made to qualifying charitable organizations, other than supporting organizations, or donor advised funds. Excess charitable contributions that have been carried over from prior tax years do not qualify for this provision.
Modification of Limitation on Charitable Contributions During 2020
The CARES Act temporarily modifies charitable contribution limitations for individual and corporations. For individuals, the existing adjusted gross income limitation is suspended, allowing individual taxpayers to take a charitable contribution deduction for qualifying cash contributions made in 2020 to the extent such contributions do not exceed the excess of the individual’s contribution base over the amount of all other charitable contributions allowed as a deduction for the contribution year. A taxpayer’s contribution base is generally 60% of a taxpayer’s adjusted gross income, but the CARES Act increases this base to 100% for qualifying cash contributions. If an individual’s contributions do exceed their contribution base in 2020, the excess contributions may be carried over for the next five tax years.
For corporations, the adjusted gross income limitation is increased from 10% to 25%. Like individuals, if a corporation’s contributions exceed this 25% limitation, the excess contributions may be carried over for the next five tax years.
The CARES Act also increases the limitation on deductions for contributions of food inventory from 15% to 25%.
Miscellaneous Tax Provisions
2020 Recovery Rebates for Individuals
The CARES Act provides for a $1,200 refundable tax credit for individuals. This rebate is increased to $2,400 for taxpayers filing jointly, and taxpayers with children can receive an additional $500 for each child. The amount of the rebate will be calculated based on the taxpayer’s 2019 federal income tax return (or the 2018 income tax return if the 2019 tax return has not been filed) and will automatically be sent to the taxpayer. If no 2018 or 2019 returns were filed by the taxpayer, the IRS may use other methods to identify and send payment, but it is possible that not all individuals who are eligible for the rebate will receive an automatic payment if they do not file a return.
Generally, U.S. citizens and aliens qualified to work in the United States (and their children) qualify for the rebate. However, the rebate is not available for nonresident aliens, dependents or for estates or trusts. The rebate begins to phase out for taxpayers with an adjusted gross income above $75,000 and $150,000 for joint filers and is completely phased out for taxpayers with an adjusted gross income above $99,000 ($198,000 for joint filers).
Special Rules for Use of Retirement Funds
The CARES Act allows for qualifying individuals to withdraw up to $100,000 from retirement plans in 2020 without a 10% early withdrawal penalty. In order for an individual to benefit from this provision, the individual, the individual’s spouse or the individual’s dependent must have been diagnosed with SaRS-CoV-2 or COVID-19, or the individual must have experienced adverse financial consequences as a result of being quarantined, furloughed, laid off, having work hours reduced, being unable to work due to lack of child care due to SaRS-CoV-2 or COVID-19, closing or reducing hours of a business owned or operated by the individual due to SaRS-CoV-2 or COVID-19, or other factors as determined by the Secretary of the Treasury.
Any withdrawn funds may be re-contributed by the taxpayer over the three years following the year of distribution without regard to that year’s cap on contributions. Unless the taxpayer elects otherwise, all income from such distributions will be included in the taxpayer’s taxable income ratably over the three years following the distribution year.
Some retirement plans permit individuals to take loans from the retirement account balance. The CARES Act provides flexibility (i.e., larger loan amounts and longer repayment periods) for loans from certain retirement plans for coronavirus-related relief.
Temporary Waiver of Required Minimum Distributions
The CARES Act temporarily waives required minimum distributions from retirement accounts for participants who were required to take such distributions in 2020. For participants who have already begun taking required minimum distributions or who were required to begin in 2020, their distributions are waived for 2020.
Exclusion for Certain Employer Payments of Student Loans
Under the CARES Act, employer payments made before January 1, 2021 to an employee (or a lender) for student loan principal and interest are now considered “education assistance” payments that are excluded from the employee’s gross income. The total amount of payments made by an employer that may qualify as “education assistance” is still subject to a cap of $5,250 per year.