Managing Liquidity Through Practical Application of the Tax Provisions in the CARES Act
Last Friday, President Donald Trump signed into law the third major piece of legislation intended to address the economic impact of the coronavirus (COVID-19) outbreak. The Coronavirus Aid, Relief, and Economic Security (CARES) Act provides for a number of temporary and permanent changes to the Internal Revenue Code.
Taxpayers should consider the following potential opportunities for accessing liquidity through refund mechanisms and cash tax savings.
Potential Opportunities for Cash Tax Refunds
Net operating losses (NOLs)
Prior to 2018, corporate taxpayers could carry NOLs back two years and forward 20 years. For NOLs arising in tax years beginning after December 31, 2017, the Tax Cuts and Jobs Act (TCJA) eliminated any potential carry back and limited the ability to apply the NOL to 80 percent of taxable income (determined without regard to the NOL deduction).
The CARES Act now permits corporations to carry back NOLs arising in 2018, 2019, or 2020 for up to five years. Additionally, for taxable years beginning before January 1, 2021, the CARES Act removes the 80 percent taxable income limitation, temporarily allowing NOLs to offset up to 100 percent of a taxpayer’s taxable income.
Corporations that generated an NOL in either 2018 or 2019 may be able to file a claim for refund by carrying back NOLs from these years for up to five years.
Alternative minimum tax (AMT) credits
Prior to the TCJA, certain corporations were subject to the AMT. A corporation’s tax liability was the greater of its regular tax liability or its AMT liability. Corporations received a credit for AMT paid (the prior-year minimum tax credit), which they could carry forward and claim against regular tax liability in future tax years, to the extent such regular tax liability exceeded AMT in a particular year.
The CARES Act modified the refundable credit so that corporations may now claim the entire credit amount in 2018 and 2019.
The TCJA repealed the AMT on corporations but also continued to allow the prior year minimum tax credit to offset the taxpayer’s regular tax liability for any tax year. For tax years beginning after 2017 and before 2022, however, the minimum tax credit was refundable in an amount equal to 50 percent (100 percent for tax years beginning in 2021) of the excess of the credit for the tax year over the amount of the credit allowable for the year against regular tax liability.
The CARES Act modified the refundable credit so that corporations may now claim the entire credit amount in 2018 and 2019. For example, a $100 million AMT credit generated pre-TCJA might generate a $50 million refund in 2018, a $25 million refund in 2019, a $12.5 million refund in 2020, a $6.25 million refund in 2021 and 2022. Following the CARES Act, the taxpayer may be entitled to a $50 million refund in 2018 and 2019.
The CARES Act also provides that a taxpayer may file an application for a tentative refund with the IRS, which then must review the application and, if appropriate, issue the related refund within 90 days. A tentative refund may be paid out before any necessary review by the Joint Committee on Taxation.
Interest expense deduction limitation
The TCJA limited the ability to deduct interest expense for tax years beginning after December 31, 2017, to an amount that does not exceed 30 percent of “adjusted taxable income” (ATI) (which is currently comparable to earnings before interest, taxes, depreciation, and amortization (EBITDA)).
For tax years beginning in 2019 and 2020, the CARES Act increases the interest deduction limitation from 30 percent to 50 percent of ATI. This additional interest expense that is deductible may give rise to NOLs (see refund opportunity discussion above) or excess estimated tax payments that may be refundable.
Qualified improvement property (QIP)
One of the key business provisions in the TCJA was the immediate deduction of certain depreciable property (bonus depreciation). The TCJA excluded, however, certain categories of property, specifically QIP, from bonus depreciation. This exclusion was widely believed to have been due to a legislative oversight.
The CARES Act makes QIP eligible for bonus depreciation. This correction is retroactive to tax years beginning on or after January 1, 2018. The additional bonus depreciation may reduce tax liabilities for 2018 and 2019 and/or give rise to refunds.
Employee retention credit
The CARES Act provides a refundable credit against employment taxes equal to 50 percent of the wages, including health benefits, paid by employers to employees who are not working due to the employer’s full or partial cessation of business or a significant decline in gross receipts. The credit applies to wages paid after March 12, 2020, and before January 1, 2021, and is available to be claimed on a quarterly basis. The credit is limited to $10,000 in aggregate per employee for all quarters.
Advance refunding of paid sick leave and extended FMLA credits
The Emergency Paid Sick Leave Act (Part Two of the COVID-19 legislation) required employers (with fewer than 500 employees) to pay sick leave for those missing work due to employees suffering the symptoms of COVID-19 or for those taking leave to provide care for a child or quarantined individual. The CARES Act amends the original legislation by limiting the amounts required to be paid by the employer. The limit of pay for those suffering from symptoms of COVID-19 is $511 per day and $5,110 in aggregate. The limit of pay for those caring for children or caring for a quarantined individual is $200 per day and $2,000 in aggregate. The CARES Act also permits employers to receive an advance of payroll credits and refunds in connection with the employer’s payment of qualified sick leave and qualified family leave wages. The forms and procedures to claim this refundable credit have yet to be released.
Potential Opportunities to Reduce/Delay Cash Tax Payments
Delay in federal tax payments
Although not included in the CARES Act, IRS Notice 2020-18 postpones the payment of specific federal income tax payments originally due on April 15, 2020, to July 15, 2020. The notice also postpones the filing date of specific federal income tax returns. This notice applies to federal income tax returns and tax payments related to the 2019 tax year, and federal estimated income tax payments that would have been due April 15, 2020 related to the 2020 tax year. The tax forms covered under this notice include: Form 1040 series, Form 1041 series, Form 1120 series, Form 8960, Form 8991, and Form 990-T. Extensions are not required to be filed to be granted this relief. The period for April 15, 2020, to July 15, 2020, will be disregarded by the IRS when calculating interest and penalties.
Payroll tax deferral
The CARES Act allows employers to defer the payment of their share (6.2 percent) of the social security tax due on wages paid in 2020. This deferral applies to payments due after the date of enactment (March 27, 2020). Fifty percent of the deferred payroll taxes are due on December 31, 2021, with the remaining 50 percent due on December 31, 2022.
Excess business losses
The TJCA limited the amount of loss related to a trade or business that a non-corporate taxpayer may deduct in any year. The limitation was the sum of (i) the income or gain attributable to that trade or business, and (ii) $250,000 ($500,000 for joint return filers), adjusted for inflation. Any excess business loss would be carried over as a net operating loss to the following taxable.
The CARES Act removes the limitation on the deduction of business losses for taxable years beginning before December 31, 2020.