By Robert Duquette, CPA, MBA

On March 27, 2020, Congress passed and President Donald Trump signed the Coronavirus Aid, Relief, and Economic Security (CARES) Act, the federal government’s response to the COVID-19 pandemic. The most expensive piece of legislation yet adds an additional $2 trillion to our national debt over the next couple years; however, it is being viewed as a necessary measure to help assure that our economy can survive the shock of being shut down during the crisis.

This blog is a brief summary of the most significant provisions within the act. Note that this is only a general summary of many complex provisions, each with its own defining terms and details. Taxpayers are advised to seek the guidance of a tax professional in determining the extent to which any of these provisions may apply or interact with other tax or business matters. Also, note that guidance and clarifications are being published daily and therefore readers are advised to stay as up to date as possible about future developments.

Individual Recovery Rebates

The federal government has been moved to offer immediate tax payments to the public to help them cope with job losses or furloughs. The Treasury will issue a $1,200 tax credit for individuals (or $2,400 for married couples) plus $500 per qualifying child. These payments will be issued “as rapidly as possible,” presumably by the end of April, through direct deposit if possible or by mail. This benefit is not available to estates, trusts, nonresidents, or taxpayers who can be claimed as a dependent by another taxpayer. The tax benefit will be phased out for single filers by 5% of their AGI above $75,000; for joint returns by 5% of their AGI above $150,000; and for head of households by 5% of their AGI above $112,500.

To receive the payment, the taxpayer must have filed a tax return for 2018 or 2019, or be receiving Social Security or veteran’s benefits. Since the rebate is actually an advance on a tax credit that you may claim on your 2020 tax return based on 2020 AGI, if your 2020 income turns out to be lower than it was on the 2019 or 2018 return used to establish the amount of the credit, and you did not receive the full credit in 2020, then you would be refunded that additional amount in 2021, or you can reduce your 2020 tax liability when you file that tax return in 2021. Additionally, any credit overpayment to you in 2020 based on a lower 2019 or 2018 tax return AGI than what your 2020 AGI turns out to be, will not have to be paid back.

Sen. Chuck Grassley (R-Iowa), chair of the Senate Finance Committee, has a website that summarizes several FAQs.

Unemployment

The provisions for expansion of unemployment insurance payments are very complex. In brief, states are instructed to increase by $600 per week, for four months, what they otherwise would have paid to an eligible recipient. Regular benefits will be extended for 13 weeks. In Pennsylvania, that means regular unemployment benefits will be paid for 39 weeks.

There has been a substantial expansion in who is eligible, not only including everyone affected by their employer’s shutdown or stay-at-home orders, but also including the self-employed, independent contractors, gig workers, those with a limited work history, part-time employees, the partially unemployed, those who must stay home because their children’s school shut down, and anyone affected by COVID-19 directly or indirectly through their household. Unemployment-eligible workers do not include those who can “telework” with pay or those who are being paid sick leave or other paid leave benefits. The “waiting week” provision is intended to be waived by this legislation.

Pennsylvania has already updated its FAQ site to include information about COVID-19. However, as of this writing, its site stated: “The federal CARES Act will provide unemployment benefits to the self-employed, gig workers, and other individuals who previously were not eligible for unemployment. Special instructions will be provided to these individuals. At this time, you should not file a claim through the existing online system or phone number if you are not currently eligible for unemployment.”

Loans for Business Survival (That Can Be Forgiven!)

The CARES Act also has loan provisions for paycheck protections and business survival. Small Business Administration (SBA) loans will be generally available for eligible businesses (including the self-employed, sole proprietors, independent contractors, and small businesses with fewer than 500 employees) to cover certain eligible expenses incurred from Feb. 15, 2020, through June 30, 2020.

According to Treasury’s Paycheck Protection Program (PPP) Information Sheet for Borrowers, “Starting April 3, 2020, small businesses and sole proprietorships can apply for and receive loans to cover their payroll and other certain expenses through existing SBA lenders; and starting April 10, 2020, independent contractors and self-employed individuals can apply for and receive loans to cover their payroll and other certain expenses through existing SBA lenders.” The loan application will not require collateral or personal guarantees.

Covered expenses generally include, within certain limitations, payroll (including the pro rata portion of net earnings from self-employment of the taxpayer) capped at $100,000 per year per employee, mortgage interest payments, rent, utilities, and interest costs on other loans. The maximum loan amount is generally calculated as 2.5 times the average monthly payroll costs in the prior year, not to exceed $100,000 annually per employee, up to a maximum of $10 million. For this purpose, “payroll costs” per the statute includes salaries, wages, commissions, tips, and bonuses; group health care insurance, retirement plan benefits, and payments for vacation, medical, family, or sick leave that is not already creditable under the Families First Coronavirus Response Act; payment of state and local tax assessed on the compensation; and self-employed net income of a sole proprietor or independent contractor up to $100,000.

The loan will generally be forgiven upon furnishing appropriate documentation of covered expenses incurred and payments made in the first eight weeks after loan origination. However, the forgiveness is reduced to the extent that employees were not retained or payroll costs were reduced by more than 25%. Although the statute provides that any unforgiven loan balance will generally be repaid starting six months after loan origination within a maximum term of 10 years, with up to a 4% interest rate, the SBA recently announced that all loans will be 1%, with a two year maturity.

One question that arises is to what extent will the forgiveness be included in taxable income, similar to many other debt discharges. The statute reads as follows: “For purposes of the Internal Revenue Code of 1986, any amount which (but for this subsection) would be includible in gross income of the eligible recipient by reason of forgiveness described in subsection (b) shall be excluded from gross income.”

One area that may need additional guidance relates to the statutory language that appears to include sole proprietors and independent contractors as being eligible. The statute provides that “During the covered period, individuals who operate under a sole proprietorship or as an independent contractor and eligible self-employed individuals shall be eligible to receive a covered loan … An eligible self-employed individual, independent contractor, or sole proprietorship seeking a covered loan shall submit such documentation as is necessary to establish such individual as eligible, including payroll tax filings reported to the Internal Revenue Service, Forms 1099-MISC, and income and expenses from the sole proprietorship, as determined by the Administrator and the Secretary.” Therefore, to what extent can such businesses actually benefit from PPP if they have no employees, and therefore no “payroll costs” or wages in the traditional sense of those terms? The PPP application form itself only asks what the “Average Monthly Payroll” is and “Number of Jobs,” without clarifying what those terms mean. The statutory language that provides for loans equal to 2.5 times “payroll costs” states that the term “payroll costs” means “the sum of payments of any compensation to or income of a sole proprietor or independent contractor that is a wage, commission, income, net earnings from self-employment, or similar compensation and that is in an amount that is not more than $100,000 in one year, as prorated for the covered period.” Under this reading, perhaps it was intended that businesses without employees would count themselves personally as being “one job,” and the payroll cost amount would be their “income” or “net earnings from self-employment.” If the intent is to have them use net earnings from self-employment, that amount would be after paying many of the costs the loan was supposed to finance. If the business owner has low net earnings, then theoretically that owner would not be entitled to receive much of a loan, and possibly none at all if they reported a net loss; yet they are the ones probably most in need to fund the expenses that caused the loss or low net earnings. Under that logic, perhaps the better amount to use for “payroll” would be their “income,” whatever that term may mean (e.g., gross profit after cost of goods sold). Clearly, more guidance is needed, and fast, since applications can be filed starting Friday, April 10, for those taxpayers. (One small-business advocacy advice website seems to agree that an uncertainty exists, while the U.S. Chamber of Commerce seems to suggest that such businesses will use their ”income” or net earnings from self-employment.) The Washington Post reported on Wednesday, April 1, that “The law specifically provides for sole proprietors and independent contractors. Regional SBA administrator Steve Bulger said Wednesday morning that loans for independent contractors are likely to be made available one week after the other small business loans, which would translate to a start date of April 10 for those loans. The SBA is working on a detailed regulation that will define how independent contractors should apply for loans, including whether their company should count them in its employee totals on loan applications. That regulation is also expected to address the status of 1099 employees and part-time employees. That regulation is expected to be finalized in the next few days, Bulger said Wednesday morning.”

There are other small business loans available:

• A separate advance of up to $10,000 available to small businesses (called an Emergency Economic Injury Grant) to be paid within three days of application that does not need to be repaid if used for eligible expenses.
• A loan of up to $2 million under the Economic Injury Disaster Loan program.

A business can apply for more than one program if the funds are not used for the same expenses.

The Treasury intends that the assistance described above be available to the small business community within days, not weeks, with the goal of same-day approval by the local lender, no additional SBA approval, and cash the same day.

The Treasury recently released guidance that addresses many FAQs on all these small business provisions, as did the U.S. Senate Small Business Committee, the U.S. Chamber of Commerce, and the SBA.

Personal Income Tax

Prior to passage of the CARES Act, the IRS had announced an extension of the April 15 deadline for individual tax return filings and tax liability payments to July 15. It also recently included gift tax returns in that extension.

For 2020 tax returns due next year, there is an up to $300 above-the-line (i.e., nonitemized) deduction for cash contributions to public charities, as well as an increased limit for 2020 cash contributions to public charities for itemizers from 60% of AGI to generally 100% of AGI.

The 10% penalty on early withdrawals (up to $100,000) from retirement accounts has been temporarily waived if the withdrawal is related to COVID-19, and the income tax on distributions can be payable over three years. The rules governing loans from 401(k) plans were also relaxed.

For employer payments toward student loans, up to $5,250 can be excluded from income.

Business Income Tax

Estimated tax payments normally due after date of enactment have been extended to Oct. 15, 2020. In general, for taxpayers not using the PPP program, there is a 50% payroll credit on up to $10,000 of wages paid (including health benefits) per eligible quarter during the crisis. For businesses with more than an average of 100 employees in 2019, the credit can be claimed for workers retained but not currently working due to the crisis. For a business with an average of 100 or fewer employees in 2019, the credit can be claimed on all employees, working or not. The first eligible quarter for the credit is one in which there has been a significant decline in gross receipts. Specifically, the first eligible quarter in 2020 will be one in which the quarter’s gross receipts are less than 50% of gross receipts for the same calendar quarter in the prior year. The credit generally ends in the first quarter in which gross receipts are greater than 80% of gross receipts for the same calendar quarter in the prior year. The credit expires at the end of 2020, and it cannot exceed the employer's total employment taxes for the relevant quarters.

Eligible employers and self-employed individuals can defer payment of their 6.2% employer share of the Social Security tax they otherwise are responsible for paying to the federal government. The deferred employment tax is to be paid over the following two years, with half of the amount required to be paid by Dec. 31, 2021, and the other half by Dec. 31, 2022.

The net operating loss (NOL) carryover rules were modified so that a loss from 2018, 2019, or 2020 can be carried back five years from the loss year. The provision also temporarily removes the taxable income limitation to allow an NOL to fully offset income until 2021. This will greatly help C corporations who can now carry back their losses to years when their tax rate was 35% instead of the current 21%.

The CARES Act temporarily suspends the pass-through excess business loss limitation rules (i.e., originally $250,000 for singles and $500,000 for joint returns before inflation adjustments, with the excess having to be carried over) for 2018 through 2020. This frees up such losses to either offset other sources of income or to be potentially carried back to years when the taxpayer’s tax rate may have been higher.

Current tax law generally limits the amount of business interest allowed as a deduction to 30% of adjusted taxable income (ATI). The CARES Act generally allows businesses, unless they elect otherwise, to increase the interest limitation to 50% of ATI for 2019 and 2020, and to elect to use 2019 ATI in calculating their 2020 limitation. (There is also some relaxation of these rules for partnerships.)

There will also be an acceleration of the ability to use previously carried over AMT credits to 2018 and 2019, and a temporary increase in the C corporate charitable contribution limit from 10% of modified taxable income to 25%.

There was a technical correction to the Tax Cuts and Jobs Act (TCJA) to allow businesses to immediately write off 100% of the costs associated with “qualified improvement property” to the interior of nonresidential real estate instead of having to depreciate those improvements over the 39-year life of the building, retroactive to 2018 and 2019. This should help taxpayers in the retail, restaurant, and hospitality industries who can now amend prior year returns to accelerate cash refunds into 2020. Another TCJA correction allows companies to get a refund of overpaid taxes resulting from the Section 965 transition tax on unrepatriated earnings.

Finally, there are numerous provisions related to paid sick and family leave payments and tax credits that were included in this legislation, and prior COVID-19-related legislation, that will benefit workers and employers, but these are beyond the scope of this article.

Be aware that the retroactive repeals and enhancements contained in several of the provisions seemingly allow taxpayers to immediately file amended tax returns, perhaps to years when their tax rate was much higher, and generate cash needed during this crisis.

Robert Duquette, CPA, MBA, is professor of practice in the College of Business at Lehigh University, a retired EY tax partner, Of Counsel to William G. Koch & Associate, and a member of the Griffin/Stevens & Lee Tax and Consulting Network. He has served on PICPA’s Federal Taxation Committee for over 25 years, focusing on federal tax reform and the national debt.

The information in this blog is general in nature, and should not be construed as legal, accounting, or tax advice, or opinion to be relied upon in connection with a specific situation. Nor is the information intended to be construed as written advice subject to the requirements of Section 10.37(a)(2) of Treasury Department Circular 230. This material may not be applicable to the reader's specific circumstances and may require consideration of other factors. Readers should contact tax and legal professionals before taking any action based upon this information.

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