Overwhelmingly passed by both houses of the US Congress this week and signed into law by President Donald Trump on March 27, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) provides a $2 trillion economic stimulus and contains many major tax changes to help businesses and individuals.
Building upon earlier versions of the CARES Act, it is the third round of federal government support in the wake of the coronavirus (COVID-19) pandemic and the resulting economic fallout, coming on the heels of the $8.3 billion in public health support passed two weeks ago and the Families First Coronavirus Response Act.
The CARES Act will help many cash-strapped individuals by establishing cash rebate payment to be issued in the coming weeks and will help businesses reduce their tax bills through changes to the Internal Revenue Code (Code) that allow taxpayers to carry back losses to prior years and increase tax deductions, among other things. The tax provisions in the CARES Act include the following. A separate LawFlash on the employer-focused, retirement plan, and employee benefit plan tax provisions is forthcoming.
Business Tax Provisions
Temporary Suspension of Net Operating Loss Limits and Increased Carryback Periods
The CARES Act temporarily repeals the 80% of taxable income limitation on the utilization of net operating loss (NOL) carryovers imposed by the Tax Cuts and Jobs Act (TCJA) (PL 115-97). Thus, for a taxable year beginning before January 1, 2021, a taxpayer can fully offset its taxable income in that year with NOLs permitted to be carried to that year from other years. For subsequent taxable years, taxpayers may continue to use NOLs arising in taxable years beginning before January 1, 2018, without limitation; NOLs arising after December 31, 2020, however, will be subject to the 80% of taxable income limitation. In addition, taxpayers now may carry back NOLs arising in 2018, 2019, and 2020 to the taxpayer’s five preceding taxable years.
The CARES Act also provides that a taxpayer is treated as having made the election under Code Section 965(n) not to apply NOLs against its liability under Code Section 965(a). In practice, this appears to mean that NOLs cannot be carried back to offset income included in Subpart F income pursuant to Code Section 965(a), as enacted by the TCJA. The taxpayer may, moreover, elect not to carry back an NOL to offset any income generated in the year of a Code Section 965(a) inclusion.
Under current law and the CARES Act, a Real Estate Investment Trust (REIT) remains ineligible to carry back losses to any year. Any loss incurred by a taxpayer in a year in which it is not a REIT may not be carried back to a year in which it was a REIT.
- Taxpayers with losses generated during their 2018, 2019, and 2020 tax years, and taxable income in their preceding five tax years (carryback years), can file amended income tax returns in the carryback years to receive a refund. For carrybacks to pre-2018 tax years, corporations may obtain refunds of taxes paid at the pre-TCJA corporate rate of 35%.
- Losses caused by the COVID-19 pandemic will likely be staggering for many large corporations as well as individuals or other non-corporate taxpayers engaged in business eligible to use NOLs. Corporations requesting refunds in excess of $5 million should expect a significant delay in receiving the refunds. Code Section 6405(a) provides that no refund of income tax in excess of $5 million for corporations will be made until the expiration of 30 days from the date on which the Internal Revenue Service (IRS) submits a report “giving the name of the person to whom the refund is to be made, the amount of such refund or credit, and a summary of the facts and the decision of the [IRS]” to the Joint Committee on Taxation for its review.
- For many taxpayers, large NOLs will be generated in 2020, which will not be eligible to be carried back until filing season in 2021, thus deferring the economic benefit that will be derived from this provision.
- Although it is not addressed in the CARES Act, Code Section 511(a)(1) states that Unrelated Business Taxable Income (UBTI) is “computed as provided in section 11”, which is the corporate income tax. The CARES Act does not exclude tax-exempt organizations (other than charitable trusts taxed under Code Section 511(b)) for UBTI purposes. Consequently, exempt organizations are likely also eligible to amend Form 990-T (Exempt Organization Business Income Tax Return) to claim NOL carrybacks. The requirement under Code Section 512(a)(6) for NOLs to be calculated separately with respect to each trade or business if the organization has more than one trade or business remains.
Client Considerations and Remaining Uncertainties
- While the relaxation on NOL limitations, standing alone, is certainly welcome news for many taxpayers, clients would be well advised to carefully consider the impact that the additional deductions may have with respect to their previously reported tax liability under Code Section 965 (transition tax), as well as their ongoing tax liability under and exposure to Code Sections 59A (Base-Erosion Anti-abuse Tax (BEAT)) and 951A (Global Intangible Low-Taxed Income (GILTI)). The interplay between these provisions and the new NOL provisions introduced under the CARES Act have the potential to produce anomalous (perhaps even unfavorable) and unexpected outcomes.
- For taxpayers carrying back NOLs, an amended return for the tax year to which a NOL is carried back must be prepared, signed under the penalties of perjury, and filed. For many taxpayers, the statute of limitations for a portion of the carryback years would otherwise be closed. Clients should consider whether to “reopen” previously closed years by carrying back NOLs from 2018 through 2020 and the ramifications of doing so. Additionally, clients should consider whether carrying back to previously closed years will trigger the need for a reassessment of financial reserves. In some instances, clients may be hesitant to reopen these closed years for a variety of reasons and may choose to forgo carryback, if possible. Clients should consider conducting a risk analysis to determine the best course of action with respect to this important decision.
- To the extent a taxpayer files amended federal returns claiming NOL carrybacks, these amended federal returns will likely trigger state filing obligations as well. Clients should consider the administrative implications when determining whether to move forward with amended federal returns.
- Clients should review agreements relating to transactions, such as sales of businesses, that may have taken into account tax deductions attributable to such transactions on the assumption, following adoption of the TCJA, that NOLs could no longer be carried back, to see whether modifications of these agreements may be possible or appropriate.
- It is unclear how quickly the IRS will process amended returns and issue any applicable refunds that are generated pursuant to this provision.
Increase of the Limitation on Deductible Business Interest
Under the CARES Act, for tax years beginning in 2019 and 2020, the limitation on deductible business interest expense under Code Section 163(j) is increased. Rather than using 30% of the taxpayer’s adjusted taxable income (ATI) for the year in the formula to compute allowable interest, the taxpayer may use 50% of ATI. Taxpayers may elect out of using this increased ATI limit for an eligible taxable year.
Additionally, taxpayers may elect to use 2019 ATI amounts when computing their business interest deduction limitation in 2020. In the case of a partnership, the election is made at the partnership level. The CARES Act provides a special formula for taxpayers that have a short year beginning in 2020.
For partnerships, the increase in ATI limit from 30% to 50% applies only to the 2020 tax year. In lieu of permitting partnerships to increase their limitation in 2019, the CARES Act provides a special rule that enables partners who received partnership allocations of excess business interest in 2019 that were nondeductible because of the 30% ATI limit. Under this provision, unless a partner elects out, 50% of the excess business interest allocated to the partner in 2019 (computed using the existing 30% ATI limitation at the partnership level) is deemed to accrue in 2020 and may be taken into account on the partner’s 2020 tax return without further limitation under Code Section 163(j). The remaining 50% of any excess business interest allocated to the partner in 2019 will remain subject to the existing limitations under Code Section 163(j).
- Historically, Code Section 163 only limited business interest expense under the “earnings stripping” rules (e.g., interest expense due to a related lender not subject to US tax). The TCJA adopted a broad 30% of ATI standard without regard to the identity of the lender. The CARES Act increases these TCJA limitations and allows taxpayers to take larger deductions to reduce taxable income.
- Taxpayers may elect out of the increase to defer the deduction and avoid increasing an already existing net operating loss.
- The failure to allow partnerships to use the increased 50% ATI limitation in 2019 likely is attributable to the fact that the CARES Act passed after the original March 15, 2020, due date for filing 2019 calendar-year partnership tax returns (although practically many of the large partnerships that are actually subject to Code Section 163(j) limitations likely had not filed their 2019 year returns by this time). Instead, the CARES Act exempts partners from Code Section 163(j) limitations with respect to 50% of the excess business interest allocated to them in 2019. This accommodation to partners does not necessarily provide them with relief equivalent to the benefits (both timing and amount) that they might have derived if the increased limitation applied at the partnership level in 2019. On the other hand, it reduces the administrative burden and complexity of amending partnership tax returns. Moreover, the available partnership-level elections under this provision have the potential to create additional excess taxable income for partners in 2020.
- While Congress corrected or clarified aspects of the TCJA, it did not address a problem created for manufacturers under proposed regulations issued by the IRS. For taxable years beginning before January 1, 2022, Code Section 163(j)(8) permits taxpayers to increase their ATI (and thus their interest deduction limitation) by adding back their depreciation, amortization, and depletion expense deductions. Under Prop. Reg. § 1.163(j)-1(b)(1)(iii), however, taxpayers that must capitalize depreciation, amortization, or depletion expense into their cost of goods sold cannot take advantage of this rule. The CARES Act does not address this problem, which could be significant for many manufacturers that may well be hit hard by COVID-19.
Reduction of the Applicable Recovery Period for Qualified Improvement Property
As enacted in 2017, the TCJA contained a drafting error that subjected qualified improvement property (such as interior improvements to retail stores and restaurants) to a 39-year recovery period instead of the 15-year recovery period intended by Congress. The CARES Act corrects this “retail glitch” by shortening the recovery period for qualified improvement property to 15 years. These technical amendments make qualified improvement property eligible for bonus depreciation. Further, the technical amendments are permanent and take effect as if included in Section 13204 of the TCJA.
Observations and Client Considerations
- Unlike most of the other CARES Act provisions, this section is a technical correction to the TCJA and it applies retroactively to 2018 and 2019, and prospectively as if it were included in the TCJA.
- Taxpayers that incur costs related to qualified improvement property during 2020 and before January 1, 2023, can deduct the full cost of the property during the taxable year in which the property is placed in service.
- Clients that placed qualified improvement property in service during 2018 or 2019 should consider amending those income tax returns to fully expense the cost of the qualified improvement property and obtain refunds or generate NOLs, which can be carried forward to later tax years. If the amended returns generate NOLs, the CARES Act will allow taxpayers to carryback the losses for up to five years or use the NOLs to fully offset taxable income in their pre-2021 tax years.
- Code Section 6405(a) provides that no refund of income tax in excess of $2 million for individuals or other non-C corporations or $5 million for C corporations, will be made until the expiration of 30 days from the date on which the IRS submits a report “giving the name of the person to whom the refund is to be made, the amount of such refund or credit, and a summary of the facts and the decision of the [IRS]” to the Joint Committee on Taxation for its review. Taxpayers requesting refunds in excess of the $2 million or $5 million thresholds should expect a delay in payment.
Modification of the Limitation on Excess Business Losses for Non-Corporate Taxpayers
Under the CARES Act, for taxable years beginning after December 31, 2017, through December 31, 2020, the implementation of the “excess business loss” provisions of the TCJA is delayed to post-2020 tax years, and individuals can use passthrough or other business losses, which would have otherwise been limited. In general, an “excess business loss” is the sum of the aggregate trade or business deductions of a taxpayer for a taxable year, over its aggregate trade or business income for such year, increased by $250,000 (as adjusted for inflation).
The CARES Act also makes technical amendments to Code Section 461(l) permanently modifying the definition of excess business loss, requiring that such loss be determined without regard to the deductions available for NOLs, capital losses, or qualified business income (Code Section 199A), and without regard to trade or business deductions, income, or gains attributable to performing services as an employee. In addition, the CARES Act modifies the treatment of excess business losses disallowed for a taxable year. Specifically, such losses are treated as NOLs for the year in which they arise, which may be carried over to subsequent taxable years.
The CARES Act also removes the limitation on excess farm losses for taxable years beginning after December 31, 2017, and before January 1, 2026.
Observations and Remaining Uncertainties
- The changes to the definition of “excess business loss” – in particular, that such losses are now determined without regard to capital losses – may ultimately have the effect of reducing a taxpayer’s excess business loss. Since disallowed excess business losses are treated as NOLs for the year in which they arise, the amended definition of excess business loss may reduce NOLs in post-2020 tax years.
- Historically, the appropriate coordination of Code Section 461 (rules for taxable year of deduction) and Code Section 1231 (capital gain or loss treatment for property used in a trade or business) has raised a number of questions. The CARES Act leaves many of these questions unanswered and, in fact, potentially further complicates the interaction between the two provisions.
Relaxation of the Limitations Associated with the Alternative Minimum Tax Credit
The CARES Act relaxes the limitations imposed by the TCJA and permits corporations with alternative minimum tax (“AMT”) credit carryovers to accelerate the recovery of refundable AMT credit carryovers. The CARES Act specifically limits Code Section 53(e) to taxable years beginning in 2018 and 2019, and for taxable years beginning in 2020 and 2021, the increased Code Section 53(c) limitation no longer applies.
The CARES Acts also increases the AMT refundable credit to 100% beginning in 2019 (rather than 2021, as prescribed under the TCJA). Importantly, this section allows taxpayers to elect to claim the full amount of the AMT refundable credit, without reduction by reason of the Code Section 53(c) limitation, for its taxable year beginning in 2018. The procedure and administrative requirements for making such election are similar to those currently found in Code Section 6411. These amendments are effective for taxable years beginning after December 31, 2017.
- Corporations with newly allowed refundable AMT credits can file an application for a tentative refund. The application is verified in the same manner as an application under Code Section 6411(a) and must be filed prior to December 31, 2020. Within 90 days from the date a taxpayer files a tentative refund claim, the Secretary of the Treasury will process the refund claim.
Recovery Rebates for Individuals
For eligible individuals, the CARES Act establishes a refundable credit, paid in cash, of $1,200 to individuals with adjusted gross income (AGI) of $75,000 or less ($112,500 or less for head of household filers) and $2,400 to married couples filing jointly with AGI of $150,000 or less. Individuals will also receive an additional $500 for each “qualifying child.” The credit is gradually phased out for taxpayers with AGI over the $75,000/$112,500/$150,000 amounts, and eliminated entirely for individuals with AGI of $99,000 and over, head of household filers with one child and AGI of $146,500 and over, and married taxpayers with no children and AGI of $198,000 and over. Nonresident alien individuals, anyone who is a dependent of another taxpayer, and estates and trusts, are not eligible for the credit. Eligible individuals and qualifying children must have a social security number in order to receive or be considered for payment purposes.
The CARES Act contemplates that the IRS will principally administer the issuance of payments by looking to 2019 federal income tax returns to (1) calculate the payments based upon AGI, filing status, and number of dependents, and (2) identify the individual’s address and direct deposit information. If individuals have not filed their 2019 federal tax return, the IRS will utilize their 2018 tax return information, and in circumstances where an individual did not file a 2018 federal tax return, the IRS will utilize information from the Social Security Administration to determine eligibility.
No later than 15 days after the IRS distributes a payment (either electronically or by mail) it will mail a notice to the eligible individual stating the payment method and amount, and contact information for individuals to report any failures to receive the payment. In addition, the relevant governmental agencies will conduct a public awareness campaign to provide information on payments to eligible individuals and to provide information to individuals who may not have filed a 2018 or 2019 tax return. The payments will not be subject to reduction or offset by any federal income tax or other liability the eligible taxpayer otherwise owes.
- The IRS will be drawing on its experience with stimulus payments issued to taxpayers pursuant to the Economic Stimulus Act of 2008 when it mailed stimulus rebate checks to 130 million taxpayers, a process that took several months.
- For eligible individuals with income levels that qualify them to receive a rebate payment, it is important that the IRS has up-to-date information, e.g., last known address and direct deposit information, in order to calculate the payment correctly and issue it appropriately. To that end, eligible individuals should file their 2019 tax return as soon as possible, especially if their information has changed and if they would not qualify based on the information in their 2018 tax return. Treasury has granted an extension to pay 2019 federal income tax liabilities to July 15, 2020, see IRS Notice 2020-18. Payment is not required to accompany a return filed before July 15, 2020, and can be made at any time on or before July 15, 2020.
Administrative Uncertainties Remain
- The timeline for actually receiving checks is unclear, but Treasury Secretary Steven Mnuchin has previously stated it will be approximately three weeks from the date of enactment.
- It is unclear how long it will take an eligible individual to receive a payment if the bank account used to receive a refund from a 2018 or 2019 return is closed or the individual has moved since filing a 2018 or 2019 return. This issue could significantly delay the individual’s receipt of the payment.
- It is unclear how the IRS will calculate and administer the payment to individuals who are eligible but have not filed a return in 2018 or 2019 (because they were below the filing threshold or for other reasons) and who do not have an earnings history on file with the Social Security Administration.
- Implementation will require Treasury and the IRS to issue regulations addressing payments to eligible individuals, among others, who filed jointly in 2019 but are now divorced, for qualifying children who are split between households, for foster children, and in relation to payments where a spouse has died.
- It is unclear whether an eligible individual can challenge the amount of rebate check that is calculated incorrectly.
- In addition, because the payments are considered an advance tax credit that eligible individuals claim on their 2020 federal income tax return, if an eligible individual’s 2019 AGI falls within the phase-out range above, and if their 2020 AGI is lower than their 2019 AGI, the Senate Finance Committee has noted that the remaining portion of the credit will be refunded or can be used to reduce the individual’s 2020 tax liability, once they file their 2020 federal tax return during the 2021 filing season. It is uncertain at this point how this credit will be claimed with the individual’s 2020 federal tax return.
Changes Impacting Charitable Giving to Nonprofit Organizations
Allowance of an Above-the-Line Deduction for Charitable Contributions
Individual taxpayers who do not itemize their deductions can generally deduct up to $300 for cash contributions made in 2020 to organizations described in Code Section 170(b)(1)(A).
Observations and Remaining Uncertainties
- While $300 is a relatively small amount, this provision is an important development for nonprofits because it represents a course correction from the TCJA which put the charitable contribution deduction out of reach for all but the top 12% of taxpayers.
- The new provision will help those nonprofits that traditionally have relied on contributions from lower- and middle-income donors for support, including many charities that provide direct services to the needy, houses of worship, and religious organizations.
- Notably, the provision excludes gifts to private non-operating foundations, supporting organizations, and gifts to establish new or maintain existing donor-advised funds.
- It remains uncertain whether Congress will extend this charitable deduction for non-itemizers in future years, or if this is a one-time incentive as part of the COVID-19 disaster response.
Modification of the Limits on Charitable Contributions During 2020
The CARES Act temporarily alters percentage limitations on cash contributions for individuals and corporations during 2020. Individuals may deduct any qualified contribution to the extent of the individual’s contribution base (i.e., the individual’s 2020 adjusted gross income computed without regard to any net operating loss carryback to 2020). Individuals may carry over contributions in excess of their contribution base to later tax years. Corporations may deduct any qualified contributions that in the aggregate do not exceed 25% of the corporation’s taxable income. Corporations may carry over any contributions in excess of its taxable income to later tax years.
A qualified contribution is a contribution paid in cash if the taxpayer elects the application of this section with respect to such contribution. In the case of a charitable contribution made by a partnership or S corporation and allocated to its partners or shareholders, the election is made at the partner or shareholder level. The CARES Act also increases the deduction limit on contributions of food inventory from 15% to 25% of the taxpayer’s aggregate net income.
Observations and Client Considerations
- This provision is extremely favorable to taxpayers desiring to give large amounts to charity, such as those who recently experienced a major liquidity event, as they can reduce their taxable income to zero in 2020.
- The provision is also helpful to taxpayers, such as individuals living on fixed incomes, who may have significant assets to give to charity but low levels of adjusted gross income. The percentage limits would otherwise constrain their ability to claim a charitable contribution deduction.
- Donors must be sure to follow the special procedures to elect the application of this provision, which is an extra step not usually required for other charitable contributions.
- The provision excludes gifts to private non-operating foundations, supporting organizations, and gifts to establish new or maintain existing donor-advised funds. We note, however, that gifts to sponsoring organizations to establish a fund that is not classified as a donor-advised fund, such as a field of interest fund, may well be permitted.
What Can Taxpayers Expect Next?
Some lawmakers have indicated a desire to pass further legislation in a fourth bill. House Speaker Nancy Pelosi previously unveiled legislation on March 23, reflecting her party’s priorities in addressing the COVID-19 pandemic and associated health and economic impacts. This draft legislation included several additional tax provisions not included in the CARES Act, including changes to the earned income credit and the child tax credit, and contained further delays to federal tax filing and payment deadlines. Republican lawmakers have encouraged Congress to delay further action and first allow for the implementation of the CARES Act.
Regardless of further congressional action, the changes brought by the CARES Act will require extensive work by Treasury and the IRS to implement. Through the promulgation of regulations, drafting of forms, publications and other guidance, there will continue to be further developments as these changes unfold.
Coronavirus COVID-19 Task Force
For our clients, we have formed a multidisciplinary Coronavirus COVID-19 Task Force to help guide you through the broad scope of legal issues brought on by this public health challenge. We also have launched a resource page to help keep you on top of developments as they unfold. If you would like to receive a daily digest of all new updates to the page, please subscribe now to receive our COVID-19 alerts.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
Sheri A. Dillon
Peter M. Daub
Michael D. Kummer
Casey S. August
Daniel F. Carmody
Charles R. Bogle
Sarah A. Nelson
Richard S. Zarin
Daniel A. Nelson
George P. Mair
Meghan E. McCarthy
Barton W.S. Bassett