Below is a brief summary of the key tax relief measures Congress has recently adopted in COVID-19 legislation that can provide benefits to businesses structured as pass-through entities for income tax purposes (e.g., S-corporations; partnerships and LLCs taxed as partnerships or as disregarded entities) and sole proprietorships.
Payroll tax credits under The Families First Coronavirus Response Act (FFCRA)
- The FFCRA requires employers with fewer than 500 employees to pay sick and family leave wages for COVID-19 related reasons. In exchange for imposing the mandate, employers are eligible to receive 100 percent reimbursement for paid leave wages, plus the allocable qualified health plan expenses and the amount of the employer’s share of Medicare tax imposed on those wages, in the form of tax credits.
- Eligible employers are able to retain payroll taxes equal to the amount of qualifying sick and child care leave that the employer pays, rather than deposit them with the IRS. The payroll taxes that are available for retention include withheld federal income taxes, the employee share of Social Security and Medicare taxes, and the employer share of Social Security and Medicare taxes with respect to all employees. If there are not sufficient payroll taxes to cover the cost of qualified sick and family leave pay, employers will be able file a request for an accelerated payment from the IRS using Form 7200, Advance Payment of Employer Credits Due to COVID-19. The IRS expects to process these requests in two weeks or less.
Employee retention credit under Coronavirus Aid, Relief, and Economic Security Act (CARES Act)
- The CARES Act provides a refundable payroll tax credit for 50 percent of “qualifying wages” paid by “qualifying employers” to employees between March 13, 2020, and Dec. 31, 2020. To qualify, the employer must be operating a trade or business in the United States or conducting non-profit activities as a 501(c) tax-exempt organization and (i) have operations that are partially or fully suspended due to COVID-19, or (ii) have a decline on gross receipts by more than 50 percent compared to the prior year, measured by the calendar quarter. If only the gross receipts test under (ii) is satisfied, the eligibility for the credit will terminate when gross receipts reach 80 percent of the prior year gross receipts for the applicable quarter.
- Qualifying wages for employers with 100 or less full-time employees include all wages. For larger employers, it includes only wages paid to employees who are not providing services “due” to COVID-19. In all cases, qualifying wages are capped at the first $10,000 (including health benefits) paid to an employee. The credit is not available to employers receiving small business loans under the Payroll Protection Program of the CARES Act.
- The credit is measured by the amount of wages earned by the employee. For example, if an employee who meets the conditions earns wages of $5,000 for a covered period, the credit would equal $2,500. The manner in which the credit can be obtained by the employer is through a reduction in the employer’s payroll tax remittance. In the event there are not enough payroll taxes due to absorb the full credit, the IRS has provided a mechanism (IRS Form 7200) for employers to receive a cash refund of the excess.
Payroll tax deferral
- The CARES Act creates essentially a short-term loan to employers by providing a delay in the payment of an employer’s share of payroll taxes. The employer’s share of payroll taxes that may be deferred consist of Social Security taxes (6.2 percent of wages up to the wage base ($137,700 in 2020)) for the period beginning March 27, 2020, and ending Jan. 1, 2021. The CARES ACT provides a similar deferral for the equivalent self-employment taxes of a self-employed taxpayer.
- The deferred amounts will need to be paid in two installments, half on Dec. 31, 2021, and the other half on Dec. 31, 2022. There is no dollar cap on the wages that are counted in calculating the taxes that may be deferred. Additionally, the deferral applies to all employers, with no requirement to show any specific COVID-19-related impact. However, the deferral is not available to any employer receiving small business loans under the Payroll Protection Program of the CARES Act if the loan is later forgiven.
Modifications for net operating losses (NOLs)
- For NOLs generated in 2018, 2019 and 2020, the CARES Act reinstates the ability to carry back the losses for up to five years. Additionally, the CARES Act suspends the 80 percent of taxable income limitation on the use of NOLs for tax years beginning before Jan. 1, 2021. These changes can allow taxpayers with available NOLs to obtain cash refunds immediately by filing amended returns for the applicable years.
- Prior to the CARES Act, the 2017 Tax Cuts and Jobs Act (TCJA) had eliminated the ability to carry back NOLs to a prior year and obtain a refund of taxes previously paid. The TCJA revised the NOL rules to permit NOLs only to be carried forward (indefinitely) and only utilized to offset up to 80 percent of a taxpayer’s taxable income.
Suspension of excess business loss limitation for non-corporate taxpayers
- The CARES Act temporarily suspends until 2021 the limitation on a non-corporate taxpayer’s ability to utilize excess business losses. The suspension is retroactive to 2018. The excess business loss limitation was initially enacted for tax years beginning in or after 2018 as part of the TCJA, and it disallows excess business losses of non-corporate taxpayers if the amount of the losses are in excess of $250,000 ($500,000 in the case of a joint return).
- When the excess business loss limitation rules do again apply in years 2021 and after, the disallowed amount is to be carried forward as a net operating loss to the following tax year. The CARES Act additionally clarifies some technical uncertainties, providing that NOLs themselves are not considered excess business losses and that employee wages are not used in the calculation. Furthermore, the CARES Act clarifies that business capital losses will not be included in the calculation so they will no longer be converted into future NOLs.
Modification of limitation on business interest
- The CARES Act increases the amount of interest expense businesses are allowed to deduct under Internal Revenue Code §163(j) from 30 percent to 50 percent of taxable income (with adjustments) for 2019 and 2020. For the 2020 tax year, the 50 percent limitation can be based on 2019 income. This will have the effect of increasing the interest expense deduction for most businesses, because it is anticipated that the vast majority of taxpayers will have more taxable income in 2019 than 2020.
Bonus depreciation on qualified improvement property
- The CARES Act makes a technical correction to the TCJA by clarifying that qualified improvement property is eligible for 100 percent bonus depreciation. This correction thereby provides an immediate write-off of 100 percent of the improvement costs in the year incurred.
- Qualified improvement property generally includes any improvement to the interior of leased or owned space of a building that is non-residential real property but only if the improvement is placed in service after the date the building was first placed in service. Among other taxpayers, the change is expected to especially benefit retailers and restaurants.
- As we previously noted in prior alerts regarding the TCJA, the TCJA included a legislative error omitting qualified improvement property from the list of 15-year property, meaning that it did not qualify for bonus depreciation, and must be depreciated over 39 years. This change is made retroactive as if originally included in the TCJA and therefore the write-off can be claimed for improvements made in 2018 by filing an amended return.
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