The CARES Act’s Tax Provisions: an Overview
On March 27, 2020, Congress passed and the President signed into law H.R. 748, the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”). The Act provides $2 trillion of economic support for businesses and individuals affected by the global COVID-19 pandemic, which includes lending facilities to distressed large and small businesses, expanded unemployment benefits, and individual and business tax changes and benefits. This client alert focuses on the individual and business tax provisions of the CARES Act.
Americans Get Cash
The marquee feature of the CARES Act is a cash rebate for all eligible individuals. It is provided in the form of an advance refundable tax credit in an amount equal to the sum of $1,200 ($2,400 in case of eligible individuals filing a joint return), plus $500 for each qualifying child. The credit is gradually phased out for individuals with adjusted gross incomes between $75,000 and $99,000 (between $150,000 and $198,000 for joint returns). The benefit of the credit applies to the 2020 tax year and is technically based on the taxpayer’s adjusted gross income in 2020. However, in order to accelerate the timing of the payment, the CARES Act provides for an advanced funding procedure under which the Treasury Department will promptly issue the refund based on the taxpayer’s 2019 or 2018 adjusted gross income and Social Security information available at the time of the refund issuance. This rebate is a refundable credit and can be received by an eligible individual even if the individual has less than $1,200 ($2,400 in case of a joint return) of adjusted gross income for the relevant taxable year.
Easier Access to Retirement Savings
The CARES Act provides individuals affected by COVID-19 with greater access to their retirement savings by, among other things:
- allowing such individuals to take penalty-free distributions of up to $100,000 during the 2020 calendar year from certain eligible retirement plans – including 401(k) plans, profit-sharing plans and IRAs – and exempting such distributions from withholding requirements;
- allowing such individuals to avoid including the distributions in their taxable income by contributing an equal amount to one or more eligible retirement plans during the three-year period commencing on the day following their receipt of such distributions;
- allowing such individuals who take distributions but do not make offsetting contributions within the three-year period to recognize any taxable income resulting from the distributions ratably over a three-year period;
- increasing from $50,000 to $100,000 (subject to certain adjustments), the maximum amount that such individuals can borrow from their qualified retirement plan accounts, for loans taken during the 180-day period following the enactment of the CARES Act; and
- delaying for one year the due date for any repayment on an outstanding plan loan where such due date would otherwise fall within the period commencing on the date of enactment of the CARES Act and ending on December 31, 2020.
These provisions apply to individuals who are diagnosed (or whose spouse or dependent is diagnosed) with COVID-19 by a CDC-approved test, as well as to individuals who experience adverse financial consequences as a result of COVID-19, including as a result of being quarantined, furloughed or laid off, having work hours reduced, or being unable to work due to lack of child care.
The CARES Act also provides relief for defined contribution plan participants and IRA owners and beneficiaries who are subject to required minimum distribution (“RMD”) requirements by waiving those requirements for the 2020 calendar year. Without this change, these individuals would be required to take RMDs during 2020 that were calculated based on the value of their accounts at the end of 2019 (which value is likely to be substantially higher than the current value of their accounts). The CARES Act also provides a special rule for individuals whose required beginning date for RMDs falls within the 2020 calendar year and who had not yet received their first RMD prior to January 1, 2020, providing for both a waiver of the RMD requirements for calendar year 2020 and further providing that the five-year period for completing distributions, if applicable, is to be determined without regard to calendar year 2020.
Plan sponsors have until the last day of the first plan year beginning on or after January 1, 2022, to amend their plans to reflect the foregoing changes to the plan distribution and loan rules.
Limitations on Executive Compensation for Businesses Receiving Loans or Financial Assistance
The CARES Act also authorizes the Secretary of the Treasury to make up to $500 billion in loans, loan guarantees and investments (hereinafter referred to collectively as “loans”) (i) to certain “eligible businesses” in need of economic relief including (A) passenger air carriers, (B) cargo air carriers and (C) businesses critical to maintaining national security, and (ii) through programs or facilities established by the Federal Reserve for providing liquidity by lending to eligible businesses, states and municipalities. The CARES Act imposes certain limitations on the amount of compensation of officers and executives of such eligible businesses.
As a condition to entering into a loan, the CARES Act requires, among other conditions, that the eligible business agree that while the loan is outstanding, and for an additional year thereafter (the “Limitation Period”):
- any officer or employee of the eligible business whose total compensation exceeded $425,000 in calendar year 2019 (“2019 Total Compensation”) will be prohibited from (i) receiving compensation for any 12-consecutive-month period during the Limitation Period in excess of 2019 Total Compensation, and (ii) receiving severance pay or other benefits upon termination of employment with the eligible business in excess of two times 2019 Total Compensation; and
- the total compensation of an officer or employee of the eligible business whose 2019 Total Compensation exceeded $3 million will be limited for any 12-consecutive-month period during the Limitation Period to (i) $3 million, plus (ii) 50% of his or her 2019 Total Compensation in excess of $3 million.
Passenger and cargo air carriers and certain contractors receiving financial assistance pursuant to a separate subtitle of the CARES Act (as opposed to loans) are also subject to similar restrictions on officer and executive compensation.
Eligible businesses seeking benefits under the CARES Act will need to examine their compensation programs carefully, including potential impacts on executive retention and recruitment, and whether termination provisions relating to compensation (such as “good reason”) would be implicated.
Higher Charitable Contribution Limits
The CARES Act provides for a $300 above-the-line deduction for charitable contributions after December 31, 2019. This provides a modest tax benefit to individuals who make charitable contributions but are unable to currently deduct them because their standard deduction is higher than the sum of their itemized deductions.
Additionally, the CARES Act increases the charitable deduction limitation for charitable contributions in 2020. Prior to the CARES Act, individual taxpayers were only allowed to deduct their charitable cash contributions up to 60% of their contribution base (adjusted gross income computed without regard to any net operating loss carryback) and corporations were only allowed to deduct up to 10% of their taxable income. The CARES Act suspends this 60% limit for individual charitable contributions made in 2020 and increases the limitation to 25% for corporate charitable contributions. Both the $300 above-the-line deduction and the increased percentage limitations apply only to contributions of cash that are not made to certain donor advised funds, supporting organizations or private foundations.
Prior to the CARES Act, food inventory donations to charitable organizations were deductible subject to a limitation, where the deduction could not exceed 15% of the corporation’s income or 15% of aggregate net income from all trades or business for non-corporate taxpayers. The CARES Act increases the limitation to 25%.
Payroll Tax Credit and Deferral
Certain employers whose businesses are affected by COVID-19 may be eligible to receive a refundable payroll tax credit of up to 50% of qualified wages (including health benefits) up to $10,000 per employee for wages paid after March 12, 2020, and before January 1, 2021. Because this credit offsets employment taxes, even tax-exempt organizations are eligible for it. For employers with more than 100 full-time employees, qualified wages are wages paid to employees when they are not working due to the COVID-19-related circumstances. For businesses with 100 or fewer employees, all employee wages qualify for the credit, whether the employer is open for business or subject to a shut-down order.
An employer is eligible for this credit only if (i) the operation of that business is fully or partially suspended by the government due to COVID-19, or (2) the business has seen a decline in gross revenue of 50% less than in the same calendar quarter of the prior year, in which case the credit is available until the business recovers to earn at least 80% of the prior year’s revenue. If the business receives a loan under the new Paycheck Protection Program, the business is not eligible for a payroll tax credit.
Additionally, employers can defer payment of the employer portion of the 6.2% payroll tax due for the rest of 2020. Normally, employers are required to make payroll tax payments monthly or twice per month. The amounts not paid in 2020 will be due in two installments on December 31, 2021, and December 31, 2022. This provision effectively provides employers an interest-free loan for payroll taxes.
Increased Availability of Net Operating Loss Deduction
Under current law, deductions for net operating losses (“NOLs”) incurred after 2017 can generally offset only 80% of taxpayer’s taxable income, with unused NOLs carried forward indefinitely (until used) into subsequent tax years. Taxpayers generally cannot carry back these NOLs to offset taxable income from previous tax years. The CARES Act temporarily relaxes the NOL rules by allowing companies with NOLs arising in the 2018, 2019 and 2020 tax years to carry those NOLs back for five years. This change applies retroactively, and as a result, companies recognizing losses during any of those three years, but with taxable income during the five years preceding the loss year, will be able to file amended returns and get refunds of the taxes paid in the prior profitable years (which may include years in which taxes were payable at a 35% tax rate).
Additionally, the CARES Act temporarily suspends the 80% offset limitation. For taxable years before January 1, 2021, taxpayers will be able to offset 100% of their taxable income with NOLs incurred in prior and subsequent years.
There are, however, several limitations on the availability of NOL deductions:
- For taxpayers who are subject to global intangible low-taxed income (“GILTI”), the NOLs may have to be used against GILTI, and not against prior year taxable income.
- Real estate investment trusts are not allowed to carry back NOLs to any preceding taxable year.
- If the taxpayer was required to include income under Section 965(a) (a transition tax on the untaxed foreign earnings of certain foreign corporations), the taxpayer will not be able to offset such Section 965(a) income with NOLs.
Increased Availability of Non-Corporate Business Deductions
Section 461(l), enacted for tax years beginning on or after January 1, 2018, limits owners of non-corporate businesses from offsetting trade-or-business losses above a certain threshold against nonbusiness income in the taxable year of the loss. The CARES Act retroactively suspends this limitation for the 2018, 2019, and 2020 tax years. Accordingly, owners or partners in operating businesses may be able to use excess losses from such businesses to offset other non-business income, such as wages, dividends, capital gains or other types of income generated in those years. The operating business losses, however, are still subject to several other imitations, such as the taxable basis, at-risk and passive activity loss limitations.
Accelerated Refunds for AMT Credits
Although corporations are no longer subject to the alternative minimum tax (“AMT”), any AMT credits that the corporation had before 2018 can be carried forward and refunded in 2018 through 2022. The CARES Act accelerates these credits so that the refund can be taken during the 2018 and 2019 tax years. Moreover, the CARES Act provides for an accelerated refund procedure so that corporations can receive payments within 90 days, bypassing the typically lengthy review for large refunds.
Increased Limitation on Interest Deduction
Starting in tax years beginning on or after 2018, Section 163(j) generally limits deductibility of interest to 30% of the adjusted taxable income (i.e., essentially EBIDTA for taxable years 2018 through 2021) of the taxpayer. The CARES Act temporarily increases that limitation to 50% of adjusted taxable income for the 2019 and 2020 tax years. Additionally, the taxpayers have an option to apply the Section 163(j) limit for tax years beginning in 2020, by using the adjusted taxable income from the previous tax year beginning in 2019. This means that the taxpayers can choose to apply the 50% limitation in 2020 based on the higher of 2019 or 2020 adjusted taxable income.
Qualified Investment Property
The CARES Act addresses what was thought to be an oversight in the treatment of “qualified improvement property” under the Tax Cuts and Jobs Act of 2017 (the “TCJA”). The TCJA did not include qualified improvement property in the category of property eligible for 15 -year (or certain accelerated) depreciation. The CARES Act clarifies that this beneficial treatment does apply to qualified improvement property, retroactively back to the original effective date of the TCJA. Accordingly, taxpayers are entitled to file amended returns for the 2018 and 2019 tax years.
Tax Treatment of Emergency Relief Loans
With respect to the $500 billion relief program (discussed above) , the CARES Act provides that, for federal income tax purposes, loans made or guaranteed by the Treasury Department will be treated as indebtedness, as having been issued for their principal amount and as carrying qualified stated interest. In addition, the Secretary of the Treasury (or its delegate) is authorized to issue regulations appropriate to carry out the intent of these relief measures, including regulations providing that the issuance of certain warrants, options or equity interests would not result in an ownership change under Section 382 (which otherwise could limit the availability of NOLs and other tax attributes).
For More Information
 “Eligible individual” means any individual other than (i) any non-resident alien, (ii) an individual who can be claimed as dependent on another person’s return, (iii) an estate or trust; provided that such eligible individual has a Social Security number.
 The large majority of the $500 billion ($454 billion) is allocated for this catch-all category for Federal Reserve programs and facilities.
 “Total compensation” includes “salary, bonuses, awards of stock, and other financial benefits.”
 The Treasury Secretary may waive the executive compensation limitations for businesses covered by programs or facilities established by the Federal Reserve “upon a determination that such waiver is necessary to protect the interests of the Federal Government.”
 See “CARES Act Expands Relief for Workers Affected by Pandemic,”Stroock Special Bulletin (March 30, 2020).
 References to “Section“ in this client alert refer to sections of the Internal Revenue Code of 1986, as amended.
This Stroock publication offers general information and should not be taken or used as legal advice for specific situations, which depend on the evaluation of precise factual circumstances. Please note that Stroock does not undertake to update its publications after their publication date to reflect subsequent developments. This Stroock publication may contain attorney advertising. Prior results do not guarantee a similar outcome.