Tax Savings Opportunities

Accountants offer insight into business and individual tax options from the CARES Act.

On March 27, President Trump signed the Coronavirus Aid, Relief, and Economic Security (CARES) Act, the third phase of legislation aimed at fighting the COVID-19 pandemic and mitigating the related economic harm for families, workers and businesses. It’s the largest stimulus package in history, with an estimated cost of $2.2 trillion. The CARES Act, among other things, provides “recovery rebates” to individuals, expands and enhances unemployment benefits, extends loans and loan guarantees to eligible businesses, offers funding for the healthcare and education systems, and provides tax relief for businesses and individuals. Read on to learn about the business and individual tax provisions of the CARES Act and how you can take advantage of available savings.

Business provisions

Deferral of employer Social Security tax You can generally defer the employer share of the 6.2% Social Security tax on wages paid from March 27, 2020, through Dec. 31, 2020, with 50% due Dec. 31, 2021, and 50% due Dec. 31, 2022. A similar rule applies to 50% of the self-employment tax liability of partners and sole proprietors.

The deferral is not available if you take advantage of loan forgiveness under the paycheck protection program provisions of the CARES Act [i.e., certain new Small Business Administration (SBA) loans for payroll and specified other expenses]. Take the loss of the deferral into account when considering whether to take advantage of a paycheck protection loan.

Employee retention credit
The CARES Act added a refundable payroll tax credit equal to 50% of certain compensation paid from March 13, 2020, to Dec. 31, 2020. To qualify, your business must either have had its:

• Operations fully or partially suspended due to a COVID-19-related shutdown order, or
• Gross receipts decline by more than 50% when compared to the same quarter the prior year.

If your business has more than 100 employees, the credit is available only for compensation paid to employees who are not working as a result of one of the two situations listed above. If your business has 100 or fewer employees, any compensation paid during the period when the operations were affected by one of the two scenarios is eligible for the credit, even if it’s paid to an employee who is still working.

Example: If a small manufacturer temporarily closes a facility due to a shelter-in-place order, but continues to pay a few employees to work from home, wages paid to the employees who are still working qualify for the credit. If the manufacturer had more than 100 employees, then wages paid to employees who are still working would not qualify for the credit.

The credit is limited to the first $10,000 of compensation paid to a particular worker. The credit is not available for compensation taken into account in computing the sick leave or family medical leave credits under the Families First Coronavirus Response Act (FFCRA). Similarly, the credit is not available to employers who take advantage of a small business interruption loan under the paycheck protection program, so you’ll need to take the loss of the credit into account in determining whether to use the paycheck protection program.

Reinstatement of NOL carrybacks
Following tax reform, net operating losses (NOLs) generated in tax years beginning in 2018 and later years cannot be carried back, and can only offset up to 80% of taxable income in carryover years. The CARES Act permits NOLs from the 2018, 2019 and 2020 tax years to be carried back to the previous five tax years (beginning with the earliest year first) and suspends the 80% of taxable income limitation through the 2020 tax year. The NOL carryback can result in an immediate refund of taxes paid in prior years.

Aside from the cash-flow benefits of obtaining an immediate refund, NOL carrybacks present an opportunity to secure permanent tax savings by using losses to offset income generated prior to tax reform when the tax rates were higher. For example, a corporate NOL from 2020 can be carried back to offset income from 2015, which may have been subject to a 35% tax rate rather than carried over to 2021 when income is subject to a 21% tax rate. In some cases, however, income in future years will be subject to higher tax rates than income in the carryback period, so you’ll need to work with your tax advisor to determine whether the carryback is right in your particular situation.

You may be able to use proactive planning measures to accelerate deductions and defer income to maximize the amount of the NOL that you can carry back. If 2019 was profitable but you anticipate a loss for 2020, you may want to consider whether accelerating income into the 2019 year and deferring deductions to 2020 to maximize the NOL for 2020 makes sense in your situation.

Example: Auburn Inc., an accrual-method C corporation, anticipates having $2 million of taxable income in 2019 and $0 taxable income in 2020. If Auburn can shift $1 million of income from 2020 to 2019, Auburn will have $3 million of taxable income in 2019 (subject to tax at a 21% rate) and a $1 million net operating loss in 2020, which can be carried back to offset income in 2015 (subject to tax at a 35% rate). While it’s counterintuitive to accelerate income, doing so creates an NOL in 2020 that can be carried back to offset income subject to higher rates in earlier years, resulting in permanent tax savings of $140,000. The additional tax for the 2019 tax year is generally due by July 15, and the refund for carrying back the 2020 loss won’t be available until sometime in 2021. If you need the cash to keep your business afloat, then accelerating income may not make sense for you.

Temporary suspension of excess business loss rules
Tax reform limited individuals from using more than $250,000 ($500,000 married filing jointly) of business losses to offset non-business income. The CARES Act repeals the limitation for years beginning before Jan. 1, 2021. If you had a business loss that was limited in 2018 or 2019 under the excess business loss rules, then you may be able to obtain a refund by filing an amended tax return.

Corporate credit for prior year AMT
Tax reform repealed the corporate alternative minimum tax (AMT) and provided an opportunity for corporations to claim a refund of minimum tax credit carryovers during 2018 through 2021. The CARES Act makes any remaining minimum tax credit carryovers fully refundable in 2019. Alternatively, corporations can elect to claim a refund for the unused carryovers in 2018.

Modification of business interest limitation
The business interest limitation was added as part of tax reform and generally limits the deduction for business interest expense to the sum of (i) business interest income, (ii) 30% of adjusted taxable income (ATI), and (iii) floor plan financing interest. Certain small taxpayers are exempt from the limit.

The CARES Act increases the limit to 50% of ATI for 2019 and 2020, potentially increasing interest expense deductions and reducing taxable income (or creating a net operating loss that can be carried back). You can elect to use your 2019 ATI in computing the 2020 limit, providing relief if your business income declines in 2020. If your business is a partnership, then the relief from the business interest limitation for 2019 takes a modified form.

With this change, you could have an opportunity to amend your return if you already filed your 2019 tax returns and your deduction for business interest was limited.

Bonus depreciation for qualified improvement property
Under tax reform, qualified improvement property (QIP) was supposed to have a 15-year cost recovery period and be eligible for 100% bonus depreciation. A drafting error, however, caused QIP to have a 39-year cost recovery period, and be ineligible for bonus depreciation. QIP includes most improvements to commercial or industrial buildings after the building was first placed in service, such as most tenant improvements. The CARES Act retroactively corrects the drafting error for QIP acquired and placed in service on or after Jan. 1, 2018.

The retroactive fix may present an opportunity for you to accelerate depreciation, either by filing a Form 3115 or, in some cases, by filing an amended tax return. If you elected out of the business interest limitation for your real property business, then you are not eligible for bonus depreciation on QIP.

Individual provisions

Recovery rebate
You may be entitled to a “recovery rebate” of $1,200 ($2,400 married filing jointly), plus an additional $500 per qualifying child, if you are a U.S. resident and can’t be claimed as a dependent of another taxpayer. The rebate begins phasing out if your income exceeds $75,000 ($112,500 head of household; $150,000 married filing jointly) and is reduced by $5 for every $100 that your income exceeds the threshold. The rebate is available only if you and your qualifying children have a Social Security number.

The IRS will begin direct-depositing the rebate or mailing checks around April 6, and will base the first round of payments on income reported on your 2018 tax return (or 2019 return, if you’ve already filed). If you receive a rebate, but your 2020 income makes you ineligible for the rebate, there is no requirement for you to pay it back. On the other hand, if you were not eligible for the rebate based on your 2018 or 2019 income, but will be eligible based on your 2020 income, you can claim the rebate as a credit on your 2020 tax return.

Waiver of early withdrawal penalty
The 10% penalty on an early withdrawal from a retirement account is waived for up to $100,000 of distributions for coronavirus-related purposes made on or after Jan. 1, 2020. A distribution is considered coronavirus-related if it is made to an individual:

• Who is diagnosed with SARS-CoV-2 or with COVID-19 by a test approved by the Centers for Disease Control and Prevention (CDC);
• Whose spouse or dependent is diagnosed with SARS-CoV-2 or COVID-19; or
• Who experiences adverse financial consequences because of quarantine, furlough, layoff, work-hour reduction, or inability to work due to lack of childcare.

If you take a coronavirus-related distribution, you can either report the distribution as ordinary income ratably over a three-year period beginning in 2020, or you can recontribute the funds to a retirement plan within three years to avoid tax on the withdrawal altogether.

Waiver of Required Minimum Distributions (RMDs) for 2020
The CARES Act waives the required minimum distribution rules for certain defined contribution plans and IRAs during 2020. The waiver is not applicable to defined benefit plans (i.e., pensions).

Example: While employed, Beth contributed to a 401(k) plan. Beth turns 70 on May 1, 2019. Beth did not receive her RMD on or before Jan. 1, 2020. Beth does not have to take a RMD in 2020.

Charitable contribution provisions
Favorable rules apply if you make cash donations during 2020 to certain charities:

• Individuals who do not itemize can claim an above-the-line deduction of up to $300 for such contributions;
• Individuals who itemize can deduct such contributions up to 100% of adjusted gross income (AGI);
• C corporations can deduct such contributions up to 25% of taxable income; and
• Business deduction limits for contributions of food inventory is increased from 15% to 25% of the business’s taxable income.

Note that contributions made to donor-advised funds are not eligible for the incentives.

Exclusion for student loan repayment
Employees can exclude up to $5,250 from income for student loan repayments made by an employer between March 27, 2020, and Dec. 31, 2020. The exclusion appears to be available regardless of whether the student loan repayment has any connection to COVID-19.

Review additional CARES Act opportunities
The CARES Act provides opportunities for timely cash tax savings. Amended return opportunities are available for the following changes brought by the CARES Act, among others:

• Five-year NOL carryback for losses generated in the 2018 and 2019 tax years;
• Two-year NOL carryback for losses generated in a year beginning in 2017 and ending in 2018;
• Repeal of the excess business loss rules for 2018 or 2019;
• Apply 50% of ATI limit instead of 30% of ATI in computing business interest limitation for 2019; and
• Apply 100% bonus depreciation to QIP placed in service in 2018 or 2019.

Editor’s note: This article is from CliftonLarsonAllen.