Taxes in Your Practice: Pandemic tax developments
Vol. 76, No. 3 / May - June 2020
Scott E. Vincent
Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City.
Congress, the administration, and the Treasury Department have been very active in responding to the coronavirus and COVID-19 pandemic. There are a variety of relief measures, such as the SBA Economic Injury Disaster Loan (EIDLE) emergency advances and developing SBA and Federal Reserve relief loan and economic programs. Significant new tax legislation has included the “Families First Coronavirus Response Act” (Families First Act), the “Coronavirus Aid, Relief, and Economic Security Act” (CARES Act), and the “Paycheck Protection Program” (PPP) that is part of the CARES Act. The Treasury Department has also implemented compliance relief measures through the Internal Revenue Service.
This article highlights some of these recent actions that may impact your practice, particularly relating to tax matters. Please note that this is not a comprehensive list, and implementation of new provisions and further relief measures are likely to modify these topics. The PPP has already seen a clarification by the IRS and is expected to result in ongoing scrutiny for taxpayers.
Families First Act
The Families First Act, one of the first legislative relief packages, provides small and mid-sized eligible employers (generally fewer than 500 employees) with refundable tax credits for the cost of providing paid sick and family leave wages to employees taking certain COVID-19 leave, and includes these provisions:
Paid Sick Leave
Employers must provide paid sick time for employees unable to work due to a variety of situations involving government or health care provider quarantine orders, isolation orders, and similar circumstances identified by Health and Human Services, Treasury, and the Department of Labor. The act outlines these requirements in both the Emergency Paid Sick Leave Act and the Emergency Family and Medical Leave Expansion Act. Employers subject to these requirements are entitled to corresponding refundable credits.
Paid Sick Leave Refundable Credit
Eligible employers may receive refundable sick leave credits for employees taking qualified leave relating to coronavirus. The credits may be available for the employee’s pay and allocable costs of health plan coverage, subject to limitations. Similar credits are available for certain self-employed persons.
Child Care Leave Refundable Credit
Employers also may receive a refundable credit for employees unable to work because of a need to care for a child due to coronavirus circumstances. Credits may be available for wages and allocable costs of health plan coverage, subject to limitations. Certain self-employed persons may qualify.
Payment of the Credits
The sick leave and child care leave credits can be retained from other current payroll taxes for immediate benefit. Employers can also request an accelerated refund from the IRS for any excess credit amounts.
The CARES Act provides a diverse set of tax and relief provisions, including the following:
Individual payments of $1,200 per person, with an additional $500 per qualifying child. Eligibility for the payments begins to phase out for adjusted gross income over $150,000 for joint returns, $115,000 for heads of household, and $75,000 for single filers. Adjusted gross income is based on 2019 tax returns, or 2018 tax returns for those who have not yet filed for 2019. The direct payments are also available for those not required to file a return.
Required minimum distribution rules for retirement plans are waived for 2020. The 10% penalty for early withdrawals from retirement accounts is also waived for eligible distributions related to coronavirus. Withdrawn funds can be recontributed for up to three years after distribution. Eligible distributions are available for individuals diagnosed with COVID-19, individuals with a spouse or dependent diagnosed with COVID-19, and individuals with adverse financial consequences of quarantine, furlough, or work reduction.
Employee Retention Credit
For the period March 12, 2020 through December 31, 2020, eligible employers receive a credit equal to 50% of qualified wages per employee for the calendar quarter. Qualified wages per employee for all quarters is capped at $10,000, so the credit is limited to $5,000 per employee. Eligible employers include those carrying on a trade or business in 2020 that is fully or partially suspended by government orders relating to COVID-19 or those with a period of significant decline in gross receipts. This period is defined to start with the first 2020 calendar quarter with a 50% decline in gross receipts as compared to the same quarter in 2019, and end with the first quarter in 2020 for which gross receipts are more than 80% of gross receipts for the same calendar quarter in 2019.
Employment Tax Payments
Employers are allowed to defer payment of employment taxes for periods March 27, 2020 through December 31, 2020 until two later dates: December 31, 2021 for 50% of amounts due and December 31, 2022 for the remaining amounts due. A similar provision allows self-employed taxpayers to defer payment of 50% of self-employment taxes to these later dates.
Net Operating Losses
New NOL carryback rules allow taxpayers to use NOLs arising in 2018, 2019, and 2020 for carryback to the five years preceding the loss year, and the loss limitation rules on farming losses are waived. For tax years after 2020, NOL carryforwards from prior to 2018 will be deductible, along with post-2017 losses with an 80% of taxable income limitation.
Farm and Business Losses
Under prior law, excess farm and business losses were subject to limitations. For businesses and for certain farm taxpayers other than corporations, these excess loss deduction limitations do not apply for 2018 through 2025.
Deductible Business Interest
For 2019 and 2020 tax years, the business interest deduction limitation is expanded to 50% of adjusted taxable income rather than 30%.
Recovery of Prior Year Minimum Tax Credits
The minimum tax credit limitation for alternative minimum tax (AMT) incurred by a corporation in a prior tax year does not apply to the corporation’s 2020 and 2021 tax years. The AMT refundable credit is also expanded from 50% to 100% of the amount determined for tax years starting in 2019.
Qualified Improvement Property Correction
The Tax Cuts and Jobs Act of 2017 included a drafting error that resulted in a variety of retail property being subject to a 39-year depreciation period. The CARES Act corrects the drafting error, so that qualified leasehold improvements, restaurant property, and retail improvement property have a 15-year depreciation period and may qualify for bonus depreciation deduction. This correction is retroactive to 2017, so amended returns and refunds may be available for impacted taxpayers.
Paycheck Protection Program
The CARES Act also includes the PPP, an emergency Small Business Administration (SBA) loan program administered through participating SBA private lenders. The program has already included two rounds of funding and generated confusion and controversy. PPP implementation and potential loan forgiveness are still developing, and several key considerations are noted here.
PPP loans have the potential for tax-free loan forgiveness, in addition to friendly terms – a 1% interest rate, no collateral, no personal guaranty, no recourse to business entity owners, no borrower fees, six-month deferral of payments, a two-year term to repay amounts not forgiven, and a full guaranty by the SBA. The potential loan forgiveness and friendly terms have resulted in extremely high demand for the program.
The PPP is generally available to small businesses with fewer than 500 employees or that meet other SBA requirements, including sole proprietorships, independent contractors, and the self-employed. There are exclusions from the program for household employers, criminal issues, and prior SBA loan defaults.
The maximum loan is $10,000,000. The available loan amount for each borrower is annualized payroll costs (not exceeding $100,000) divided by 12 and then multiplied by 2.5, with adjustments for certain EIDL loan grants and balances.
Calculating payroll costs for the PPP loan amount is complicated and has resulted in many questions and evolving guidance. Eligible payroll costs generally include compensation to employees, payment for leave, allowances for separation, payment for certain employee benefits such as group health coverage, payment of employer state and local taxes on employee compensation, and wages, commissions, income, or net earnings from self-employment for independent contractors and sole proprietors. There are a variety of exclusions from the payroll cost calculation, including annual salary or earnings exceeding $100,000 as prorated for the measurement period, federal employment taxes, wages for which a payroll tax credit is allowed under the Families First Act, and others.
Forgiveness of the PPP loan requires additional calculations and timely application to the SBA lender. Generally, the loan can be fully forgiven if the funds are used for payroll costs, interest on mortgages, rent, and utilities during the eight weeks after the loan is funded. At least 75% of the amount forgiven must have been used for payroll costs. To qualify for forgiveness, the employer also must retain employees or rehire them so that employee numbers or salaries are maintained at required levels relative to prior periods, with alternative measurement periods and considerations detailed in the act.
There is a June 30, 2020, deadline for expenditures to qualify for forgiveness but a separate provision measuring expenditures over eight weeks. However, many PPP loan recipients will have received funding after May 1, potentially resulting in less than eight weeks to complete the expenditure requirement for PPP forgiveness. Hopefully, this inconsistency in timeline requirements will be corrected.
The CARES Act also provides that amounts forgiven under the PPP will be excluded from gross income, even though forgiveness of indebtedness is normally taxable.
In response to the CARES Act exclusion from income for PPP loan forgiveness, the IRS announced in Notice 2020-32 that no deduction will be allowed for an otherwise deductible expense if payment of the expense results in forgiveness of a CARES Act PPP loan, and the income associated with the forgiveness is excluded from gross income by the CARES Act. The IRS concludes that allowing an exclusion from gross income and also allowing deductibility for the same expenditures would provide an impermissible double tax benefit under Code § 265. Please note that there is legislation proposed in Congress to reverse this IRS position and allow deductibility of ordinary business expenses regardless of PPP forgiveness.
Treasury Department and IRS Actions
Treasury and the Internal Revenue Service have taken a variety of actions targeting relief, including the following:
Filing and Payment Deadlines
Most federal tax filings and payments normally due from April 1, 2020, to July 14, 2020, are extended to July 15, 2020. The extensions are automatic and apply to all taxpayers. See IRS Notice 2020-18.
Despite automatically extended deadlines, the IRS is encouraging taxpayers expecting refunds to proceed with filing.
The IRS has largely stopped active collections and has many functions suspended or with reduced capability. Payments on existing Installment Agreements are suspended from April 1, 2020 to July 15, 2020. Offer in Compromise payments and processing are generally suspended until July 15, 2020. Liens and Levies are also suspended in most cases until July 15, 2020, as are a variety of other field activities.
Prior to July 15, 2020, the IRS will generally not start new field, office, or correspondence examinations, except to preserve the statute of limitations or under other special circumstances.
The IRS website indicates that appeals employees will continue to work on pending cases but will not hold in-person conferences. Taxpayers are encouraged to continue meeting appeals response deadlines and requirements.
All in-person meetings with the IRS are generally suspended. The IRS Practitioner Priority Service hotline and many other contact sources with the IRS are currently unavailable.
We find ourselves in unprecedented times, which have resulted in a variety of legislative, executive, and administrative actions. These actions are being taken on an expedited basis and include complicated provisions for implementation and compliance, which are likely to result in confusion and further evolving legislation and guidance over many months. We will all need to carefully watch and monitor these issues and further governmental actions as they play out in 2020 and beyond.