Since our last alert, Congress has passed the CARES Act stimulus legislation, and the Internal Revenue Service ("IRS") has released further guidance on tax deadline postponements, issued a nationwide evacuation notice, and announced dramatic changes to its enforcement practices for the next several months. This alert summarizes the following key federal tax developments:
- CARES Act tax provisions for employers, including deferred employment taxes; wage credits for employers experiencing a COVID-19-related closure; and special rules for retirement plan distributions and student loan assistance to employees.
- Other business-focused tax provisions, including increased deductibility (and a potential 5-year carryback) of losses; relaxation of the IRC Section 163(j) limitation on business interest expense; expensing of qualified improvement property; and accelerated recovery of AMT credits.
- Stimulus provisions for individual taxpayers, including refundable tax credits and increased charitable contribution deductions.
- The latest guidance on tax deadline postponements.
- Impact on tax audits and appeals of the IRS evacuation order and "People First Initiative."
Our prior alert described proposed provisions of the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act" or "Act"). The CARES Act is now law. It includes tax provisions targeted to provide relief to employers, to businesses in general, to individuals, and to particular industries.
- CARES Act Tax Provisions for Employers
- Deferral of Employment Tax (and Self-Employment Tax) Liabilities
The CARES Act defers the due date for the employer portion of Social Security taxes for calendar year 2020 for most employers. Social Security taxes are paid at a rate of 12.4% of wages up to a ceiling amount that is $137,700 in 2020, with half paid by the employer and half withheld from the employee's wages. Self-employed individuals pay at the rate of 12.4% of self-employment income up to the ceiling amount, and similar payments are required under the railroad retirement system.
For any eligible employer, the 6.2% employer portion of Social Security taxes that are due with respect to wages paid in 2020 (and the corresponding portion of railroad retirement taxes) do not need to be paid during 2020. Instead, those amounts are due 50% on December 31, 2021, and 50% on December 31, 2022.
For self-employed individuals, half of the 12.4% Social Security tax that is due with respect to self-employment income earned in 2020 is likewise deferred to 2021 and 2022. A self-employed individual can compute estimated and actual tax liabilities for 2020 without regard to this amount and the payment will in effect be due 50% on the due date (without extensions) of the 2021 return and 50% on the due date (without extensions) of the 2022 return.
Employers that receive forgiveness of a loan under the CARES Act's "paycheck protection program" are not eligible for the employment tax deferral. The statute does not clarify how this provision will be administered in the case of an employer that defers payroll taxes before receiving loan forgiveness.
To coordinate with the tax credit provisions of the Families First Coronavirus Response Act, Public Law 116-127 ("FFCRA"), described in our prior alert, the CARES Act provides for an advance refund of the credits for paid leave available under the FFCRA, so that taxpayers continue to realize the benefit of the credits on a current basis notwithstanding the deferral of the obligation against which the credits are allowed.
- Wage Credits for Employers Subject to Shutdown or Severe Revenue Decline
An employer that fully or partially suspends its business during 2020 due to a government order relating to COVID-19 or that suffers a greater than 50% reduction in year-over-year quarterly revenues during 2020 is entitled to a refundable payroll tax credit. The credit is not available to any employer that receives a loan under the CARES Act's "paycheck protection program."
The credit is available—during 2020 only—for any quarter during which the suspension is in effect, for any quarter in which a 50% gross revenue reduction occurs, and for any subsequent quarter until the quarter in which the employer's gross receipts are more than 80% of its gross receipts for the same quarter of the prior year.
The credit is computed as 50% of the wages (up to $10,000 per employee) paid from March 13 to December 31, 2020, to employees who are not working because of the event that makes the employer eligible for the credit. Employers with 100 or fewer employees may also include in their credit base wages paid to employees who continue to work. Wages that constitute family or sick leave pay for which an employer receives a credit under the FFCRA are not eligible for the wage credit.
If an employer increases wages during a period in which it is eligible for the credit, the portion of wages attributable to the increase does not qualify for the credit unless the employer has 100 or fewer employees. Subject to the $10,000 per employee limit, certain group health plan expenses may be treated as employee wages for purposes of the credit.
- Retirement Plan Distributions and Loans
The CARES Act makes it easier for retirement plan participants to access funds from a retirement account during 2020 to meet needs related to the pandemic. For "coronavirus-related distributions":
- Neither the 10% early withdrawal penalty nor the mandatory 20% income tax withholding applies.
- The amount that must be included in taxable income (if any) is spread evenly over the 2020, 2021, and 2022 tax years, unless the taxpayer elects to include it all in 2020.
- At any time within three years and a day of the distribution, the recipient can recontribute some or all of the distribution to any retirement plan or account to which the distribution could have been rolled over tax-free. The amounts recontributed are treated as rollovers for purposes of computing contribution limits.
- It remains to be seen how the rollover provisions and the income tax inclusion provisions will be coordinated in cases where the participant makes the rollover contribution after including all or a portion of the distribution in income.
A coronavirus-related distribution is a distribution that is made on or after January 1, 2020, and before December 31, 2020, to an individual:
- who is diagnosed with COVID-19 or a SARS-CoV-2 infection using a CDC-approved test,
- whose spouse or dependent is so diagnosed, or
- who experiences adverse financial consequences as a result of quarantines, furloughs, layoffs, business closures, child care responsibilities, or certain other factors attributable to COVID-19 or SARS-CoV-2.
At most $100,000 in distributions can be treated as coronavirus-related distributions in a single tax year, and under the literal words of the statute, a distribution made on December 31, 2020, does not qualify, although this may be clarified in subsequent guidance.
The CARES Act also increases the loan limit from $50,000 to $100,000 and liberalizes the repayment rules for loans from certain retirement plans to individuals meeting the tests in the preceding paragraph.
Finally, the CARES Act loosens the required minimum distribution requirements for certain defined contribution plans and IRAs for 2020, similar to the relief provided in 2009 under the Worker, Retiree, and Employer Recovery Act of 2008 (WRERA).
Remedial amendment provisions apply to the above changes, providing a grace period for conforming amendments to plan documents.
- Updates to Family and Sick Leave Under the FFCRA
The CARES Act makes three modifications to the relief available under the FFCRA, which we described in a prior alert. First, if an employer rehires a worker who was laid off no earlier than March 1, 2020, that worker can meet the eligibility test for Emergency Family Medical Leave based on any 30 of last 60 calendar days prior to being laid off. Second, the IRS is authorized to make advance refunds—on a payroll by payroll basis—to employers that are entitled to payroll tax credits in respect of either sick leave or family leave payments under the FFCRA. Third, the amount of sick leave payments under the FFCRA is limited to the same daily amounts for which payroll tax credits are available: $511 per day for sick leave where the employee is quarantined or experiencing symptoms of COVID-19, and $200 per day for sick leave to care for a family member affected by COVID-19.
The IRS announced on March 27, 2020 (in Notice 2020-21), that the commencement date for paid leave credits under the FFCRA will be April 1, 2020.
- Employer-Provided Student Loan Assistance
The CARES Act allows employers, for 2020 only, to expand tax-free employee educational assistance programs to include student loan repayment. Payment by an employer of principal or interest on a "qualified education loan" (generally, a loan the proceeds of which were used to pay tuition, room, board, or other qualified higher education expenses at an eligible educational institution for the employee, the employee's spouse, or a dependent) after the enactment of the CARES Act and prior to January 1, 2021, would qualify as "educational assistance" under IRC Section 127. Employer-provided educational assistance up to an overall annual cap of $5,250 is excluded from the employee's income so long as the other provisions of IRC Section 127 (including nondiscriminatory eligibility requirements) are satisfied. The employee would not be entitled to a deduction for any student loan interest paid by the employer and excluded from the employee's income under this provision.
- Other Benefit-Related Provisions
- The CARES Act offers relief from certain funding requirements for single employer defined benefit pension plans for 2020.
- The CARES Act permits the reimbursement of expenses for over-the-counter menstrual care products from health savings accounts, health flexible spending arrangements, and Archer medical savings accounts. This change applies to all periods from 2020 forward.
- Other CARES Act Provisions Affecting Business Taxation
- Increased Loss Deductions
The CARES Act retroactively suspends application of the 80%-of-income limitation on the use of net operating loss ("NOL") carrybacks and carryovers, which was enacted as part of the 2017 tax reform, until a taxpayer's first taxable year beginning after December 31, 2020. Thereafter, the 80% limitation will be applied without considering certain rate-reducing deductions enacted as part of tax reform (qualified business income, foreign-derived intangible income, and global intangible low-taxed income).
The excess business loss limitation for noncorporate taxpayers is also retroactively suspended until a taxpayer's first taxable year beginning after December 31, 2020. For subsequent periods to which the limitation applies, it will apply (a) without taking into account salary or wages as business income, (b) taking into account capital gains and losses only to the extent of the lesser of business net capital gain or overall net capital gain, and (c) prior to the deduction for qualified business income.
NOLs arising in any taxable year beginning after December 31, 2017, and before January 1, 2021, other than a year in which the taxpayer is taxed as a real estate investment trust, are eligible to be carried back up to five years. Carrybacks cannot offset a repatriation tax liability under IRC Section 965.
NOL carrybacks originating in tax years ending in the 12 months prior to enactment of the CARES Act (i.e., March, 2019, or later) would be eligible for the "quick" refund procedure under existing IRC Section 6411.
- Because this procedure requires that an application be filed within 12 months after the end of the tax year from which the NOL is carried back, it generally would not be available for losses arising in tax years ending before March, 2019 (and the filing period for a year ending in March or April, 2019, would be very short).
- The CARES Act would provide specific relief for tax years that include portions of both 2017 and 2018—both reviving the period for filing quick refund applications and permitting modification of certain elections regarding NOLs made on a tax return for such a year.
- It is unclear at this point whether quick refunds will be available for NOLs arising in calendar 2018 or fiscal years ending January or February, 2019.
- Business Interest Limitation
For taxable years beginning during 2019 or 2020, the CARES Act increases the cap on deductibility of business interest from 30% to 50% of adjusted taxable income unless the taxpayer elects not to have the higher cap apply. In addition, for a taxable year beginning in 2020, a taxpayer may elect to apply the limitation by reference to adjusted taxable income for the last taxable year beginning in 2019.
Partnerships are eligible for the relaxed cap only in taxable years beginning in 2020. In lieu of applying the relaxed cap at the partnership level for taxable years beginning in 2019, the excess business interest allocated for such a year by a partnership to a partner is subject to a special rule, unless the partner elects otherwise. Under the special rule, 50% of such interest is deductible by the partner without respect to the adjusted taxable income limitation in the partner's first taxable year beginning during 2020.
- Qualified Improvement Property
The CARES Act adds qualified improvement property to the class of 15-year property for purposes of the accelerated cost recovery system, making such property eligible for expensing under IRC Section 168(k) so long as it otherwise qualifies.
- Charitable Contribution Deduction
The CARES Act temporarily increases the limitation percentage for deduction of certain cash charitable contributions by corporations. A corporation may elect to treat cash contributions made in 2020 to a Section 170(b)(1)(A) organization (generally an organization subject to the 50% limitation for individuals) as "qualified contributions." Qualified contributions are subject to a limitation based on 25% of the corporation's taxable income (after deducting non-qualified contributions) rather than the usual 10% limit.
In addition, for contributions during 2020, the CARES Act increases the percentage of income limitation that applies to contributions of food inventory eligible for an increased deduction under IRC Section 170(e)(3) from the usual 15% to 25%.
- Accelerated Recovery of AMT Credit
After the elimination of the corporate alternative minimum tax ("AMT") in 2017 as part of tax reform, corporations are permitted to utilize their carryover AMT credits subject to the limitations on such credits under prior law. In addition, corporations can utilize excess credits over a four-year period ending in the first tax year beginning during 2021.
The CARES Act accelerates the period for deducting excess AMT credits so that they are deductible in full in the first tax year beginning during 2019, or, at the taxpayer's election, in the first tax year beginning during 2018. An application for quick refund relating to the use of AMT credits under the CARES Act may be filed until December 31, 2020, and will be processed within 90 days.
- Aviation Excise Tax Holiday
The CARES Act suspends the application of the excise taxes on passenger airline tickets, transportation of property by air, and kerosene used in commercial aviation during the period from the March 27, 2020, to December 31, 2020.
- Loan Forgiveness
The CARES Act provides for partial forgiveness of certain "paycheck protection program" loans to small businesses to fund obligations for payroll and certain mortgage, rent, and utility payments.
The cancellation of indebtedness under this provision is excluded from gross income for tax purposes. However, as noted above, employers that receive such loan forgiveness are not eligible for the employment tax deferral described above. It is unclear how the disallowance will be administered in the case of an employer that defers payroll taxes before receiving loan forgiveness.
- CARES Act Tax Provisions for Individuals
- Refundable Tax Credits
Our prior alert described proposed provisions of the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") which has now been enacted. The CARES Act provides for cash payments in the form of refundable tax credits of up to $1,200 per individual taxpayer plus $500 per dependent child. The Treasury Secretary is to process these refunds "as rapidly as possible." Credits will consist of:
- A base credit of $1,200 for individual filers, married individuals filing separately, heads of household, and qualifying widowers, or $2,400 for married couples filing jointly
- An additional credit of $500 for each child qualifying for the child tax credit
- The total credit phases out for joint filers with adjusted gross income in excess of $150,000, heads of household with adjusted gross income in excess of $112,500, and other taxpayers with adjusted gross income in excess of $75,000; the phase-out amount is 5% of the adjusted gross income in excess of the applicable threshold, up to the total credit available
Credits are available only to a U.S. citizen or resident (as determined for income tax purposes) who cannot be claimed as a dependent on another person's return. In the case of a joint return, both spouses must have U.S. social security numbers (unless one spouse is a member of the U.S. armed forces). Eligibility, phase out amounts, number of children, and filing status are determined based on the taxpayer's 2019 return if one has been filed, and otherwise may be determined based on the 2018 return. For recipients of Social Security and Railroad Retirement benefits, if no return is on file for 2018 or 2019, information from the benefit statement for 2019 (Form SSA-1099 or RRB-1099) may be used instead.
- If a taxpayer would be eligible for a greater credit based on filing status, immigration status, number of eligible children, and adjusted gross income for 2019 than the credit that is available based on the taxpayer's 2018 return, it may be advisable to file the 2019 return expeditiously, notwithstanding the filing extension described above.
If the eligibility criteria result in a greater credit for 2020 than what was already paid via the advance refund process, the additional credit will be available when the 2020 return is filed.
Refunds will be paid by check or by credit to any account that is authorized by the taxpayer to receive federal income tax refunds. The usual rules permitting federal income tax refunds to be offset by obligations for other tax years, other federal taxes, certain state tax liabilities, and certain other obligations to the federal government generally will not apply to these advance refunds. The CARES Act appropriates just under $580 million of additional funds to assist in IRS administration of the refunds.
- Charitable Contribution Deductions
The CARES Act increases availability of charitable contribution deductions in 2020 both by allowing certain contributions to be deducted "above-the-line" and by loosening percentage limitations on the deduction.
Up to $300 of eligible charitable contributions made by an individual in 2020 are deductible in computing adjusted gross income ("AGI"), making the deduction available for taxpayers who claim the standard deduction, and potentially affecting the taxpayer's eligibility for other tax benefits that are tested based on AGI. To be eligible for the deduction, a contribution must be made in cash, to an organization (other than an IRC Section 509(a)(3) supporting organization) eligible to receive contributions subject to the 50% contribution limitation under IRC Section 170(b)(1)(A), and not to a donor advised fund.
An individual may elect to treat cash contributions made in 2020 that would otherwise be subject to the 50%-of-AGI limitation—including the taxpayer's distributive share of charitable contributions made by a partnership or S corporation—as "qualified contributions." Qualified contributions may be deducted up to 100% of AGI (after taking into account deductions for non-qualified contributions) rather than the usual 50% limit.
- Delay in Federal Income Tax Filings and Payments Until July 15, 2020
As described in our prior alert, the due dates for filing federal income tax returns and making federal income tax payments otherwise due on April 15, 2020, have been postponed by three months to July 15, 2020. On March 27, 2020, the IRS issued Notice 2020-20, which grants a coterminous extension of the due date for federal gift and generation-skipping transfer tax returns and payments (from April 15 to July 15, 2020).
The IRS issued on March 24, and updated on March 25, 2020, a list of questions and answers that addressed two open points identified in our prior alert, along with a number of other issues:
- The deadline for making contributions
for 2019 to individual retirement accounts, health savings
accounts, and Archer medical savings accounts is extended to July
15, 2020. The same is true for the grace period under IRC Section
404(a)(6) for employer contributions to certain retirement plans.
- However, the April 15, 2020, deadline for correcting any excess elective deferral to a retirement plan from calendar year 2019 is not extended.
- An automatic six-month extension of the filing deadline for returns subject to the postponement may be requested at any time on or before July 15, 2020, but will still run from the statutory due date—i.e., only to October 15, 2020.
- The postponement applies to all income tax returns due on April 15, 2020, even if that due date is the result of an extension (e.g., an automatic six-month extension of the due date for a return for a fiscal year ending June 30, 2019, that was originally due on October 15, 2019).
- The postponement applies to deferred installments of repatriation tax payments under IRC Section 965 that are due with a 2019 return on April 15, 2020. The postponement likewise applies to payments of base erosion and anti-abuse tax and of the 10% tax on certain retirement plan distributions that are due on April 15, 2020.
- The relief does not apply to tax
filings and payments due between April 15 and July 15.
- This means that second quarter estimated tax payments continue to be due June 15, 2020.
- Federal income tax returns and payments for individuals or corporations with a fiscal tax year ending in January or February will continue to be due on May 15, 2020, or June 15, 2020.
- Taxpayers who have already filed a
2019 return may defer payments that have not yet been made until
July 15, 2020.
- Taxpayers who have scheduled a payment to be made on April 15 will need to take affirmative action to reschedule the payment. The Q&A contains instructions for rescheduling a payment depending on how it was scheduled.
- The deadline for filing refund claims is not extended by the relief.
Although the IRS Q&A is quite extensive, it does leave open a few issues. The most notable open question is how a calendar filer should compute estimated income tax payments for the second quarter of 2020. Normally, the amount due for the second estimated payment would be a percentage of the annual liability (50% or a different percentage based on annualization) reduced by the estimated payments already made. That reduction would include the first estimated payment and any overpayment the taxpayer has elected to credit from the prior tax year.
- While it seems clear that the deferred filing of a 2019 return on which an amount is credited as an estimated payment for 2020 should not affect the availability of that amount to reduce the payment due on June 15, 2020, it is less clear what should happen if some of the payments for 2019 are deferred to July 15, 2020.
- It likewise is unclear what should happen if the first estimated payment is made sometime after June 15, 2020.
- If the IRS takes those deferred payments into account as if made on April 15, then any amount paid will reduce the payment due on June 15—so, in effect, both the first and second estimated payments may be made together on July 15, 2020, without resulting in any penalty.
- If the IRS does not relate the payments back to April 15, then it would appear that the payment due on June 15, 2020, would be a full 50% (or other annualization-based percentage) of the 2020 income tax liability. In this case, even if the taxpayer were to pay a portion of that liability, such as the 25% that would normally have comprised the second quarter estimated payment, on June 15, a penalty would accrue on the remainder for the month between June 15 and July 15.
- Neither of those results would be consistent with the IRS's apparent intention to defer the April 15 payment while leaving the June 15 payment requirement in place.
Other issues left open after the Q&A include:
- Whether the relief will apply to a partnership or S corporation tax return for a fiscal year ending January 31, 2020, which would have been due April 15, 2020. Notice 2020-18 lists partnerships and corporations as "Affected Taxpayers" but the Q&A does not list Form 1065 or Form 1120-S among the affected forms. Form 1065 is considered an income tax return for some purposes and an information return for other purposes, and information returns are not covered by the relief.
- Whether the relief applies to persons required to file IRS Form 3520 (reporting certain gifts from non-U.S. persons or transactions with a non-U.S. trust) with a due date of April 15, 2020.
- IRS Evacuation Notice and "People First Initiative"
The IRS issued an evacuation notice on March 27, 2020, that will make work from home mandatory for nearly all IRS employees beginning Monday, March 30, 2020. There will be individualized exceptions for employees completing "mission-critical-duties" that cannot be accomplished remotely.
The People First Initiative, announced two days earlier on March 25, provides some insight into how remote work will affect examination activity and other IRS interactions with taxpayers. The initiative postpones payments due under installment agreements and offers in compromise, suspends certain collection activities, and stops most new audit activity. The initiative will initially run from April 1 to July 15, 2020, although some of the modifications discussed below have already begun.
Highlights of the initiative include:
- The IRS will not begin new audits except where necessary to preserve the statute of limitations or at a taxpayer's request (for instance because of staff availability).
- In-person meetings on existing audits will be suspended, but examination activity may be continued remotely.
- New refund claims will be processed where that can be done without in-person contact.
- Although the announcement urges taxpayers to continue to comply with information requests in ongoing examinations, it recognizes that circumstances may present challenges to doing so.
- The Office of Appeals will continue to work cases, but without in-person conferences. Conferences may be held over the telephone or by videoconference. Taxpayers are "encouraged to promptly respond" to requests for information.
- Collection activities, including automatic and field-initiated liens and levies and new referrals to private debt collectors will be suspended.
- Taxpayers may stop making payments under existing installment agreements from April 1 to July 15, 2020, although interest on the underlying liability will continue to accrue.
- Most due dates under pending offers in compromise will be postponed to July 15, 2020, including time to provide information, time to file delinquent 2018 returns, and time to make payments if the offer is accepted.
It is particularly important for taxpayers to be conscious of statutes of limitations during this period. The IRS will request extension of periods governing assessment and collection and may pursue actions to protect the government's interest if extensions are not granted. Conversely, taxpayers will need to take action to protect their own rights where periods for filing a claim for refund, filing a refund suit or a petition with the U.S. Tax Court, perfecting an appeal, etc., are close to expiration. The current crisis generally will not extend the period for taking such actions, and taxpayers should consult their advisors to ensure they meet applicable deadlines.