President Trump signed the $2.2 trillion economic stimulus package as the third phase of emergency legislation in response to the coronavirus pandemic on Friday, March 27. The “Coronavirus Aid, Relief, and Economic Security Act,” (CARES Act) contains tax and nontax relief measures that are designed to avert a U.S. economic collapse.
Some headline features of the CARES Act include one-time cash payments for eligible individuals, the expansion of unemployment benefits, the establishment of two major federal loan programs for large and small businesses, as well as a number of tax provisions relevant to private equity and venture capital funds as well as their portfolio companies.
Small and Large Business Loans and Investments
The CARES Act establishes two major federal loan programs. The first is a $500 billion loan program for large businesses and municipalities. These funds are subject to oversight by a Treasury Inspector General who is expected to be appointed for this purpose. As a part of this oversight there is a provision that will “prohibit businesses controlled by the President, Vice President, Members of Congress, and heads of Executive Departments from receiving loans or investments from Treasury programs.”
The other large loan program consists of $367 billion in loans and grants to small businesses. The bulk of this money, $349 billion, is for guaranteed loans made under the Small Business Act. However, a separate smaller component of this program allows business with 500 or fewer employees to access up to $10 million each in forgivable loans for expenses such as payroll, mortgage or lease payments, or utilities. In order to obtain these loans, eligible businesses must compensate all employees for eight weeks, and portions of the small business loans can be forgiven if the business generally does not terminate its employees or reduce their wages (monthly averaging formulas are provided), and waivers are provided for re-hiring by June 30.
Employer Payroll Tax Holiday
The CARES Act will provide a payroll tax holiday that allows employers to defer the employer portion of their 6.2% FICA tax liability (or the equivalent portion of self-employment tax for the self-employed) through Dec. 31, 2020. Businesses taking advantage of this holiday would repay 50% of the amount deferred in 2021 and the remaining 50% in 2022. The payroll tax holiday could lead to $349 billion of deferred payroll taxes, though the final amount may be less given the anticipated rise in unemployment.
Tax Loss Limitation and NOL Carryback Changes
The tax reform law commonly known as the Tax Cuts and Jobs Act (TCJA) essentially eliminated the ability of businesses to carryback net operating losses (NOLs) to prior years. Before the TCJA, there was a two-year carryback period; the TCJA generally repealed the ability to carry back NOLs and further reduced the ability to deduct current NOLs to 80% of taxable income. The CARES Act reverses the TCJA change and expands the scope of NOL carrybacks. Under the CARES Act, businesses may carryback NOLs incurred in 2018-2020 for five years, and may fully offset income in the carryback years.
Portfolio companies and blocker corporations should consider modeling out the impact of these provisions, including their interaction with other domestic and international tax provisions, to fully understand the cash tax impact of an NOL carryback. These NOL deduction changes may also impact the financial statements of corporate entities, such as for current and deferred tax items.
As a part of the changes to the provisions regarding losses, the excess business loss limitation under Section 461(l) is also modified. The CARES Act suspends the excess business loss limitation until 2021. This suspension of the excess business loss limitation should be carefully analyzed by owners of flow-through portfolio companies, funds, and management companies.
Business Interest Expense Limitation Relief
The TCJA had introduced an additional limitation on the deductibility of business interest expense and generally capped the deduction at the total of business interest income plus 30% of adjusted taxable income, which is a concept similar to tax-basis EBITDA. The CARES Act lessens the impact of the business interest limitation. For 2019 and 2020, the 30% limit used to determine the amount of deductible business interest is increased to 50% for all taxpayers other than partnerships. The limit for partnerships is increased to 50% only for 2020; however, partners allocated 2019 excess business interest (EBI) may treat their EBI in a more favorable manner in subsequent years.
Retail Glitch Fix
Aside from the large amount of spending, loans, and grants outlined above, there are specific changes to the tax code designed to stimulate growth. The first is the highly anticipated fix for the “retail glitch.” The “retail glitch” resulted from a drafting error in the TCJA that mistakenly repealed the 15-year depreciable class life for qualified improvement, retail and restaurant property, eliminating the ability to claim bonus depreciation on such property. The CARES Act makes a technical correction to the TCJA to re-establish the 15-year depreciable class life for these assets, effective for property placed in service after Sept. 27, 2017.
Flow-through portfolio companies, funds, and management companies should consider the impact of the Bipartisan Budget Act of 2015 (BBA) partnership audit rules when analyzing the impact of this provision. The BBA rules may prevent a cash refund in the tax year to which the adjustment relates, and instead provide for the benefit in a subsequent tax year.
Employee Retention Credit
There is also a new employee retention credit that comes in the form of a payroll tax credit for 50% of the first $10,000 of compensation (including healthcare benefits) paid by an affected employer. An affected employer is one whose operations were fully or partially suspended due to a COVID-19-related shutdown order, or whose gross receipts declined by more than 50% when compared to the same quarter in the prior year. This credit is based upon qualifying wages paid by an affected employer and is also dependent on the size of the employer. For small employers (100 of fewer full-time employees), the credit is based upon 100% of wages paid by an affected employer. For large employers, the credit is based upon qualifying wages paid to employees who are not providing services due to a coronavirus shutdown order. The credit covers qualifying wages paid during the period from March 13, 2020 through Dec. 31, 2020.
Tax Changes for Charitable Contributions
There are also changes designed to increase the deductibility of charitable contributions. This includes a new $300 above-the-line deduction for cash contributions to a qualifying charity. This provision allows a charitable deduction to those who don’t itemize. The deduction limit for contributions of food inventory is increased from 15% to 25% of AGI. Corporations also receive an increased contribution limit for cash contributions from 10% to 25% of taxable income. The new above the line deduction may reverse some of the decline in charitable contributions that was at least in part attributable to the TCJA’s changes to the itemized and standard deduction. Charitable giving fell by an inflation-adjusted 3.4% from the year prior to the passage of the TCJA to the year after, and 2% fewer individuals made charitable contributions after the passage of the tax reform act.
Other Tax Law Changes
Corporations will also see an additional benefit because the rules for refunds of corporate AMT credits have been modified. Instead of receiving these refundable credits over a number of years, ending in 2021, corporations may now receive the entire refundable credit in 2019.
Additionally, there is a temporary holiday for aviation fuel excise taxes and a temporary exemption from the excise tax on alcohol for all distilled spirits contained or used in hand sanitizer. This will likely help local alcohol brewers across the country, many of whom have switched to production of hand sanitizer as a response to reduced demand for alcoholic beverages and an increased demand for hand sanitizer.
The CARES Act is the largest single rescue package ever passed by Congress. With unemployment claims jumping by 3.3 million in a single week, and many states and cities expecting to be shut down for several weeks, at the least this measure is widely seen as a necessary step to recovery. Congress has also signaled that the stimulus provisions in this measure are just another in what is expected to be an ongoing process. House Majority Leader Steny Hoyer (D-Md.) reportedly indicated that there will likely be a 4th and 5th phase of pandemic relief legislation.
Private equity and venture capital funds as well as their portfolio companies should carefully consider the impact of the provisions in the CARES Act on their 2019 tax return filings and Schedule K-1s and disclosures. The timing of this measure complicates the timelines of financial statement preparation and audit, as well as the timeline for the issuance of Schedules K-1 to investors. Some funds may want to consider issuing 2019 Schedules K-1 in draft form to their investors to gain additional time to apply these changes to their tax returns.
For more information about this and other coronavirus legislation please visit our coronavirus resource center or contact us.
Published on April 03, 2020