- Recording: Interpreting the CARES Act
Join our multipart livestream series to engage in the latest changes related to these uncertain times. You’ll hear strategies for navigating what these developments mean for you. Topics include issues related to legislation, liquidity, workforce, and other relevant topics.
In case you missed it:
What we talked about:
Boyd: Good afternoon to our CLA family members, clients, community partners, and friends. Welcome back to our third livestream. We are grateful to have all of you and wish you, your families, and friends health and safety during this time.
We have a special session today. Last Friday was a monumental day for the country. President Trump passed the CARES Act which includes several provisions totaling over $2 trillion in stimulus intended to help organizations, individuals, states, and municipalities. The bill was 880 pages and provides various small business lending, emergency funding for hospitals and health care providers, tax incentives, and unemployment provisions.
Our discussion today will focus on:
- Lending provisions – we will talk to Todd Sprang from our financial institutions about the lending perspective as well as Jack Rybicki about the borrower perspective
- Workforce impacts from the bill – this will be brief with a full, separate livestream on Thursday; and
- Close with discussing individual and business tax provisions with Chris Hesse.
With that, I would like to introduce Todd Sprang from our Financial Institution Group and Jack Rybicki who is leading our COVID Economic Relief Team. They will walk through the lending provisions of the bill. Welcome gentlemen!
I’d like to start with an overview of the Payroll Protection Program. Jack can you provide a quick snapshot of this new loan program?
Rybicki: Leslie – Last week we heard about the SBA’s Economic Injury Disaster Loan program, which I understand an organization applies for directly with the SBA. Todd, Who Can Lend Under the PPP?
Sprang: The SBA has an existing network of lenders that participate in their 7(a) Loan Program. The same network will be utilized for making PPP loans. In addition, the SBA expects it will extend authority to make loans under the PPP to additional lenders determined by the SBA and the Secretary of the Treasury to have the necessary qualifications to process, close, disburse and service loans made under the PPP. Based on some reports in the media, all banks, credit unions — and some non-bank lenders — may be able to make loans, but while we await more guidance I would direct borrowers to existing 7(a) lenders.
Boyd: What can organizations expect initially?
Sprang: Three things.
- There’s high demand for this program, so it’s not unreasonable to think that funding will be expanded beyond $349 billion and the timeframe may extend beyond June 30th.
- Lenders are ramping up capacity while awaiting more direction from SBA. That’s expected soon and will likely come in stages, so your lender may not have all the answers yet.
- The goal of lenders is to process and disburse as quickly as possible. That said, realize that the current network of lenders under the 7(a) Program originated a little more than $20 billion of loans in 2019. This program is 15 times that volume, so Initial system infrastructure could be overwhelmed. The SBA has been working to create an electronic application portal to facilitate the lenders’ ability to move applications through the system. However, similar to recent reports about unemployment claims in certain states that were the first to implement various forms of “stay at home” orders, it’s not unreasonable to expect that infrastructure capacity will be initially strained.
Boyd: Let’s turn to the specifics of the PPP. The first question on everyone’s mind is, “Am I eligible?”
Rybicki: Eligible organizations generally include small businesses with fewer than 500 employees, including sole-proprietors, independent contracts, and other self-employed individuals, 501(c)(3) nonprofits, 501(c)(19) veteran’s organizations, and Tribal business concerns.
The affiliate rules, which could limit qualification, are waived for hospitality and food service entities (NAICS code 72 organizations) and franchisees. It is important you identify any affiliates, which are loosely defined as sister organizations under the ownership/control of the individual or group that owns/controls your company. This may be a real issue for organizations owned/controlled by private equity firms or diversified family offices, as eligibility will be determined by looking at the combined picture. It is unclear at this time how the “affiliate” rules will be enforced, but the Act specifically references the exclusion above, which indicates that congress was contemplating they will be applicable.
On a positive note, we believe the “alternate size standards” that could limit the entities eligible for the program, based on certain revenue thresholds, have been waived and only apply to the employee count test — potentially allowing certain businesses with greater than 500 employees to still qualify. For instance, certain manufacturing business can have up to 1,250 employees and still qualify as a small business. [provide link to the SBA Table of Size Standards Effective August 19, 2019]
Boyd: So now I know I qualify; how much will I be able to get under the PPP?
Rybicki: The loan amount is sized based on 2 ½ times the average monthly payroll for the 1-year period prior to the grant of the loan, with the maximum loan amount of $10 million. There are some alternative measurement periods which can be used for businesses that commenced within the last 12 months, or are seasonal in nature.
The components of an average monthly payroll include:
- Salary, wages, and commissions
- Cash tips
- Vacation, parental, family, medical or sick leave
- Health benefits
- Retirement benefits
- State and local employment taxes
- Payments to independent contracts or sole proprietors or net earnings from self-employment
- Limitations include:
- $100,000 maximum for an individual employee
- Federal unemployment and federal tax withholding may be backed out
- Non-US resident employees
- Any qualified sick leave or qualified family leave that a credit is allowed for under the FFCRA
You will need to provide supporting payroll records, payroll tax filings, etc. to substantiate these amounts for your loan application process.
Sprang: From a lender perspective, imagine each applicant trying to make interpretations or assumptions when gathering this information. While application forms may address some of this, lenders would appreciate enhanced “consistency” in this area as it will allow them to analyze, process, and disburse more quickly.
Boyd: So now I know the amount of the loan my organization qualifies for, what can I use these funds for?
Rybicki: Allowable uses include payroll costs (as previously defined), along with interest on mortgage and other debt obligations, rent, and utility payments incurred during the 8-week period following the origination date of the loan.
Boyd: I understand that loans under the PPP are subject to forgiveness, which sounds too good to be true. Can you explain how this feature works?
Rybicki: This program is designed to incentivize employers to retain their employees, so they don’t have to participate in the federal and state unemployment programs.
The forgiveness amount will be determined by a two-part test, with the first portion based on the average full-time equivalents during the Feb 15 – June 30, 2020 period compared to a representative pre-COVID comparable period (i.e., same period PY or Jan 1 – Feb 29, 2020). So, if you had average FTE’s in 2020 period of 200 and average FTE’s in the comparable period of 250, you would be entitled to 80% loan forgiveness.
The second part of the test then looks at the wages you are paying. As long as the wages you are paying are have not been reduced by more than 25% in the current period when compared to the pre-COVID period, then there is no limitation. However, if you have implemented payroll or wage reductions in excess of 25%, the forgiveness amount would be further reduced by any reduction in excess of 25%. This test appears to be measured at the individual employee level, not in the aggregate.
There is relief for organizations that have already made the difficult decision to terminate employees or reduce compensation. The current year FTE and wage reductions tests described above will exclude the impact of previous actions if you bring these employees back on and/or reinstate wages once the loan has been granted.
One other great feature of this program is that any amounts forgiven under this program are NOT subject to income tax in the future.
Boyd: This sounds like a great program many organizations should consider when making decisions around their employees over the coming months. Is there other information an owner should consider about this program?
Rybicki: There are a few other program specifics I’d like to point out:
- For the portion of the loan not forgiven, the borrower will have a repayment obligation to the lender. The repayment term of the remaining loan cannot exceed 10 years and the interest rate cannot exceed 4%.
- Loans are nonrecourse and the typical personal guaranty requirements have been waived
- The borrower will be required to submit information to the lender to substantiate the use of the funds and the underlying data needed to calculate the forgiveness amount
Boyd: So, we have heard there are questions out there about the use of the PPP in relation to other lending and relief programs. What can we share with our audience about that topic?
Rybicki: The PPP can be used in conjunction with the Economic Injury Disaster Loan Program or other relief programs, like the payroll tax credits and sick and family leave credits under the FFCRA. However, a borrower cannot “double dip” on the various relief packages available. What that means is that if an organization intends to take advantage of various credits under the FFCRA, those wages will need to be excluded from the portion of a PPP loan subject to forgiveness. Same thing with the EIDL program, some organizations may have already received loans under that program to pay operating expenses that they couldn’t otherwise pay due to COVID-19 economic impact. To the extent that those operating expenses include expenses allowable under the PPP, the PPP proceeds would need to be used to pay down the EIDL loan previously granted, or reduce the EIDL loan amount applied for if you are still in the application process.
If you think about it in this way, you can’t get relief for spending the same money from multiple sources. If you follow that simplified guidance you will generally be okay.
Sprang: From a lender perspective, they also will be addressing the interaction of PPP with other lending and relief programs including the ongoing discussions they are having to modify existing loans, and the interaction of payment deferrals under PPP with payment deferrals on existing debt. That’s a pretty involved discussion that goes beyond today’s session, so lenders can watch for CLA’s financial institutions group to put out more information in various forms this week. Borrowers may find some of that information insightful also.
Sprang: During the covered period, all lenders under the PPP must provide complete payment deferral for “impacted borrowers” having a covered loan. Protocols for determining and documenting the appropriate 6 to 12 month deferral period for each borrower will need to be established. Also, we understand that Lenders are experiencing certain system challenges with respect to modifying existing loans to handle deferral periods, but those challenges may be lessened for new loans under the PPP. When you combine the deferral features of PPP with the forgiveness features of PPP, it makes these less like loans and more like grants.
Boyd: Thank you Gentlemen. This has been very helpful. We recommend you contact your lender and your CLA professional to strategize about the lending programs. We can help you make decisions on which program to pursue and help you gather information to do the applications as well.
Now I would like to introduce Chris Hesse. Chris is a principal in our National Tax group. He has been closely involved with the bill via his role as chair of the AICPA Tax Executive Committee.
Chris, what can you tell us about the tax provisions of the CARES Act?
Hesse: Thanks, Leslie, for the opportunity to discuss the tax provisions of the CARES Act. There are perhaps 14 tax provisions in the Act, some very well known by now and others not so well known. There are both individual and business provisions, but they are mixed are to whether they are truly individual or business provisions.
Boyd: You say that there are mixed provisions. What do you mean?
Hesse: For example, the individual provisions include an increase in the adjusted gross income limitation for cash donations to 100%. This provision, however, also increases the corporate limitation to 25% of taxable income (up from 10%) and an increase in the limitation for business donations of apparently wholesome food to 25% (up from 15%).
Boyd: What other provisions are in the individual section of the bill that affect businesses?
Hesse: the retirement plan provisions are in the individual section, but also have an effect on businesses. In addition to the waiver of the Required Minimum Distributions for 2020, the Act increases the loans available from qualified retirement plans from $50,000 to $100,000. The 2020 due date of an outstanding loan is deferred for a year. Also, a business may now pay an employee’s student loans as a tax-free fringe benefit under the education allowance. Total education tax-free fringe benefit stays at $5,250, but now includes the principal and interest on an employee’s student loan payment in 2020. It’s just a one-year provision and is not available as a tax-free fringe benefit for employees who are related parties.
Boyd: Okay, so when we look for tax provisions benefiting businesses, we shouldn’t limit ourselves to just reviewing the table of contents in the Act. What’s the first business provision listed? Is that the employer retention credit?
Hesse: It is. This is a credit of 50% of up to $10,000 of employee wages. The operation of the trade or business must have been fully or partially suspended during the calendar quarter due to governmental orders limiting commerce, trade or group meeting due to COVID, or a 50% decline in revenues measured on a quarterly basis compared to the prior year’s quarter. Tax-exempt organization benefit from this provision as well, but it appears that the tax-exempt organization doesn’t have a 50% decline in revenues test.
The retention credit breaks down into two classes of employers: those with more than 100 full-time employees and those with no more than 100 full-time employees. For employers with more than 100 FTEs, the credit is available for wages of employees not able to work as a result of the government-ordered suspended operations or meeting the decline in revenues test. For the smaller employers, those with no more than 100 FTEs, all wages paid during the government order suspended operations or meeting the decline in revenues test. That sounds like the same test. The difference between the large and small employers, though, is that the employers with more than 100 employees qualify for the credit only for wages of employees not able to work.
The credit is measured on gross wages plus certain excludible group health plan costs.
Critical in the evaluation, though, of whether an employer qualifies for the credit is whether the employer receives a covered SBA loan under the Paycheck Protection Program of the CARES Act. Employers who receive a PPP loan do not qualify for the retention credit. This is effective for wages paid after March 12, 2020, through December 31, 2020, but remember: only a maximum of $10,000 of wages for each employee.
Boyd: The retention credit is only available for a business that does not take a covered loan from the SBA. Got it. This is where we really have to understand the intricacies and interplay of the provision and make the best holistic decision. What about the employer payroll taxes?
Hesse: The employer share of the 6.2% FICA tax can be deferred for all of 2020. Of the total deferral, 50% is due December 31, 2021 and the other 50% is due December 31, 2022. I’m concerned about employers participating in the program and not having the ability to make those payments to the IRS at the end of 2021 and 2022. It’s nice that they have the use of the money in the meantime, but you don’t want to owe the IRS money without the ability to pay.
Boyd: do self-employed people have a benefit on their self-employment tax?
Hesse: They do. Here’s where we get into some confusing math. 50% of the self-employment tax of a sole proprietor or partner can be deferred. That’s similar to the employer share of FICA. Of the amounts deferred, 50% is due December 31, 2021 with the balance due December 31, 2022. Estimated tax payments due June 15, 2020 through January 15, 2021 can be reduced by this 50% of SE tax not due until the end of 2021 and 2022.
And one last caveat: the deferral of the 50% FICA tax (or 50% of SE tax) is not available if the taxpayer has a PPP loan forgiven. This is a difference with the provision under the retention credit. The retention credit is not allowed if the taxpayers takes a PPP loan, but merely taking a loan doesn’t deny the deferral of the payroll taxes. The deferral of payroll taxes is denied if that PPP loan is forgiven.
Boyd: again, we must analyze these provisions, the PPP loan and the tax provisions, together. The Covid Response team is developing a tool to assist in that analysis. There are some changes in the net operating loss rules.
Hesse: Yes. The 80% taxable income limitation has been delayed. Under the Tax Cuts and Jobs Act, post-2017 NOLs were limited in deductibility to 80% of pre-NOL income. That has been delayed, to apply beginning for NOLs incurred in 2021 and later years.
In addition, the 2018 through 2020 NOLs may be carried back five years. This is a great opportunity, especially for C corporations who were in the 34% or 35% tax brackets in pre-2018 years. And it can increase cash flow by receiving refunds of previously paid taxes. A technical correction to the TCJA was also added allowing fiscal year taxpayers with a year beginning in 2017, ending in 2018, to carryback their NOL two years. There may be some action needed by July 25 (120 days after enactment) to change previous NOL elections.
Boyd: Big NOL changes. Some of our clients were limited in the amount of NOL they could compute under the TCJA. How is the excess business loss affected?
Hesse: The effective date of the excess business loss under Section 461(l) was delayed until years beginning in 2021. This is another amended return opportunity for our clients with large business losses (losses greater than $500,000) to amend the 2018 return, perhaps generate an NOL, and carry that NOL back five years.
Boyd: What are some strategies people can consider to create NOL carrybacks?
Hesse: Some taxpayers already had NOLs for 2018 and 2019. Of course, with the change to delay the application of the excess business loss to the year beginning 2021, some clients with large business losses will find that an NOL was created for 2018 or 2019. Unless guidance is provided by the IRS otherwise, the earlier returns will need to be amended to free-up the excess business loss. For 2020, equipment and qualified improvements to real property are direct expenses due to bonus depreciation. Traditional tax planning opportunities with respect to accounting methods, incurrence of expenses, and recognition of income.
Boyd: One of the deduction limiting provisions of the TCJA for our larger clients was the business interest expense limitation. The CARES Act increased the adjusted taxable income computation. How was it increased?
Hesse: For 2019 and 2020, what was a 30% of adjusted taxable income limitation is increased to 50%. Adjusted taxable income is taxable income determined without business interest income or business interest expense and adding back depreciation and amortization. This will allow a greater interest expense deduction for 2019 and 2020.
Also, the 2020 ATI limitation can be based upon 2019 income. This will be a big benefit. As taxable income takes a hit in 2020, more business interest expense will be limited. By using the 2019 income, our clients will be able to deduct more of their interest expense than what otherwise might have been available.
Boyd: The business interest expense limitation is one of the more complex provisions of the TCJA. What you described isn’t the end of the story, though, is it? How does the CARES Act change apply to partnerships?
Hesse: Differently, of course! Many 2019 partnerships have already been filed. Congress didn’t want to require partnerships to amend to take advantage of these changes. I think it is because Congress recognized that most partnerships can’t file amended returns. They have to file for an Administrative Adjustment Request. Rather than go through that process, the CARES Act says that the partner receiving an excess business interest expense amount (that is, the partner’s share of the excess business interest), can deduct 50% of the 2019 excess interest on the 2020 tax return (not the 2019 return). The other 50% will hold at the partner level until the partner receives excess taxable income in 2020 or a later year. The 2020 partnership return will be computed using the 50% of ATI limitation.
Simple, isn’t it?
Boyd: Anything else on your list?
Hesse: Quickly, the Qualified Improvement Property (QIP) cost recovery period was fixed retroactively. The intended 15-year cost recovery period was restored, which also means that QIP qualifies for bonus depreciation for 2018 and later years. Returns filed computing 39-year depreciation can be amended or, perhaps, use a Change in Accounting Method Form 3115 to catch up for 2018 bonus depreciation now available. We need to wait for IRS procedures on this one to determine the best choice for the client.
Lastly, the corporate Minimum Tax Credit can electively be claimed as a refundable credit on the 2018 corporate return, or the remaining credit can be accelerated into 2019.
Boyd: Many things to digest as over the next few months!
We hope today gave a nice overview of the bill. What I hope it points out is that there are many strategies to create liquidity and relief for both organizations and individuals. Many of the relief provisions are interwoven. Therefore, it’s important to have a high-level strategy to determine the best levers to pull and to weave this in to your overall cash management and liquidity plan. Thank you to all of you for your questions. Thank you to our subject matter experts in the chat pod for engaging with the questions and to our presenters for their insights. If you have additional follow ups, please contact a CLA professional.