These initiatives have been developed quickly and under intense pressure. As a result, their implementation remains dynamic, with guidance and interpretation still evolving daily. Below we highlight the U.S. federal tax measures introduced under the CARES Act. We flag that certain of these tax provisions effectively roll back rules that were introduced under the major tax reform legislation of 2017, the Tax Cuts and Jobs Act ("TCJA"). The TCJA has been subject to a slow and confusing rollout of guidance that remains ongoing more than two years after its enactment. The intersection of the CARES Act roll backs alongside the ongoing lack of TCJA guidance in many areas, particularly in the international tax arena, is shaping an ever more complicated and uncertain U.S. tax landscape for businesses of all sizes to navigate.

Temporary Special Tax Regime for Losses

A significant change introduced under the 2017 TCJA was the adoption of a stricter regime for the use of net operating losses ("NOLs"). After the TCJA, corporations are only allowed to use NOLs against a maximum of 80% of taxable income and are not permitted to carry back NOLs, two limitations that did not apply before the TCJA. However, the CARES Act temporarily repeals the 80% limitation, permitting NOLs to offset 100% of taxable income for tax years 2018, 2019 and 2020^[1].  The TCJA also temporarily permits corporations to carry back NOLs incurred during tax years 2018, 2019, and 2020 to the 5 prior taxable years.

As a practical matter, corporate taxpayers will need to file amended tax returns to claim refunds for prior tax years that will now benefit from the retroactive use of NOLs against 100% of taxable income. In particular, for NOLs expected to be incurred in 2020 due to Covid-19 business slow down, corporations should be able to apply them against their 5 previous years' taxable income, presumably being more prosperous years, as a means of accessing cash via the resulting tax refunds. In addition, because the corporate tax rate for years prior to 2018 was high, at 35% (reduced to 21% by the TCJA), the tax benefit produced by the carry back of NOLs could be significant for those prior high tax rate years.

Finally, the CARES Act also relaxes the rules governing excess business losses for individual taxpayers. The TCJA limitation on business losses for non-corporate taxpayers is now delayed under the CARES Act until 2021. As a result, individuals operating through pass-through entities or as sole proprietors will not be limited in their use of business losses to offset their non-business income for tax years 2018, 2019, and 2020.

Temporary Relaxation of Interest Deduction Limitations Rules

The 2017 TCJA introduced a new limitation on the deductibility of business interest expense, aligning the United States more closely with the European Union and OECD recommendations by limiting such deductions to 30% of adjusted taxable income, and allowing excess business interest expense to be carried forward indefinitely. The CARES Act temporarily raises the threshold to 50% for tax years 2019 and 2020, and permits businesses to use their last tax year as a benchmark for computing the 50% limitation (i.e., a year when income generally would have been higher).^[2]  As a result, lower adjustable taxable income for 2020 resulting from reduced activity should not lower the overall threshold for computing the 50% limitation. This modification should significantly increase interest expense deductions and reduce effective tax rates leading, ideally, to increased liquidity for companies able to benefit from this modification.

Funding and Tax Measures for Individuals

The CARES Act supports individual U.S. taxpayers as follows:^[3]

• First, the CARES Act provides for direct cash payments to eligible U.S. individuals (defined as those with social security numbers other than non-resident alien individuals). Any individual U.S. taxpayer with an adjusted gross income of $75,000 or less ($150,000 for a couple filing jointly) will receive a $1,200 cash payment ($2,400 for joint filers), with the payment reduced and phased out for higher income brackets (phased out entirely at $99,000 gross income for individuals and $198,000 for joint filers). An additional $500 per child is allocated for qualifying taxpayers eligible for the child tax credit.
   
• Second, federal unemployment insurance compensation is available for qualifying unemployed individuals for up to $600 per week for a 4 month period, supplementing any State unemployment compensation the taxpayer receives. Unemployment eligibility also is extended to allow individuals to receive unemployment compensation for up to 39 weeks in 2020. To encourage employers to implement work sharing programs in lieu of terminating employment, employees with reduced work hours are eligible for partial unemployment compensation.
   
• Third, individuals will be entitled to a $300 deduction for qualifying charitable contributions made in 2020. In addition, the limitation on charitable contribution itemized deductions is increased for cash contributions made in 2020 to qualifying charities.
   
• Finally, the CARES Act facilitates access to cash currently held in retirement accounts by waiving various withdrawal penalties. Generally, a 10% penalty is applied to early withdrawals from retirement accounts such as tax advantaged 401k savings accounts. The CARES Act suspends the 10% penalty for any withdrawal of up to $100,000 in 2020 from an eligible retirement account, by a person affected by Covid-19. Further, taxpayers may elect to ratably include the distribution in taxable income over a 3 year period, or to re-contribute the withdrawn amount to an eligible retirement plan within 3 years, converting the withdrawal to a loan.

Funding and Tax Measures for Small Business

The CARES Act introduces a number of measures aimed at ensuring small businesses can access vital liquidity in order to maintain as many employees as possible on their payrolls notwithstanding the slowdown in activities.

First, the CARES Act allocates $349 billion to fund loans to small businesses, self-employed individuals, and independent contractors. In addition to tapping into various existing SBA lending programs,^[4] the CARES Act introduced the Payroll Protection Program ("PPP") under which loans may be used to cover, inter alia, payroll costs, mortgage or rent, utility payments, and interest or other payments on debt incurred before February 15, 2020. The maximum loan available is $10 million, with the eligible loan amount calculated as a function of monthly payroll (e.g., 2.5 x average monthly payroll). The interest rate is set at 1% for a 2 year term, with payments deferred for 6 months. If a PPP loan is secured between February 15 and June 30, 2020 and used for permitted purposes, the loan may be forgiven, effectively converted to a government grant.^[5] The forgiven amount will not be taxable (i.e., not treated as cancellation of debt income).

Second, to support those businesses not receiving a small business loan but that are working to retain employees, refundable tax credits may be claimed against employer social security taxes equal to 50% of the qualified wages of each employee not exceeding $10,000.^[6] To qualify, employers must show that their operations were partially or fully suspended due to Covid-19; or that they suffered a significant economic loss therefrom. Significant economic loss is defined as gross receipts for any 2020 quarter being less than 50% relative to that same quarter in 2019.

Finally, the CARES Act also provides a significant deferral benefit for employer payroll taxes.^[7] Employers normally are required to remit to the IRS 6.2% of each employees' wages (up to the social security wage limit), generally on a monthly or quarterly schedule. The deferral benefit will apply to employer social security taxes normally remitted between March 27, 2020 and December 31, 2020, with the remittance deferred such that 50% of that tax will now be payable on December 31, 2021, and the remaining 50% payable by December 31, 2022. No interest or penalties will apply to the deferred amount. This deferral benefit is not available if the taxpayer has benefitted from certain funding and debt forgiveness under the CARES Act.

Federal Financial Assistance for Distressed Corporates and Financial Companies

In addition to the SBA programs, the CARES Act creates a $500 billion fund for financial assistance to distressed companies through loans, loan guarantees, and potential capital participation. Specific conditions for eligibility generally include being organized under U.S. law, having significant U.S. operations and a majority of employees in the United States, being unable to secure adequate credit elsewhere and, in some cases, having sufficient collateral. Certain restrictions will apply to any company receiving direct financial assistance, including prohibitions on share buy-backs, excessive executive compensation, and dividend distributions. The federal funding will be provided by direct loans to qualifying small to mid-sized businesses, or, for large U.S. corporates, by the New York Federal Reserve lending, buying bonds, or investing, including specifically supporting U.S. commercial paper issuers by issuing asset backed securities to inject liquidity for repurchase of outstanding commercial paper.

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[1] Section 2303 of the CARES Act.
[2] Section 2306 of the CARES Act.
[3] Section 2020 of the CARES Act.
[4] Existing programs include the SBA Loan Guarantee Program, the Economic Injury Disaster Loan Program, and the Small Business Investment Company Loan Program.
[5] Subject to certain exceptions, "small business" for these purposes is defined by a 500 employee threshold, generally including employees of affiliates. The applicable affiliation rules are quite broad, deeming entities to be affiliates when one controls or has power to control the other, or when a third party or parties controls or has the power to control both. As a result, private equity and venture capital businesses, and their portfolio companies, may not qualify for these PPP loans to the extent they are deemed to be affiliates, which may cause the 500 employee threshold to be crossed. Such companies may have better success with the Small Business Investment Company Loan Program which contains some waivers of the affiliation rules.
In a cross border context, the affiliation rule combined with a requirement that the business operate "primarily in the United States" or "significantly contribute to the U.S. economy" introduces uncertainty regarding eligibility for foreign controlled U.S. business operations with U.S. payrolls. An interim final rule issued on the evening of Friday April 3rd appears to indicate that only U.S. resident employees should be counted, meaning foreign resident employees of a foreign parent or other foreign affiliates may not negatively impact the employee count for the U.S. business. We are monitoring guidance in this regard.
[6] Section 2301 of the CARES Act. Notably, this payroll tax credit is different than the payroll tax credit highlighted in our first Tax Alert issued on March 26, 2020, which highlighted the refundable payroll tax credit related to paid sick leave under the Families First Coronavirus Relief Act.
[7] Section 2302 of the CARES Act.

This legal update is not intended to be and should not be construed as providing legal advice. The addressee is solely liable for any use of the information contained herein and the Law Firm shall not be held responsible for any damages, direct, indirect or otherwise, arising from the use of the information by the addressee.

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