Deciphering the CARES Act for Business Owners
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") was signed into law. The CARES Act includes a $2.2 trillion dollar stimulus package aimed at providing assistance to those businesses and individuals impacted by COVID-19. This client alert discusses (i) the Paycheck Protection Program, the CARES Act's $349 billion expansion of the Small Business Administration (the "SBA") 7(a) loan program, and (ii) certain of the CARES Act's tax provisions for businesses.
The Paycheck Protection Program
The SBA's 7(a) Loan Program
The SBA offers loans ("7(a) Loans") to support small businesses pursuant to Section 7(a) of the Small Business Act. Rather than making loans directly to businesses, the SBA offers 7(a) Loans indirectly through a network of banks. The SBA incentivizes banks to lend money to businesses that might otherwise be considered riskier investments by guaranteeing 7(a) Loans on behalf of the borrower. During the period beginning on February 15, 2020 and ending on June 30, 2020 (the "covered period"), the Paycheck Protection Program (the "PPP") will make 7(a) Loans available to a broader class of businesses.
Under normal circumstances, an applicant for a 7(a) Loan must establish that it is a "small business concern," meaning that the business is (i) independently owned and operated; (ii) not dominant in its field of operation and (iii) within the relevant small business size standard set forth by the SBA. Under the PPP, covered loans are available to any business concern that was operational on February 15, 2020 and employs no more than the greater of (i) 500 employees or (ii) the size standard for the applicant's industry as determined by the SBA. The PPP includes a carveout for applicants in the food and accommodation industry by applying the abovementioned size standards on a per-location basis.
The SBA's affiliation rules apply for the purposes of determining the number of people that an applicant employs. This means that the employees of an applicant's affiliate are counted as employees of the applicant for the purposes of meeting the PPP's size standards. Generally, entities are affiliates of each other when one controls or has the power to control the other, or a third party or parties controls or has the power to control both. The SBA analyzes a number of factors to determine whether an affiliation exists and considers the totality of the circumstances at hand. Exceptions to the SBA's affiliation rules exist for certain entities, including venture capital operating companies (as defined in U.S. Department of Labor regulations) and investment companies (as defined in the 1940 Act) that are beneficially owned by less than 100 persons. The PPP also waives the SBA's affiliation rules for (i) the food and accommodation industry, (ii) franchises and (iii) entities that receive assistance from Small Business Investment Companies.
To qualify for a 7(a) Loan under the PPP, an applicant must (i) certify that the uncertainty of current economic conditions necessitates the loan request to support ongoing operations and (ii) acknowledge that the funds will be used to retain workers and maintain payroll or make mortgage payments, lease payments, and utility payments.
Traditionally, an applicant for a 7(a) Loan has to establish that the applicant has no other source of available credit. The PPP waives this requirement for loans made during the covered period.
The maximum loan amount available under the PPP is the lesser of: (i)(a) average total monthly payments made by the applicant for permitted payroll costs incurred during the one-year period leading up to the date the loan is made multiplied by (b) 2.5 and (ii) $10 million.
“Payroll costs” include payments made by the applicant for (i) salary, wages and commission; (ii) tips; (iii) vacation, parental, family, medical or sick leave; (iv) dismissal or separation; (v) group health care benefits; (vi) retirement benefits (vii) state or local taxes assessed on the compensation of employees and (viii) payments of any compensation or income of a sole proprietor or independent contractor up to $100,000, as prorated for the covered period. "Payroll costs" do not include compensation of an employee in excess of $100,000, as prorated for the covered period.
The SBA will guarantee 100 percent of loans made under the PPP. During the covered period, applicants are not required to pledge any assets as collateral or make a personal guarantee. The SBA is requiring lenders to provide borrowers complete deferment relief with respect to payments of principal, interest and fees for at least six months with an option to extend deferment for up to one year. Interest rates on loans made pursuant to the PPP are capped at 4 percent.
Borrowers can use loan proceeds for (i) payroll costs, (ii) mortgage interest, (iii) rent, (iv) utilities and (v) interest on any other debt obligations that were incurred before the covered period.
Loan proceeds that borrowers use to pay for payroll costs, mortgage interest payments and rent during the 8-week period beginning on the date of origination of the loan are eligible for loan forgiveness. To incentivize borrowers to retain employees, the amount of loan forgiveness is reduced pro rata for reductions in the borrower's workforce. The amount of loan forgiveness will also be reduced by reductions in total salary or wages of employees during the covered period in excess of 25 percent when compared to the most recent full quarter that such employee was employed by the borrower prior to the covered period. Borrowers can avoid reductions in the amount of loan forgiveness they would otherwise incur due to the a reduction in the number of employees between February 15, 2020 and April 26, 2020, if such reduction is eliminated by June 30, 2020. Loans amounts that are forgiven are not included in the borrower's gross income when forgiven for federal income tax purposes. Loans that have a balance remaining after any loan forgiveness is applied may have a maximum maturity of 10 years from the date on which the borrower applies for loan forgiveness.
Certain Tax Provisions for Businesses
Employment Tax Relief
The CARES Act has two major provisions dealing with employment taxes with respect to employers impacted by the coronavirus. First, eligible employers can take a refundable tax credit against the employer's employer tax liability for the employer's social security employment taxes (the 6.2% amount) equal to 50% of the qualified wages paid after March 12, 2020 in each calendar quarter of 2020, up to $10,000 of qualified wages per employee for the calendar year. An eligible employer is an employer who has had to fully or partially suspend operations because of a governmental order dealing with the coronavirus or an employer whose gross receipts for any 2020 calendar quarter is 50% of its receipts for the same calendar quarter in 2019 and continuing until a calendar quarter is at least 80% of the employer's gross receipts from the same quarter in 2020. What constitutes qualified wages for this purpose depends on the number of employees employed by the employer and its affiliates. If the employer has more than 100 employees, qualified wages are only those wages paid to employees who are actually not working during the period up to the amount that the employer would have paid each such employees in the 30 day period immediately before the period such employee's services were suspended. If the employer has 100 employees or less then qualified wages are those wages paid to its employees during that period in which the employer is a qualified employer, other than paid time off wages for which the employer already received a credit under the Families First Coronavirus Response Act. As a credit, this means the employer does not pay the social security taxes on these wage amounts. The employer can take advance use of this credit by offsetting payroll tax deposits it otherwise would have been required to make up to the amount of this credit. This credit, however, is not available for employers who take the small business loans mentioned above. Second, the Cares Act delays the deposit date of 50% of the social security employment taxes otherwise payable until December 31, 2021 and the remaining 50% until December 31, 2022. This delay in payment provision also applies with respect to the self-employment taxes on 50% of self-employment earnings that are the equivalent to these employer social security taxes. The deferral provisions are not available for those employers who do take advantage of the tax-free loan forgiveness of those small business loans mentioned above. It must be noted that these provisions only provide a credit or delay in payment for the social security portion of FICA, the one that is already subject to a wage cap, not the 1.45% Medicare portion. Nevertheless, these provisions put money back in the employers' pockets to provide some liquidity relief. As noted, employers will need to weigh the benefit of the credit with the benefit of the SBA loans and the forgiveness of them in light of their own factual circumstances if the employer was otherwise eligible for such loans. These tax provisions, however, can benefit larger businesses as they are not limited by the 500 employees rule discussed with respect to the SBA loan provisions.
Net Operating Loss Changes
The CARES Act provides some temporary tax relief for the NOL provisions that were enacted in the 2017 Tax Act. First, with respect to net operating losses incurred in a taxable year beginning before January 1, 2021, those losses incurred in 2020 and prior years can offset 100% of the 2020 taxable income, instead of 80% as was part of the 2017 Tax Act. Second, losses created in 2018, 2019, and 2020 can be carried back up to five years. The 2017 Tax Act had eliminated loss carrybacks for losses generally created after January 1, 2018. For taxable years beginning after January 1, 2021, losses carried forward from 2018, 2019, and 2020 to that year and future years are generally subject back to the 80% rule. Third, the additional business loss rule that applied to individuals which generally prohibited individuals from deducting business losses of more than $250,000 per individual (or $500,000 per married couple) against other income assuming compliance with all the other loss limitation rules (at risk, passive activity, and basis, for example) does not apply with respect to losses incurred in the 2017 through 2020 taxable years. Instead, those losses will only be subject to the net operating loss carryforward rules described above. These loss changes may enable taxpayers to obtain greater tax refunds for earlier years to help with liquidity concerns for themselves and perhaps their lenders.
Interest Deduction Limitation
The Code Section 163(j) interest deduction limitation provision that was enacted as part of the 2017 Tax Act was modified such that the instead of the 30% limitation that limited the net interest expense deduction to no more than 30% of adjusted taxable income, net interest expense incurred in 2019 and 2020 tax years may offset up to 50% of adjusted taxable income. Further, a taxpayer may elect to use its adjusted gross income in 2019 for the purposes of the 2020 limitation as its 2019 adjusted gross income may be higher given the economic conditions in 2020 caused by the coronavirus pandemic. Special rules apply to partnerships in determining their interest limitations. These changes will allow more interest expense to be deductible, creating greater potential losses in 2019 and 2020 that can be carried back to earlier years to obtain tax refunds.
Acceleration of Minimum Tax Credits Utilization
Certain corporate taxpayers who had previously been paying corporate alternative minimum tax had credits that could be applied over time to pay their regular federal income tax liability. The 2017 Tax Act limited how these credits could be applied, stretching the ability to use them until 2021. The Cares Act accelerates their use to 2018 and 2019, with the ability to elect to apply them in full to 2018. This permits corporate taxpayers to also apply these credits to obtain cash refunds with respect to their 2018 and 2019 tax years.
Correction of 2017 Tax Act
The CARES Act also corrects a known mistake in the 2017 Tax Act that restores the treatment of qualified leasehold property as 15 year property instead of real estate so that such property can be treated as bonus depreciation.
For a related client alert discussing CARES Act compliance issues, please click here.
The foregoing provides only general information and is not intended to constitute legal or tax advice and cannot be used for the purposes of avoiding penalties under any applicable tax or other law. Business and individuals should contact their applicable counsels and advisors for particular legal and tax advice in light of their own individual circumstances. For assistance, please contact one of the Goldberg Kohn lawyers listed herein.
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