As a result of the COVID-19 outbreak, the Coronavirus Aid, Relief, and Economic Security (or “CARES”) Act was enacted and provides broad tax relief to businesses and individuals. The provisions, which were geared to enhance cash flow during the economic downturn, include corrections to tax reform provided under the Tax Cuts and Jobs Act (“TCJA”) passed just a couple of years ago.
While the tax law changes apply to a wide range of businesses, several changes that have the largest impact on franchisors and franchisees include:
- Net operating losses (NOLs) generated in 2018, 2019, and 2020 may be carried back five years; 80% taxable income limitation temporarily repealed until 2021
- Technical correction for Qualified Improvement Property (QIP) to treat as 15-year property subject to 100% bonus depreciation, retroactive to January 1, 2018
- Employee Retention Credit allowed for employers whose businesses have been fully or partially suspended or that experienced a 50% reduction in gross receipts in a given quarter
- Employers may defer payment of the employer share of Social Security payroll taxes from the date of enactment to the end of 2020, to be payable by the end of 2021 and the end of 2022
- Expansion of charitable deduction rules for 2020, including an increase of the charitable deduction limitation for food inventory
Net Operating Loss Carryback and Carryforward
Prior to 2018, net operating losses (“NOLs”) could be carried back two (2) years and carried forward twenty (20) years. The TCJA brought changes by disallowing the carryback period for NOLs generated in 2018 and future years and increasing the carryforward period to an indefinite life. NOLs generated in 2018 and future years that were carried forward, though, could only offset up to 80% of taxable income in the carryforward year.
The CARES Act significantly changes these rules by allowing NOLs generated in 2018, 2019, and 2020 to be carried back for a five-year period. Further, the Act temporarily repeals the 80% taxable income limitation for taxable years 2018 through 2020. This carryback provision not only provides significant opportunity to increase current cash flow, but also allows the greatest tax benefit of those losses by allowing them to offset income at pre-TCJA rates (35% for corporations and 39.6% for individuals) rather than offsetting future income otherwise taxed at the post-TCJA maximum rates of 21% and 37% for corporations and individuals, respectively.
Correction to Allow Bonus Depreciation for Qualified Improvement Property
To fix what has been termed the “retail glitch,” referring to an error in the TCJA that unintentionally excluded certain qualified improvement property (“QIP”), which are general improvements to the inside of commercial buildings, from 100% bonus depreciation, the CARES Act assigns a 15-year cost recovery period for such property, thereby making it 100% bonus eligible. This change takes effect as if it were correctly treated within the TCJA, which means that the change becomes effective retroactive to January 1, 2018. This effective date allows taxpayers to consider the alternatives of either filing amended returns to claim the benefit, or “catching-up” the depreciation in the current year through a change of accounting method. This change significantly impacts those businesses with the restaurant and retail industries.
Employee Retention Credit
Eligible employers whose business is fully or partially suspended due to orders from a government authority due to COVID-19, or that have experienced a significant decline in gross receipts, may be eligible to claim an employee retention credit. The credit is a refundable payroll tax credit against the employer’s share of Social Security taxes equal to 50% of wages paid from March 13, 2020, to December 31, 2020, capped at wages of $10,000 per employee (i.e., a maximum credit of $5,000 per employee). Qualifying wages are those paid by businesses during a shutdown order or during a period of significantly declined gross receipts.
For employers with more than 100 full-time equivalent employees in 2019, only wages paid when the employee was not providing services are eligible for the credit. For employers with 100 or fewer employees, any wages when a business was fully or partially suspended or who experienced a significant decline in gross receipts are eligible for the credit. The credit is provided for wages paid through December 31, 2020.
Payment Deferral of Employer Payroll Taxes
The CARES Act allows for a payment deferral of the 6.2% employer portion of Social Security taxes from the date of enactment through December 31, 2020. Note that if you took advantage of the Paycheck Protection Program (“PPP”) loans, the deferral ends once you receive notification that your PPP loan has been forgiven if prior to December 31, 2020. The deferred payment is postponed, with 50% due by December 31, 2021, and the remaining 50% due by December 31, 2022.
Expanded Deduction for Charitable Contributions
The CARES Act suspends the 50% AGI limitation for 2020 cash contributions for individuals and expands the corporate limitation to 25% of taxable income. The provision that mostly impacts restaurant owners is an increase in the limitation on deductions for contributions of food inventory from 15% to 25%.
These changes may provide significant cash flow benefits for you and your business. It is imperative to work closely with your tax advisor to determine how these changes impact you and develop a plan of action to maximize your tax benefit opportunities.