The $2.2 trillion Coronavirus Aid, Relief, and Economic Security Act (CARES Act), enacted March 27, 2020, is the largest economic relief package in United States history. Many of the Act’s tax-specific provisions are relevant for private equity (PE) funds, investors and portfolio companies.
PE taxpayers will need to plan carefully in order to effectively use the CARES Act to help them through this uncertainty. For instance, those who receive a small business loan cannot also claim the employee retention credit. Likewise, certain credits available in the recently enacted Families First Coronavirus Response Act must be considered in conjunction with the CARES Act. Each portfolio company or PE fund should consult with professionals to evaluate these benefits in light of its own facts and circumstances.
The CARES Act creates a refundable credit that can be used to offset certain payroll taxes. This credit is generally available to businesses that are either fully or partially suspended due to COVID-19. The credit is also available to businesses that continue to operate but endure a significant decline in gross receipts. The credit is equal to 50% of qualified wages, not to exceed $10,000 per employee, through the end of this calendar year. Employers with fewer than 100 employees are eligible for this credit even when an employee continues to perform services. Portfolio companies should evaluate eligibility prior to filing their first-quarter employment tax return. Taxpayers taking this credit cannot take a small business loan under the CARES Act Paycheck Protection Program (PPP) or utilize the Work Opportunity Tax Credit.
The CARES Act defers payment of the employer’s portion of Social Security taxes, i.e., 6.2% of the base. The deferral applies to wages incurred through the end of the year. Half of the deferred liability is due Dec. 31, 2021, and half is due Dec. 31, 2022. This deferral is additionally extended to 50% of self-employment taxes. Essentially, this is an interest-free loan, and there is no requirement that the taxpayer be impacted by COVID-19. However, employers that utilize the loan forgiveness component of the payroll protection loan program are not eligible for this deferral.
The Tax Cuts and Jobs Act (TCJA) established that, beginning in 2018, NOLs could only offset 80% of current-year income. The CARES Act repeals this change for the 2018, 2019 and 2020 tax years. Moreover, the CARES Act establishes that NOLs arising in 2018, 2019 and 2020 may be carried back five years. Portfolio companies that paid income taxes in 2018 or 2019 should consider filing amended returns to fully utilize NOLs.
In a much longed-for technical correction to the TCJA, the CARES Act fixes the so-called “retail glitch.” QIP is now 15-year property, which makes this property eligible for bonus depreciation retroactive to 2018. QIP generally includes most improvements to a building’s interior. Real estate-related PE funds and certain operating portfolio companies should consider amending tax returns or changing their accounting methods to take advantage of this important correction.
Caution: Entities organized as partnerships that are subject to the consolidated partnership audit rules (CPAR) cannot file amended returns. Such taxpayers should consult with their tax advisors regarding their options.
The TCJA limited the amount of pass-through business losses that could be used to offset nonbusiness income. This “excess business loss” limitation was effective beginning in 2018. The CARES Act delays this limitation until 2021. PE investors subject to the excess business loss limitation should consider filing amended tax returns to claim refunds.
The TCJA limited total interest expense to an amount equal to 30% of adjustment taxable income (ATI). The CARES Act modified this rule to deduct interest expense equal to 50% of ATI for 2019 and 2020. However, special rules apply to partnerships. Broadly, a partnership does not get to use the increased limitation in 2019, deferring any potential benefits of the 50% threshold to 2020. This change is particularly important for real estate-related businesses and funds.
In addition to the favorable tax items discussed above, the CARES Act also creates loans for small businesses.
The PPP are loans issued by private lenders and fully guaranteed by the federal government. The principal purpose of this loan is to help employers retain their employees. The loans are intended to cover eight weeks of payroll expenses, applied for at any date between Feb. 15, 2020, and June 30, 2020.
Companies with 500 or fewer employees may apply for loans of up to $10 million to cover payroll and other employee-related costs as well as debt, rent and utility payments.
Under the program, an eligible recipient includes:
Since the SBA’s affiliation rules apply (subject to a narrow exception for accommodation and food services businesses), PE-owned businesses must account for the employees of other portfolio companies owned by the same PE fund when calculating the 500-employee threshold.
In addition, certain expenditures can qualify for loan forgiveness. Amounts eligible for this forgiveness are based on monies used to cover certain payroll, mortgage interest, rent and utility costs paid within eight weeks of the loan’s origination date. Limits would apply to the amount eligible for forgiveness. For example, if a business borrows $5 million under this program, and incurs $2.5 million of eligible expenses within eight weeks of obtaining the loan, that $2.5 million is eligible for forgiveness. This debt forgiveness is not subject to federal taxation, but state taxation is not certain at this time.
Taxpayers that participate in this program are not allowed to use the employee retention credit. And, if they have part or all of the payroll interruption loan forgiven, they are not eligible for the payroll tax deferral.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.