By: Jun Kang, Zhiyuan (Sean) Liu
On March 27, 2020, the United States President Donald Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). As part of the 2 trillion coronavirus aid package, the CARES Act contains various tax relief and tax benefit provisions for businesses, individuals and families, as summarized below. We believe that the provisions will have significant impact on M&A, corporate restructuring and general financing transactions.
For a summary of non-tax provisions provided in the CARES Act, please see our companion memorandum.
Applicability to Business Concerns and Individuals
The tax provisions contained in the CARES Act, as described below, are generally applicable to all U.S. business entities regardless of their ultimate ownership as well as foreign entities engaged in a trade or business in the United States.
(i) All U.S. businesses required to file Internal Revenue Service Form 1120 (corporations), Form 1065 (multi-member LLCs and partnerships) or Form 1040 (sole proprietors) should be eligible for the benefits.
(ii) The eligibility does not depend on the ultimate ownership of the business and it does not matter whether the shareholders, members or partners are non-U.S. persons.
(iii) The start-ups, venture-capital-backed or not, seem to benefit most from the tax provisions because their businesses tend to hire employees with relatively low wages (plus presumably attractive stock options).
(iv) For example:
• Fuyao Glass America Inc., a U.S. entity owned by a Chinese company, is eligible for the tax benefits granted in these tax provisions.
• KBP BioSciences USA. Inc., a company backed by 3E Bioventures (a non-U.S. venture capital fund) would be eligible for the tax benefits.
• Bank of China, New York branch would also be eligible because it is a foreign corporation engaged in the U.S. business through a branch.
(v) For U.S. and non-U.S. Individuals:
• A U.S. expatriate (a U.S. citizen or green card holder who lives and works outside the United States) generally is eligible for individual tax benefits. However, it is not clear how the foreign earned income exclusion (up to $105,900 for 2019 per taxpayer) interplays with the adjusted gross income threshold (which is generally determined after exclusion of foreign earned income) for the refundable $1,200/2,400 tax credit. We expect the Internal Revenue Service to issue administrative guidance on this.
• A non-U.S. citizen who has no green card but is treated as a U.S. tax resident under the substantial presence test (i.e., having a physical presence of at least 183 days in the U.S. in 2019, as determined under the U.S. tax rules) and has a U.S. taxpayer identification number will qualify for the $1,200/2,400 tax credits if he or she otherwise meets the requirements under the CARES Act. For example, a non-U.S. citizen who is on a H-1B work visa can qualify if he or she spent sufficient days in the U.S. in 2019 and satisfies the income requirements under the CARES Act.
• An individual's employment status is not relevant in determining the eligibility for this benefit: temporary workers, independent contractors, and full-time or part-time employees can all qualify.
• A nonresident alien, however, is not eligible for the $1,200/2,400 tax credits.
1 Tax Relief for Businesses
a. Employee Retention Credit for Employers Subject to Closure due to the Coronavirus ("COVID-19").
• The CARES Act provides a refundable payroll tax credit for "eligible employers."
• Generally, an employer is required to pay 6.2% Social Security tax on an employee's wages (up to $137,700 per employee in 2020).
• For an "eligible employer" with 100 or fewer full-time employees, it is entitled to a payroll tax credit paid by such employer from March 13, 2020 to December 31, 2020, up to 50% of the first $10,000 of eligible wages per employee.
• An eligible employer is an employer that was carrying on a trade or business during 2020 and meets either of the following two tests:
1) The operation of the trade or business is fully or partially suspended due to orders from a governmental entity limiting commerce, travel, or group meetings; or
2) Gross receipts declined by more than 50 percent when compared to the same quarter in the prior year until a quarter when gross receipts are greater than 80 percent of the gross receipts for the same quarter in the prior year.
• Once the credit amount exceeds all applicable payroll taxes for a calendar quarter, the excess will be refunded to the employer.
• The credit under this provision only applies to wages paid after March 12, 2020, and before January 1, 2021.
• For eligible employers with more than 100 full-time employees, only wages paid to employees who are not providing services for the employer due to COVID-19-related circumstances are eligible for this credit.
• Employers who take a small business interruption loan, as described in our companion memo, are not eligible for this credit.
b. Deferral of Employer Payroll Tax Payments
• Employers and self-employed individuals are allowed to defer the payment of the employer share of the payroll tax for the period from the enactment of the CARES Act through the end of 2020.
• Half of the deferred amount will be due December 31, 2021, and the other half due December 31, 2022.
c. Suspension of the Net Operating Loss (NOL) Limitations
• NOLs arising in 2018, 2019 and 2020 can be carried back five years under the CARES Act.
• The 80% taxable income limitation on NOLs under the current law is modified to take effect only after December 31, 2020, and thus would not apply to taxable years beginning in 2018, 2019 and 2020.
• The carried back NOLs are not taken into account in determining the one-time "repatriation" toll charge under section 965 of the Internal Revenue Code of 1986, as amended (the "Code") if carried back to a year in which such toll charge is determined.
d. Suspension of Loss Limitations for Non-Corporate Taxpayers
• The disallowance of "excess business loss" under section 461(l)(3) of the Code is modified to take effect only after December 31, 2020, and thus would not apply to taxable years beginning in 2018, 2019 and 2020.
• With this disallowance lifted temporarily, non-corporate taxpayers such as individuals and partnerships may claim more losses incurred to offset their tax liabilities.
e. Accelerated Refundable Alternative Minimum Tax (AMT) Credits for Corporations
• Corporate AMT was repealed in 2018 and the previously paid AMTs were allowed as refundable credits beginning in 2018 over a 4-year period.
• The CARES Act allows corporate taxpayers to claim the entire amount of refundable AMT credits for taxable year 2019 or taxable year 2018 at the taxpayer's election.
f. Relaxed Limitation on Business Interest Deductions
• Section 163(j) of the Code generally limits the net business interest deduction amount to 30% of the "adjusted taxable income" for taxpayers other than certain small businesses.
• The CARES Act increases such limit percentage to 50% for taxable years beginning in 2019 and 2020.
g. Bonus Depreciation Applies to Qualified Improvement Property Under the CARES Act
• Through a technical fix of relevant provisions under the tax reform passed in late 2017, the CARES Act allows taxpayers to claim a 100% bonus depreciation immediately for costs associated with improvements to the interior of nonresidential buildings, instead of depreciating the costs over 39 years.
• This technical fix provides incentives for hospitals to improve their medical facilities to better tackle the pandemic.
2 Tax Relief for Individuals and Families
a. 2020 Recovery Rebates for Individuals
• The CARES Act provides a one-time refundable tax credit for individual taxpayers who are not nonresident aliens or dependents in an amount equal to $1,200 (for single taxpayers) or $2,400 (for married couples filing joint returns), plus $500 for each child.
• The rebate amount is reduced by 5% of the excess of the taxpayer's adjusted gross income (generally, a taxpayer's total net income reduced by applicable adjustments under the tax law) over—
o $75,000 in the case of single taxpayers,
o $112,500 in the case of heads of households, and
o $150,000 in the case of joint filers.
• Accordingly, the amount is generally reduced to zero for single filers with income exceeding $99,000, $146,500 for head of household filers with one child, and $198,000 for joint filers with no children.
• The rebate amount will be calculated based on a taxpayer's 2019 tax return, or 2018 tax return if the taxpayer's 2019 return has not been filed.
• Treasury is directed to issue refunds for such credits as rapidly as possible.
b. Relaxed Requirements Relating to Retirement Funds, Plans and Accounts
• Under the CARES Act, coronavirus-related distributions in 2020 from eligible retirement plans (including IRAs) would not be subject to the 10% early withdrawal penalty if the distributed/withdrawn amount does not exceed $100,000.
o Income attributable to such distributions would be taxed ratably over a three-year period.
o Taxpayers may also recontribute such distributed amount to an eligible retirement plan without regard to the annual cap on contributions.
• The CARES Act provides flexibility for loans from certain retirement plans for coronavirus-related relief.
• The CARES Act also suspends the minimum distribution requirements for certain defined contribution plans (such as 401(k) plans) and IRAs for calendar year 2020.
c. Modifications for Charitable Contributions
• The CARES Act provides taxpayers who do not itemize their deductions a tax deduction up to $300 for eligible charitable contributions made in 2020.
• For individual taxpayers that itemize their deductions, the CARES Act suspends the 50%-adjusted-gross-income limitations on charitable contribution deductions. Individual taxpayers may claim 100% of their charitable contribution amount made in 2020 as an itemized deduction.
• For corporate taxpayers, the limitations on charitable contribution deductions of 10% of taxable income is increased to 25%.
• The CARES Act also increases the limitation on deductions for contributions of food inventory from 15% to 25% for both noncorporate and corporate taxpayers.
d. Exclusion for Certain Employer Payments of Student Loans
• The Act enables an employer to make payments on an employee's qualified education loan on a tax-free basis after the date of enactment and before January 1, 2021. The $5,250 cap on the educational assistance payment also applies to such student loan payments made by employers.
3 Other Tax Related Provisions
a. Certain Loan Forgiveness Is Excluded from Income
• The CARES Act establishes a Paycheck Protection Program under which certain business concerns and non-profits organization may borrow from participating banks to pay certain employee expenses (see our companion memo).
• This loan may be forgiven under certain circumstances. The CARES Act provides that the forgiven amount is excluded from income.
b. Suspension of Section 382's Applicability to Governmental Financial Assistance
• The CARES Act authorizes the Treasury to provide loans, guarantees and other investments, which may be issued in exchange for warrants, stock options or other equity-like instruments, in support of eligible businesses, states and municipalities of up to $500 billion.
• Under the general tax rule, such issuance may result in a change in ownership of the issuer under section 382 of the Code, which could create significant limitations on the issuer's ability to use its NOLs to offset tax liability.
• The CARES Act grants the Treasury the authority to issue regulations to make section 382 inapplicable. The Treasury issued similar rules in connection with the government bailout during the 2008 financial crisis. See the IRS Notice 2008-76, etc.
c. Debt Treatment for Governmental Loans and Guarantees to Certain Financial Institutions
• Treasury Secretary is authorized to designate financial institutions as "financial agents of the United States" to perform all reasonable duties the Secretary determines necessary to respond to the coronavirus, and to provide loans or guarantees to the financial agents.
• The CARES Act provides that such loans or guarantees provide certainty on the financial assistance: any such governmental loan or guarantee shall be treated as indebtedness for U.S. federal income tax purposes that is issued for its stated principal amount and the stated interest on which will be "qualified stated interest" that is deductible as it accrues.
d. Tax Holidays for Airline Related Industries
• The CARES Act provides a tax holiday for (a) the 7.5% aviation excise tax for the transportation of passengers, (b) the 6.25% aviation excise tax for the transportation of cargo and (c) taxes on certain uses and transportation of kerosene as aviation fuel, in each case until January 1, 2021.
4 Our Takeaways
The CARES Act is the Congress's largest response to the COVID-19 pandemic. In addition to other major interventions, the Act provides significant tax relief – including at least $300 billion in payments to individuals and more than $1 trillion to businesses, large or small. These provisions will have significant impact on the following corporate transactions.
The Act creates many tax benefits as well as deferred payment obligations which may be received or borne by the target company after closing. Therefore, corporate and tax attorneys representing clients in M&A transactions should be prepared to build in a provision in the acquisition documents on how to account for these benefits and obligations. For example:
• Whether the buyer should get the tax refund attributable to the carryback of the pre-closing NOLs?
• If a loan to a target company made prior to closing is forgivable, whether the buyer has the obligation to obtain the forgiveness? What happens if the seller did not provide proper certifications when applying for the loan?
• How to account for the refundable tax credits attributable to the wages paid by the target company prior to closing?
• How to account for the post-closing payroll tax payments attributable to the deferred pre-closing taxes (e.g., through working capital adjustment or purchase price adjustment or tax adjustments)?
• Will the increased interest deduction limitation reduce certain disadvantages for leveraged target companies?
The tax provisions in the CARES Act also make the tax due diligence and tax representations in the acquisition documents more complicated.
• Companies should revisit their restructuring plans to maximize the tax benefits available under the CARES Act.
• A temporary suspension of certain limitations on using prior year and current year losses would be helpful to companies doing taxable restructurings.
Bank and Venture Capital Financing:
• Almost all provisions are temporary in nature, and lenders and investors should factor this in when modeling borrowers' or portfolio companies' cash flows during the terms of the loans or other types of investment.
Disclaimer: This article provides general information only, which may or may not reflect the most current legal developments and does not constitute legal or other professional advice. Readers should seek appropriate legal advice from counsel in their relevant jurisdiction(s) before taking or refraining from taking any action in reliance on any information contained in this article. Nothing in this article shall create an attorney/client relationship with King & Wood Mallesons LLP or with any lawyer at King & Wood Mallesons LLP.