Coronavirus Economic Stimulus Package Highlights
In response to the COVID-19 pandemic, Congress passed a series of legislations including the “Coronavirus Aid, Relief, and Economic Security Act” or the “CARES Act”, which was signed into law by President Trump on March 27, 2020. The CARES Act is designed to provide economic relief for individuals and small businesses who have suffered economic hardships due to the coronavirus pandemic. The $2 trillion CARES package is the largest financial support package in U.S. history.
This article breaks down the CARES Act (hereinafter, “CARES”) by first analyzing the economic relief provided to individuals followed by small businesses.
The most commonly sought relief under CARES with regard to individuals includes the stimulus checks for people who fall within certain income thresholds, an increase in unemployment benefits, temporary student loan suspensions and modification of retirement plans.
In order to provide economic relief to small businesses, CARES grants the authority to the Small Business Administration (hereinafter, “SBA”) to allocate $377 billion to small businesses that have experienced economic disruptions due to COVID-19 through two loan programs: expansion of the Economic Injury Disaster Loan and creation of the Paycheck Protection Program.
Out of $377 billion amount, $349 billion is allocated to the Paycheck Protection Program. (There are currently discussions on adding $250 billion or more to the Paycheck Protection Program). Small businesses with 500 or less employees including nonprofits (even though small businesses with more than 500 employees may qualify provided that they satisfy the definition of a “small business concern” under section 3 of the Small Business Act, 15 U.S.C. 632), sole proprietors, and independent contractors are all potentially eligible for the Paycheck Protection Program loan.
Other forms of economic relief in response to the coronavirus pandemic include providing potential tax relief to employers affected by COVID-9 and temporary changes in net operating losses.
Economic Relief for Individuals
In a time of an economic crisis, payment of income taxes would most likely cause an additional burden for many people. From all apparent indication, this is why the filing of personal tax returns for the 2019 tax year has been extended to July 15, 2020. The same also holds true for California’s tax returns since the filing of California’s tax returns has also extended by the Franchise Tax Board. However, the taxpayer can still file on or before the April 15, 2020 deadline.
The July 15 extension is automatic as opposed to the filing of Form 4868 which otherwise would have been required but for these extraordinary circumstances. Note that the estimated taxes will not be extended as of now with the exception of Q1. Interestingly, Q2’s estimated taxes can potentially be paid before Q1 if the taxpayer exercises the option of extending Q1’s returns since Q2 traditionally falls on June 15, whereas Q1’s estimated taxes have been extended to July 15.
One of the biggest forms of economic relief provided to individual taxpayers are the stimulus checks. Assuming the taxpayer qualifies, the minimum amount of the stimulus check will be $1,200. Even though the taxpayer will receive capital based on the amount of the qualification, if any, the distribution will be characterized as a tax credit that will be applied towards the 2020 tax year.
If an individual’s Adjusted Gross Income (hereinafter, “AGI”) is under $75,000; married couple’s under $150,000; and head of household’s under $125,000, then they will all qualify for the full benefit based on their filing statuses. The amount of the benefit will be $1,200 for an individual and head of household, $2,400 for a married couple filings their taxes jointly, and an additional $500 for every child who is claimed as a dependent.
There is a $50 phase out for every $1,000 of AGI above their respective income thresholds. Thus, if Amy is single and she makes $125,000, the calculation will be as follows: $50 multiplied by 50 (representing the difference between $125,000 and $75,000), or $1,200. Therefore, if $1,200 (amount of the benefit) is subtracted from $1,200 (amount of the rebate phase out), Amy will not receive a check since her total amount of the benefit would amount to zero (0).
The increase in unemployment insurance is also another relief provided to individuals in response to COVID-19. Those who were receiving unemployment insurance or recently filed for unemployment are now eligible for a $600 per week increase in their unemployment benefits. The $600 increase will not affect the unemployment benefits that were already being received at the state level. Note that those who have been partially unemployed due to the diagnosis of COVID-19 may also potentially qualify for unemployment benefits. Self-employed individuals and independent contractors are also eligible for unemployment benefits.
Other highlights for individuals include temporary suspension of student loans and RMDs. Student loan payments have been suspended until September 30, 2020 with no accrual on interest. Required Minimum Distributions have also been suspended for 2020. In addition, each person under a qualified plan may withdraw up to $100,000 without facing 10% early withdrawal penalty or having 20% automatic withholdings.
Economic Relief for Small Businesses
Some of the main vehicles designed to provide economic relief under CARES to small businesses include the SBA loans: Economic Injury Disaster Loan and Paycheck Protection Program Loan. Other forms of relief include the Employee Retention Credit and payroll tax deferment until 2021. Note that if a business takes a loan under the Paycheck Protection Program, it will not be eligible for the Employee Retention Credit or the payroll tax deferment.
The Economic Injury Disaster Loan, or EID has been available during many disasters in the past such as Hurricane Harvey. It was recently expanded by the SBA in response to the COVID-19 epidemic. The EID is designed to provide working capital loans to small businesses that are subject to federally designated disaster areas, which in the case of COVID-19 is the entire United States as of March 13, 2020. The Paycheck Protection Program, or PPP, which was also created by the SBA under the authority of CARES, is specifically tailored in response to COVID-19.
The EID loan is entirely funded through the SBA. It consists of an advance of $10,000 and a loan of up to $2 million at a 3.75% interest rate with a maturity period of 30 years. The $10,000 advance will be classified as a grant and no income will be recognized nor will that amount be required to be paid back to the SBA. The EID is a nonrecourse loan, meaning no personal guarantee will be mandated, and no collateral on the loan will be required so long as the loan amount does not exceed $200,000. The loan payments can be deferred for from six months up to one year even though interest will continue to accrue during the deferral period.
The EID aims to provide for the sick leave of employees who are unable to work because of the coronavirus; for employers to maintain payroll during periods of business disruptions; and other expenses such as satisfying financial obligations that include rent or mortgage that cannot be satisfied due to loss in business revenue.
Nothing prevents the borrower from applying for both the EID loan and the Paycheck Protection Program loan. If the borrower already applied for the EID loan before April 3, 2020, she can refinance the EID loan under the Paycheck Protection Program loan at a much more favorable interest rate, but at a much shorter maturity period. Even though the borrower is not required to return the $10,000 advance under the EID loan, the total amount of the PPP loan may nevertheless be reduced by $10,000.
The Paycheck Protection Program, or PPP, is guaranteed by the SBA, but it is not funded by the SBA unlike the EID loan. It is funded by private enterprises such as existing SBA lenders and federally insured depository institutions like banks. Unlike the EID loans which are processed by the SBA, PPP loans have to be approved by the private entities that are enrolled in this SBA program.
The PPP has similar intentions as the EID, but it is arguably broader and more restrictive than the EID. PPP’s aim is to provide various incentives to employers so they can maintain payroll during the COVID-19 pandemic and cover basic expenses. The means for reaching that aim is to provide funding to the employer for covered expenses that includes employee salaries, rent, utilities, costs related to insurance premiums, interest on debt that was incurred before February 15, 2020, and continuation of group healthcare benefits during periods of paid sick, medical, or family leave.
The borrower of a PPP loan can borrow up to $10 million at a 1% interest rate with a maturity period of two years (note that the SBA guidelines state that the maturity period can be as much as ten years). The initial payment for the loan can be deferred for six months, but the interest on the loan will accrue during the deferral period. Similar to the EID, no collateral, personal guarantees or borrower or lender fees payable to the SBA such as closing costs will be mandated for the PPP loan.
The distinguishing characteristic of a PPP loan is the potential forgiveness of the entire loan amount if the employers meet the covered expenses requirement and maintain the salary levels of their employees.
To calculate the loan amount, the borrower will use the average of the payroll expenses for the last one year before the loan is made increased by a factor of 2.5. For example, if the borrower’s monthly payroll expenses are $10,000, he will be entitled to receive $25,000 under the loan, which is 2 ½ times his monthly payroll expenses. Payroll expenses covered under PPP per SBA’s guidelines include not only salaries, wages, and commissions, but also group healthcare and retirement benefits, vacation payments and sick leave.
Note that there are salary limitations with respect to the calculation of payroll expenses. The maximum amount of the employee’s wages the employer is entitled to include in the final calculation of the total loan amount is $100,000 per annum. As such, if Avo, who may be one of the borrower’s employees or the borrower himself, makes $120,000 a year or $10,000 per month, Avo will only be entitled to $8,333 per month instead of his full $10,000 monthly salary.
The full loan amount or a portion thereof may be forgiven if the funds are spent on covered expenses for the first eight-week period from the date of the loan disbursement and if no more than 25% of the forgiven amount is used for non-payroll expenses. In other words, 75% of the loan amount must be allocated towards payroll expenses within the meaning of the SBA’s guidelines. For tax purposes, the forgiven portion will be classified as a grant and it will not count as income on the borrower’s tax returns as earned income or forgiveness of debt.
To illustrate the loan forgiveness requirements, suppose that Avo’s loan amount is $25,000. He ends up using $20,000 for the first eight weeks from the date of the loan disbursement on covered expenses. The remaining $5,000 will not be forgiven, but nothing prevents Avo from closing out the loan before interest kicks in since there are no prepayment penalties or fees. However, Avo could not have used more than 25% of the $20,000 forgiven amount, which in this case is $5,000, on non-payroll expenses such as rent and utilities.
Even if the forgiveness requirements are met, the portion of the forgiveness amount may nevertheless be reduced if the business has less employees during the eight-week period after the loan is issued compared to the prior period. However, if the business rehires those employees that were let go within a 30-day period after firing them, the business will be exempt from this rule. There are two formulas used to determine the reduction amount of the forgiveness portion of the loan and the borrower has the luxury of applying the formula that is more favorable to him.
The first formula (“Formula 1”) factors in the average full-time employees the borrower had on a monthly basis between February 15, 2019 and June 30, 2019. The second formula (“Formula 2”) factors in the average full-time employees the borrower had on a monthly basis between January 1, 2020 and February 29, 2020.
Let’s assume that Avo’s potential forgivable loan amount is $20,000 and that he had 20 employees during the time period specified under Formula 1 and 18 employees during the covered period. Formula 1 is calculated as follows: $20,000 x (18/20) or 0.9, which equals $18,000. Therefore, the forgiven portion of Avo’s loan amount would be $18,000 under Formula 1.
Let’s assume that Avo’s potential forgivable loan amount is still $20,000, but he had 18 employees during the time period specified under Formula 2 and 18 employees during the covered period. Formula 2 is calculated as follows: $20,000 x (18/18 ) or 1, which equals $20,000. Therefore, Avo could apply the more favorable Formula 2 and the forgiven portion of his loan would be the full $20,000.
The forgiveness amount, which in the example above may be as much as $20,000, may also be reduced if the employee’s salary is reduced by more than 25% compared to the previous quarter. However, if the reduction is reversed within 30 days, this rule will not apply.
For business owners who do not participate in either of the loan programs (EID and/or PPP), they can utilize the Employee Retention Credit, which in effect is a credit against payroll taxes for the employer; calculated by 50% of the qualified wages of the employee(s) capped at $10,000 per employee with a maximum tax credit of $5,000 per employee.
Another option is to defer the payroll taxes for the 2020 tax year. For payroll taxes that are due for the 2020 tax year, they can now be paid with the following schedule: 50% have to be paid by December 31, 2021, and the remaining balance by December 31, 2022. However, the taxpayer should consider whether to use a payroll company for the 2021 and 2022 tax years, and instead consider placing the funds into a separate account that is accessible by the business owner, since there is a likelihood that the payroll company may go out of business and the deferred amount may be lost, yet the taxes on them will nevertheless be due.
There are also tax credits available for the employer’s portion of the Federal Insurance Contributions Act (“FICA”) contributions if the employee is required to be quarantined due to the coronavirus or take care of a family member who has coronavirus or a child who is not going to school because of school closing. If the employee is required to miss work because she is infected by the coronavirus, the amount of the eligible tax credit for the employer will be $200 per day for a maximum of 10 days. The amount of the credit is limited by the lesser of wages plus healthcare costs the employer provides or $511 per day. If the employee is required to miss employment due to family leave, the amount of the eligible tax credit for the employer will be $200 per day capped at $10,000.
The FICA refunds may be claimed when filing quarterly returns, which are typically due on April 30th, July 31st, Oct 31st, and January 31st. If the tax credit taken was less than the quarterly taxes that were paid in the previous quarter, the taxpayer would have to wait until the following quarter to apply the credit. For example, if the FICA contribution during the last quarter was $500, but the tax credit for the current quarter is $1,000, the taxpayer would not have the $500 difference returned and would instead apply the credit on the following quarter’s return.
One final development that may be of great importance to business owners pertains to net operating losses. Carryback losses were temporarily brought back ever since they were largely eliminated under the GOP Tax Cuts and Jobs Act. For the 2018, 2019 and 2020 tax years, a business can carryback its net operating losses for 5 years and the 80% threshold will no longer apply. Therefore, a business may carryback its net operating losses for those years on 100% of the taxable income to the preceding five years.
Important Note: This article is published for informational purposes only and it is not meant to provide legal, financial, or tax advice. The law and guidance in this area are changing virtually on a daily basis. The information presented above is our understanding of the three complex sets of legislations passed in response to the coronavirus pandemic including the CARES Act. Please consult with your advisors to determine which of the relief efforts mentioned in the article, if any, are applicable to your circumstances.