The CARES Act was designed to provide financial assistance to businesses and individuals that are likely to be adversely affected due to COVID-19. Here are some tax provisions which may lower or defer your future tax bills.
Net operating losses. When businesses experience a loss during a tax year, the loss could be carried back to a prior year to get refunds or carried forward to future years to reduce future taxes. In 2018, the Tax Cuts and Jobs Act disallowed the carryback of losses and limited carryforwards so they can only be applied to 80% of a business’s future income.
The CARES act allows NOLs in 2018, 2019, and 2020 to be carried back five years to offset taxable income during those years. It also allows carryforwards to offset 100% of taxable income in 2019 and 2020. But in 2021, the 80% carryforward limitation is restored.
Because the NOLs can result in refunds or reduction of future taxes, businesses that are breaking even may want to consider increasing their spending between now and the end of the year.
Also, be mindful that your state may not allow NOL carrybacks in determining state taxable income. This disparity can create a situation where your business can have different NOL carryover amounts when calculating your federal and state taxable income.
Retirement distributions. The CARES Act provides three special rules for retirement distributions taken in 2020. First, any withdrawal made while under the age of 59½ can withdraw up to $100,000 without incurring the 10% early withdrawal penalty. Second, the distribution will be included in taxable income in equal installments for three years. Finally, if the distribution is repaid within three years, then the tax consequences can be undone.
This distribution is available to anyone who has been diagnosed with COVID-19 or has family members diagnosed with COVID-19. It is also available to anyone who has suffered adverse financial consequences due to COVID-19.
Employers are allowed to opt out of this plan. So employees with 401(k)s will need to get their employer’s authorization before obtaining this distribution.
The purpose of these rules is to give assistance to people who have suffered financially due to COVID-19. However, it does provide some planning opportunities. People in lower tax brackets might opt to not repay the distribution. Instead, they should pay the tax and put money into a Roth IRA where the contribution is nondeductible but the appreciation and future distributions are nontaxable.
Employment tax deferral provisions. Businesses with employees can take advantage of tax deferral opportunities. Since these are deferrals, the deferred amount must be paid back.
The CARES Act allows employers to defer payments of the employer’s portion of Social Security and Medicare taxes. These payments can be withheld from their required deposits or when making payment with the employment tax return.
The deferred amount can be repaid in two installments in the distant future. The first half of the deferred taxes must be repaid by December 31, 2021. The other half must be repaid before December 31, 2022.
However, businesses cannot take the deferral retroactively. In other words, if the business paid all employment taxes in the past, they cannot ask for a refund of the amount eligible for the deferral.
Some businesses may want to take advantage of this deferral rule mainly due to the distant repayment requirement. But they are taking a bet that they will have the money to pay the deferred amount in addition to their current employment taxes. Businesses that are currently struggling but anticipate surviving should think hard before using this deferral. Businesses that don’t need the deferral probably shouldn’t take it unless they know what they are getting into.
The other employment tax deferral is the one President Donald Trump enacted through his executive memorandum in August. More details about this are here but generally, employers can defer payment of the employees’ portion of their Social Security tax between September and December 2020. The deferred amount can then be repaid through an extra withholding between January and May 2020. The memorandum suggests that forgiveness is possible but there is currently no guidance.
This deferral has been heavily criticized. There is no benefit to employers and it might create financial difficulties for employees living paycheck to paycheck. In my opinion, this deferral is best used by closely held entities where the owner is the only employee or where there are a few highly trusted employees.
With some planning, the above provisions can reduce or defer your future tax bill. But plan carefully as some of the deferred taxes have to be paid back eventually.
Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at sachimalbe@excite.com. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.