COVID-19 and The CARES Act
President Trump recently signed into law the “Coronavirus Aid, Relief, and Economic Security Act”, more colloquially known as the CARES Act. Its purpose is to provide emergency economic assistance and health care response for individuals, families, and businesses affected by the 2020 Coronavirus pandemic.
The twelve hundred page legislation is massive in size and scope, and sweeping in the number of Americans impacted. The amount of financial assistance provided is unprecedented, and it is estimated that at a minimum, 93% of U.S. citizens will receive financial aid in some way, shape, or form.
Below is Peak’s synopsis of the most far reaching aspects of the bill that we have determined are most impactful to our clients and their families. There are many provisions of the legislation that are subject to interpretation by the Department of Treasury and certain aspects of the aid package that need to be clarified through the specific regulations formed around the legislation. In some instances, this summary is consistent with the facts on the ground and in other circumstances we apply our educated opinion on how the new regulations and assistance will work in practice.
The direct financial relief offered is over $2.2 trillion, which represents 10% of the U.S. gross domestic product. No bill like this has ever been codified by our government and it should be understood that the rapidity of its passage and the emergency nature of the government’s response may result in uneven application of the aid. As such, it seems very likely that another Coronavirus bill will be introduced to offer new programs and economic relief and to cure the potential deficiencies and oversights in the CARES Act. Our analysis will be as sprawling as the legislation. There are still many unanswered questions, but we remain engaged in determining the impact of all new developments.
Perhaps the provision of most interest to Americans is the one that is the most far reaching: namely the so called Recovery Rebates which will provide money directly to citizens. $1,200 will be distributed to individuals, $2,400 to married couples, with an additional $500 for dependent children under the age of 17 (which eliminates most college students) subject to certain income phase out levels of $75,000 for individuals, $150,000 for joint tax filers, and $112,500 for those who file as Head of Household, with each threshold defined as adjusted gross income (AGI). Income over these limits will result in a $5 reduction for every $100 of the amount over AGI.
Importantly, eligibility will be determined based on the most recent income tax return filed (it has been clarified that Social Security recipients who don’t file taxes will not be required to file a return). As such, if your income in 2019 is higher than 2018 and will impact your ability to receive a relief check, a choice may be to delay your 2019 tax filing. As well, if your 2019 income is lower than 2018 and would be beneficial in the relief computation, file your tax return now if possible and do not wait until July 15, the new deadline for the submission of your 2019 tax return. Remarkably, if your 2018 or 2019 income makes you ineligible for the Recovery Rebates but your 2020 income (as reported in 2021) makes you eligible, you will get a true up credit at that time.
While U.S. legislators and the U.S. Department of the Treasury are committed to getting payments out in two weeks, it is quite likely based on similar efforts to provide emergency aid in the past that it may take as long as two to three months for most people to receive the funds, meaning receipt of aid may not occur until May or later. Further, for taxpayers who have direct deposit information linked for tax refund or Social Security purposes, payments will be made electronically to your bank. For others, payments will be made by check to the last address identified on tax returns or at the Social Security Administration.
Obviously, receipt of a rebate will be a problem for people who have moved or have closed bank accounts formerly reported to these governmental institutions. As an attempt to remedy this situation, the Treasury will send a notice 15 to 30 days before the payments are made describing the computation used to determine the amount and where the funds are being directed. There will be a toll free number for people to call if there are questions and this will be an opportunity to correct any errors, including rectifying outdated information. For those who have changed addresses since their last tax filing, you are encouraged to file IRS form 8822 immediately which will update your address at that agency. You may also simply file your 2019 tax returns now with updated direct deposit or address information (but only if it is not disadvantageous from an income perspective as discussed above).
Besides direct payments, there are a number of other important provisions of the Act designed to assist individuals and families. Some of these directives allow more liberal use of retirement funds for those adversely impacted by the economic emergency. For example, Individual Retirement Account (IRA) owners or those separated from service with active group accounts such as 401ks and 403bs are allowed to take up to $100,000 from those accounts at any time in 2020 and either spread the tax burden over three years in even increments and/or replace the funds within three years subject to certain very broad and favorable criteria. A person’s ability to take advantage of these distributions will hinge on they themselves, their spouse, or a dependent being diagnosed with COVID-19, being laid off, furloughed, or having hours reduced, unable to obtain child care and therefore unable to work, a small business closure or reduced hours, or other reasons that can be credibly presented to the IRS as the impetus for the withdrawal. Distributions under the legislation will not be subject to the 10% penalty usually applied to withdrawals made under age 59.5, and also are not subject to mandatory tax withholding. All representations made to access IRA funds are self-certifications that the person is eligible for the distribution under the criteria. It is expected that that IRS will give the taxpayer the benefit of doubt that any assertions made are accurate but again, deliberate fraud can result in severe penalties.
Although still murky, the mechanism used to either pay back the IRA/401k funds or spread the tax burden over three years will be through tax returns and in some cases though amended tax returns, especially for those who initially pay some or all the taxes on the distributions, but then decide to use the opportunity to repay the amounts at any time during the three year period.
For those who are still active in a group plan such as a 401k or a 403b and who are allowed by the plan rules to take loans against their retirement savings, the legislation will enhance the conditions of these potential loans. Under normal circumstances, group plan participants (the employee) are allowed to borrow up to $50,000 against their retirement plan or one half their vested balance, subject to certain limitations. Under the CARES Act, the loan cap is increased to $100,000 or 100% percent of the vested balance if the vested balance is lower than $100,000. Typically when these loans are taken, the employee or plan participant repays the loan through paycheck reductions commencing immediately (in effect, paying yourself back using a paycheck deduction), but the new rules allow those payments to be postponed for up to one year.
Another aspect of the law designed to assist those effected by COVID-19 is the suspension of required minimum distributions (RMDs) in 2020 from IRAs, group plans (like 401ks), and inherited IRAs. There have been many questions about how this might apply to those who have already taken some or all of their RMD in 2020. The first recourse is to use what is known as the 60-day rollover option, which can be used once every 365 days. If the RMD recipient replaces the funds (including any taxes withheld) within 60 days of receipt, the RMD is effectively negated. This option, however, does not apply to inherited IRA holders as only the original IRA owner can take advantage of a 60-day “rollover.” For those who took their RMDs more than 60 days ago, there is little recourse. One method is to file a claim that the distribution occurred for the same reasons applied under the new rule allowing retirement plan distributions of up to $100,000 (see above). Another is to file an appeal with the IRS identifying the new regulations as an exception to the 60-day rule, although this approach may be more difficult. RMDs are expected to be applicable as normal in 2021 with the traditional mortality table and divisors applied based on your age in that year.
Besides the direct cash infusions, perhaps the most generous individual aid will come in the form of enhanced unemployment benefits. For the first time, self-employed individuals will be eligible for unemployment payments. There is no waiting period for any person applying for payments and funds are provided from the first day of unemployment. Perhaps the most beneficial aspect of the approach is an augmentation to the weekly benefit of $600 for up to four months. In light of the average unemployment check coming in at about $364, this amount is significant. However, even though the enhancement to unemployment by the federal government is set at $600, base levels of unemployment assistance can vary widely from state to state. Additionally, the federal government will pick up an additional 13 weeks of unemployment pay after the normal duration of payments established by the states have run their course.
For the charitably inclined, there is a new $300 dollar 2020 deduction for donations made directly to qualified organizations. Significantly, the deduction can be taken even if you don’t itemize. The tax benefits are relatively small but it is a unique carve out that allows people to help fund the many charitable entities that have stepped up to help during the pandemic or to assist churches or other institutions that have been closed down and are themselves suffering from a lack of cash flow. Also, for the very wealthy who itemize deductions and make generous donations as a matter of duty and habit, contributions are now allowed up to 100% of adjusted gross income (although contributions to donor advised funds do not fall under the benefit).
Student loans and health care related rules have also been temporarily altered by the CARES Act. For student loans, no payments are required until September 30, 2020 and no interest will accrue during this time. However, the suspension is not automatically instituted by the loan service providers and those impacted must be proactive and request the suspension. For those borrowers who are part of the Public Service Loan Forgiveness (PSLF) program or others similar, it is imperative that you take the steps to suspend your payment as it constitutes free money if the other conditions of the program are ultimately met. The features involving changes to health care include the ability for Medicare members to receive the COVID-19 vaccine free of charge and also to request up to a 90 day supply of medication instead of the normal 30 day limit.
Arguably the cornerstone of the CARES Act is the provision of extraordinary financial aid, roughly $350 billion for small businesses, known as the Paycheck Protection Program (PPP). It provides generous loans backed 100% by the federal Small Business Administration (SBA) which can be forgiven entirely if certain conditions are met. Loan interest is capped at 4% with the maximum duration set at ten years and a maximum amount of $10 million. There are no prepayment penalties or loan fees. While sole proprietors must wait until April 10, 2020 to apply for funds, the window for every other business opened on Friday, April 3. The largest portion of the funds are focused on two year loans with a 1% interest rate although loans can meet any conditions consistent with the guidelines. There’s only one loan per organization although it might be possible to roll previous SBA loans with more unfavorable conditions into the PPP.
PPP loans are straightforward, as well as the criteria applied to have the loan fully forgiven. Broadly scoped, businesses of 500 workers or less fall under the program although there are some carve outs for certain entities. Each eligible business must simply make a good faith certification that the loan is necessary due to the uncertainty of current economic conditions caused by the Coronavirus. It is expected that the standard will be applied liberally due to the subjectivity of the meaning of the word “uncertainty” although making a provably false attestation would be considered a felony.
What specific amount can the small business apply for? The formula is simple: the maximum amount is 2.5 times the average monthly payroll costs of the 12 months preceding the loan application, although there are special rules applied for seasonal businesses and newer businesses. Compensation is capped at $100,000 per employee (increments above $100,000 are negated in the formula). Funds disseminated can be used for payroll costs, insurance premiums, mortgage interest or rent, utilities, and a few other categories. The loan forgiveness aspect is also easily calculable. If the business maintains the same number of employees and compensation for the eight weeks subsequent to the receipt of the funds as they had from February 15, 2019 to June 30, 2019 OR January 1, 2020 through February 29, 2020 (the business owner can choose the more favorable period), the loan is discharged and essentially becomes a tax-free grant. However, it is important to note that use of the loan proceeds for non-payroll purposes is capped at 25% and forgiveness for any funds that are used for purposes other than payroll costs is capped at 25%. In short, for business owners the easiest way to have the loan forgiven is to allocate all of it to payroll costs, if possible. For businesses that laid off employees at the onset of the negative economic effects of the pandemic, there is the opportunity to become eligible for a loan by rehiring employees let go by June 30, 2020. Ultimately, if the loan is not forgiven, service payments can be deferred for at least six months and up to a year.
The application for the PPP is on the SBA website. It is four pages in length and simple to complete, although the data used to compute the loan amount must be gathered and retained. The best approach is to set aside for posterity the payroll documents and other collateral used to compute the loan amount. Businesses who are eligible for the PPP should first approach their personal banker for assistance. If that professional is not participating in the Program, several large banks, including Citi, Chase, Bank of America, Wells Fargo, and Capital One, have committed to initiate and service applications. In most instances, these requests for funds can be made on-line. Loans are provided on a first come first served basis, but a speedy application at this time is almost impossible as many institutions are not prepared to implement the program and some aspects of the PPP have not yet been clarified by the Treasury to the satisfaction of many lenders. As a practical matter, applicants should be patient but prepared to move forward once these initial problems are worked out. Also, to lessen the urgency, congressional leaders and the President have already committed to future funding for the PPP if it becomes clear that the budget for the program is being rapidly depleted.
There are other financial aid earmarks for small businesses that are separate and distinct from the PPP. However, if a business successfully attains aid under the PPP, they are ineligible for these benefits. There is a new employee retention credit equal to 50% of wages paid to an individual up to a maximum of $10,000 per person. It is targeted at businesses that were forced to close or drastically curtail normal operations due to government mandates and/or had a drastic drop off in revenues due to the pandemic forced slowdown. Generally, if a business can show a 50% loss of revenue in 2020 against the comparable quarter in 2019, the retention credit can be applied for every quarter this prevails until revenues are at an 80% level of the previous quarter effective to the end of 2020. For those businesses, including sole proprietors, who aren’t eligible for the retention credit, the alternative program is the Deferral of Payment of Payroll Taxes which is designed to aid in cash flow if it has become compromised due to the pandemic. With this new program, payroll taxes applicable in 2020 can be deferred to future years by making good on 50% of the taxes deferred in 2021 and the rest in 2022.
To close out the unprecedented size and scope of the financial aid being extended to small businesses under the CARES Act, changes have been instituted in the methodology used to apply net operating losses (NOLs) for tax purposes. For tax years 2019 and 2020, businesses can utilize NOLs generated in prior years to offset 100% of taxable income. Businesses that incurred NOLs in tax years 2018 and 2019, or incur them in 2020, can carry forward losses for up to five years. In effect, this serves to accelerate tax refunds.
At Peak, we are committed to working with each and every one of you to determine which aspects of the CARES Act may benefit you. For example, if you are suffering a hardship because of the Coronavirus, there are trade-offs between taking a loan from your 401k or 403b and taking a direct taxable distribution from an IRA. Together we can help you choose the best option. A few proactive clients have already asked about undertaking Roth conversions in 2020, not necessarily as a benefit of the CARES Act, but because markets are much lower now than at the beginning of the year, making conversions particularly attractive. In some cases, the waiver of RMDs in 2020 may also make conversions more tax advantageous. For those who have already taken RMDs in 2020, the use of the 60-day rollover rule should be weighed immediately against your need for cash flow. However, for other aspects of the legislation, there is plenty of time to develop thoughtful strategies to determine what financial actions you can and should take. We stand at the ready to help you through this crisis and look to better days ahead.