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May 18, 2020

With the Families First Coronavirus Response Act (FFCRA), Pub. L. 116-127, on the books for over eight weeks, the CARES Act, Pub. L. 116-136, on the books for seven weeks, and the Paycheck Protection Program and Health Care Enhancement Act (PPPHCEA), Pub. L. 116-139, being enacted almost three weeks ago, we thought it would be helpful if we look back and provide our observations in light of all the post-legislative guidance. 

1. Good Things Come to Those Who Wait … Except When They Don’t

While the public has been struggling to understand, let alone address, the pandemic, the Internal Revenue Service (IRS) was yet again placed in a daunting position by Congress and the President of the United States: enforce new tax provisions that are effective immediately. The IRS has set out to address the challenge by issuing numerous Revenue Procedures, Notices, and Frequently Asked Questions in an effort to provide guidance as quickly as possible. As a result of that guidance, it is clear that in general, good things come to those who wait, as taxpayers have generally received a better answer by waiting for the new guidance to come out, than if they had applied the law based only on the statutory language. For example, prior to Notice 2020-26 (previously discussed in detail here), taxpayers might have filed a paper amended return to claim the carryback of a 2018 net operating loss (NOL). Notice 2020-26 allows taxpayers to file an application for a tentative refund instead (Form 1045 or Form 1139). The Notice was followed by an IRS announcement that the application for a tentative refund can be faxed rather than mailed so that it can be processed faster. 

A&M Taxand Says: There are still numerous areas in which it is unclear how the new statutory provisions apply. The IRS has stated that additional guidance is forthcoming on a wide range of topics. If that guidance follows the approach of the guidance issued with respect to the FFCRA and the CARES Act, then it will generally be taxpayer favorable. As a result, taxpayers who are able to wait for guidance may be in a better position than those who are not. A&M Taxand is actively monitoring the guidance issued by the IRS, as well as the Treasury Department, the Small Business Administration (SBA), and the Department of Labor (DOL) in response to COVID-19. Our COVID-19 insight center includes all of the insights that we have released to date.

With that said, unfortunately, waiting is not always all that it is cracked up to be. For example, the CARES Act created the Paycheck Protection Program (PPP), which in essence provided a forgivable loan from the government for certain expenses. Although the PPP was touted as a way to infuse needed liquidity into the market, all the funds allocated to the program were gone in less than a week, while many would-be applicants were still navigating the process. While the PPPHCEA infused additional resources into the PPP program so additional loans will be granted, the additional funding is not expected to satisfy demand. 

A&M Taxand Says: If you meet the qualification requirements for the PPP, then apply immediately. This truly is a great example of you snooze… you lose.

2. Who Knew Counting to 100 or 500 Would Be so Hard?

The FFCRA and the CARES Act contain provisions that focus on the number of employees an employer has.

  • An employer generally must provide paid sick leave (in addition to any leave they had already provided) and paid family medical leave (FMLA) for certain COVID-19 absences if the employer has fewer than 500 US employees as of the date the employee wishes to take leave. (FFRCA)
  • An employer may be eligible for an employee retention credit (ERC) for certain wages and qualified health plan expenses. However, to determine which wages qualify, the employer needs to know whether it averaged 100 or fewer employees in 2019. (CARES Act) [1]

Unfortunately, which employees count towards the various thresholds vary:

  • For the FFRCA, full-time and part-time employees count, as well as temporary employees and employees that are on leave, so long as they are in the US. An employer cannot terminate or furlough workers solely to provide coverage.
  • For purposes of the ERC, it is clear that full-time employees count. IRS guidance is unclear as to whether full-time equivalent employees (FTEs) count.

Additionally, in determining the application of these provisions, a taxpayer may need to aggregate its activities with those of other taxpayers. For example, the ERC treats all businesses that are under common control as a single taxpayer (applying certain very broad tests under sections 52 and 414 of the Internal Revenue Code). By contrast, for purposes of the sick and family leave credits, two businesses are aggregated only if they constitute an “integrated employer” under the FMLA. While the tests under section 52 and 414 are generally objective and based on common ownership, the “integrated employer” standard is based on all facts and circumstances and requires a relatively high degree of actual operational and managerial integration between two entities.

A&M Taxand Says: For purposes of the FFRCA, based on current law, our current view is that most private equity funds would generally not need to aggregate across the portfolio, or aggregate separate entities within a given portfolio investment, to determine the number of employees under the integrated employer test. These are not new rules; therefore, funds should look at the positions they have taken historically as well and consult with their advisor as to their specific position. 

For purposes of the ERC, based on current law, our current view is that most widely held private equity funds would need to look at all 50% or greater owned US entities within a portfolio company together, but would likely not need to aggregate the US entities of every portfolio company of a fund. However, this is not clear in the law and is very fact specific, so each fund should assess their situation separately with their advisors.

3. A Taxable Year Is a Taxable Year

It seems pretty straightforward to say a taxable year counts as a taxable year. However, it is important to remember that short taxable periods count as full taxable years. For example, a corporation that has a taxable period from January 1st – November 30th, and another taxable period from December 1st – December 31th, must count each period as a separate taxable year for purposes of measuring the NOL carryback period. This is essential when determining how far back an NOL can be carried.

Additionally, it is worth noting that the five-year NOL carryback provisions under the CARES Act apply with respect to taxable years that begin after December 31, 2017 and before January 1, 2021. As a result, a taxpayer may be able to change its taxable year to end before December 31, 2020 to create a subsequent taxable year that extends beyond January 1, 2021, and thereby maximize the period of time during which losses will be eligible for the five-year NOL carryback provision.

A&M Taxand Says: The decision to change a taxable year should not be made lightly as it may have long-lasting implications. Therefore, taxpayers should be wary of making such a change without a thorough examination of the potential consequences.

4. How Many Tax Returns Should a Tax Paying Taxpayer File, If a Tax Paying Taxpayer Wants a Refund?

If the question did not make you laugh, then the answer definitely will. The number of tax returns that a tax paying taxpayer needs to file to claim a refund depends on how quickly a taxpayer wants a refund and the amount of the refund. A refund claim is generally subject to Joint Committee on Taxation (JCT) review if the amount of the refund is in excess of $5 million for C corporations and $2 million for all other taxpayers. The general time frame for the IRS to process a refund that is subject to JCT review is approximately 5 – 6 months.

However, taxpayers need immediate liquidity. As a result, there are certain refunds for which a taxpayer can file a tentative application, which generally is supposed to be processed within 90 days. The rules on when and how a tentative application can be requested are complex and differ between taxable years. Refund opportunities under COVID-related legislation arise due to the newly granted ability to carry back NOLs incurred in taxable years ending after 2017.

What a taxpayer has to file to get a refund can be confusing. For example, a taxpayer can file a tentative application for a refund (Form 1045 or Form 1139) for 2018 for the refundable Minimum Tax Credit, but it has to file an amended return for 2018 in order to claim a refund associated with the Retail Glitch Fix (discussed here). Similarly, a taxpayer may be able to file a Form 1045 or Form 1139 for a refund as a result of the carry back of a NOL, but it has to file an amended return to claim a refund for the non-refundable Minimum Tax Credit (i.e., a credit taken pre-2018) that results from the carry back of the NOL.

Additionally, the tentative claim for a refund or amended return also poses its own complexities. For example, a Form 1045 or Form 1139 to carry back a NOL from a taxable year ending on December 31, 2018, has to be filed by July 15, 2020 [2].  However, a Form 1045 or Form 1139 to claim the refundable Minimum Tax Credit for 2018 does not need to be filed until December 30, 2020. (NOTE: It cannot be filed on December 31, 2020.) While a taxpayer can file duplicate forms for the same taxable year, if they wanted to file just one to claim both refunds, it needs to be filed by July 15, 2020.

A&M Taxand Says: The CARES Act and recent IRS guidance have provided many options to taxpayers as to which form to file to claim a refund. In determining which form to use, it is imperative that the form’s associated deadline, which can vary depending on the purpose for which the form is filed, is considered. Taxpayers should consult their advisors to determine which form should be used and its associated deadline.

5. Passthrough Entities Deserve More Than Breadcrumbs

As of 2014, there were approximately 7.4 million passthrough entities (partnerships and S corporations) in the United States. That number has continued to grow and yet those entities are generally unable to take advantage of the “Business Provisions” of the CARES Act in order to obtain liquidity for their businesses, because they generally do not pay taxes. As a result, while C corporations are evaluating how to maximize their liquidity based on the CARES Act provisions, passthrough entities are left looking for breadcrumbs … the hope of obtaining a PPP loan or qualifying for an ERC, which is available for all businesses (including passthrough entities).

It is important to note that if an entity does qualify for the ERC, the credit (as provided in the CARES Act) is limited to 50% of the qualified wages that the entity actually paid. Under the Democrats’ recently released HEROES Act, the limit is increased but it is not 100% and it is subject to additional limitations. Therefore, the ERC, whether under the CARES Act or the proposed HEROES Act, should be viewed as a partial reimbursement. Thus, as discussed in a recent alert, companies that are seeking greater liquidity are considering wage reductions, layoffs, or furloughs.

One alternative that passthrough entities should consider is whether they should convert to C corporation status so that they can avail themselves of the liquidity provisions, at least with respect to the current taxable year. Additionally, depending on the size of the entity, it may qualify as a qualified small business that affords its owners with great taxable benefits (e.g. up to $500 million of gain exclusion on exit) as discussed in a recent alert.

6. Consolidated Groups Will Be Consolidated Groups

Albert Einstein purportedly said, “The hardest thing in the world to understand is the income tax” -- and this was before the advent of the modern consolidated return regulations. In order to appropriately apply the consolidated return rules, one must first understand the rules that apply to taxpayers in general. Then, the consolidated return rules must be overlaid on the general rules, at times providing different rules than those that apply to a corporation that is not a member of a consolidated group. These consolidated return rules are complex as they seek to clearly reflect the taxable income of the group while retaining the separate attributes of its members. As a result, sometimes members of a consolidated group are treated as divisions of the same corporation (e.g., the intercompany transaction rules), and at other times separate company existence is respected (e.g., separate return loss year (SRLY) rules or NOL carryback rules). 

Therefore, the consolidated return rules raise their own questions that have to be thoughtfully considered. For example, a member of a consolidated group that carries back an NOL may be generating a refund for another taxpayer. See our discussion of the NOL carryback here.

A&M Taxand Says: The mechanics of some of the consolidated return regulations are complex and may yield results that are not intuitive. Careful application of the rules is necessary in order to ensure that taxpayers are making appropriate decisions.

7. Low Valuations Aren’t Necessarily All Bad

Before COVID-19, the stock markets were reaching for record highs. As of this writing, they have recovered somewhat from the plunge they took in March, but in general, stocks are well off their recent highs. The lack of current and forecasted profitability in many sectors has driven valuations of public and private companies down. While this doesn’t make your portfolio look good in a snapshot, it may provide opportunities to restructure and rearrange business segments without incurring significant tax cost.

Companies that have been considering internal restructuring may have been deterred by the potential recognition of taxable gains on stock or asset transfers. Low current valuations – which everyone hopes will be temporary – may reduce or eliminate those gains and make restructuring more attractive. A&M tax valuation professionals can assist you in determining those values and, accordingly, the tax cost of a restructuring. Cross-border internal restructurings (IP transfers, out from under transaction, etc.) may have become temporarily easier to accomplish in both domestic and foreign jurisdictions at lower tax costs. Additionally, as discussed in a previous alert, it would be beneficial, if not essential, for companies to evaluate or re-evaluate their transfer pricing documentation and policies.

Taxpayers may also take advantage of depressed valuations to recognize losses that now can be carried back for five years, if recognized before 2021. If a subsidiary is under water, now may be the time to trigger a worthless stock deduction, which may be achieved without actually disposing of the subsidiary’s business. No one wants their trade debtors to go under, but if accounts receivable become doubtful, the creditor may have an opportunity to resolve doubt in favor of a bad debt deduction.

8. In Bankruptcy, the Tortoise May Beat the Hare

In bankruptcy, a taxpayer is always looking for the fastest way to receive cash. As a result, when a corporation in bankruptcy faces the possibility of claiming a refund on an amended return (Form 1120X) or on an application for a tentative refund (Form 1139), for example, due to the carryback of an NOL, the initial reaction is to file a Form 1139. As discussed in #4 above, a Form 1139 is supposed to be processed within 90 days, and if the refund is subject to JCT review, that review occurs after the issuance of the refund. On the other hand, a refund that is claimed on an amended return is reviewed by JCT (if subject to their review) prior to the issuance of the refund and there are no set guidelines as to how long the process could take, although it is typically 5 – 6 months.

However, the timing of the cash refund should not be the only factor in deciding which form a taxpayer should file. In bankruptcy, the IRS is allowed to claim an administrative expense equal to the excessive allowance of a tentative carryback adjustment. As a result, if a Form 1139 is filed, then the IRS may (and likely will) assert an administrative expense claim in the full amount of the tentative refund. Therefore, the receipt of the cash can be viewed as an interest free loan or a contingent liability until the IRS completes its review of the return. There are circumstances in which the IRS review can delay the taxpayer’s exit from bankruptcy. On the other hand, if the refund is issued as a result of a Form 1120X, receipt of the cash generally concludes the process. Additionally, the taxpayer may be able to take advantage of procedures to shorten the time frame in which the IRS must determine the amount of the refund.

A&M Taxand Says: A corporation in bankruptcy has to balance the desire to receive cash and successfully emerge from bankruptcy against the ability to remain solvent. There are many nuances that apply to corporations in bankruptcy, which A&M professionals in the Restructuring Tax Services (RTS) group address on a daily basis. If you are in bankruptcy, or considering filing for bankruptcy, we would be happy to assist you or your advisors in navigating these nuances.

9. 50 States = 50 Different Tax Laws

Although many states conform their tax laws to the federal tax laws, this does not mean that all of the changes made to the federal tax law by the CARES Act will apply for state tax purposes. In fact, as discussed in a recent alert, New York recently decoupled from the CARES Act changes to the modified interest deduction rules. Similarly, although the IRS has provided a grace period for the filing of tax returns, paying of certain taxes, and certain time sensitive matters with the issuance of Notice 2020-23 (as discussed here), the state tax relief that has been granted varies widely by state.

A&M Taxand Says: In addition to monitoring federal tax developments, clients are encouraged to consider 2020 state tax legislation for each state in which they have a filing obligation. As we continue to monitor developments, we will maintain a high-level state and local tax response summary that is available here.

10. There Is No One Size Fits All Approach to All of the Cares Act Provisions

The foregoing discussion should make it clear that the tax provisions of the CARES Act are intricately interwoven with each other and with existing rules and procedures, making the decision on when and how to apply the new provisions a complex exercise. A taxpayer’s ability to benefit from the new rules can depend on its history and current tax posture with respect to such diverse items as depreciation, interest expense, consolidated returns, NOLs, foreign tax credits, GILTI, and BEAT. For example, the CARES Act changes to the section 163(j) interest expense limitation (discussed in detail here) and depreciation of qualified improvement property can generate or enhance NOL carrybacks. But the benefit of those carrybacks can be diluted by their effects on other tax attributes in the carryback year, such as foreign tax credits, or on income taxed at reduced rates, such as GILTI and FDII.  

A&M Taxand Says: An optimal approach to the CARES Act provisions can only be uncovered by the application of sophisticated modeling to the taxpayer’s specific facts and circumstances. A&M Taxand is happy to help you navigate these intricacies, as well as discuss strategies that can be implemented to maximize liquidity and long-term growth.

[1] It is worth noting that the CARES Act also provides that one of the requirements to qualify for the PPP is that, with certain exceptions, an employer must have 500 or fewer employees. However, the rules for determining the number of employees are different from the rules applicable to the ERC.

Additionally, earlier this week, the Democrats released bill text for the HEROES Act (discussed here -, which would change the computation of the ERC, including the impact the number of employees has on the availability of the ERC.

[2] It should be noted that under the Democrat’s proposed HEROES Act, taxpayers are unable to claim an NOL carryback from taxable years that began before January 1, 2019.