The Coronavirus Aid, Relief, and Economic Security (CARES) Act provides two distinct and substantial employment tax benefits for certain employers under Sections 2301 and 2302 of the Act. Section 2301 provides a refundable payroll tax credit for certain wages paid to employees from March 13 to December 31, 2020. Section 2302 allows employers to defer the deposit of certain employment taxes for as much as two years. Taken together, these provisions provide significant relief for employers and are designed to encourage employers to continue paying wages to employees during these unprecedented times.
Section 2301 Employer Retention Credit
Insight:
This credit is not limited to small employers. However, any employer who receives a Small Business Administration Loan under the Paycheck Protection Program of the CARES Act is ineligible to receive this employee retention credit.
Section 2301 of the CARES Act provides a payroll tax credit of up to $5,000 per employee for eligible employers. The credit is equal to 50% of “qualified wages” paid to employees during a quarter, capped at $10,000 of “qualified wages.” The credit is available for wages paid from March 13 to December 31, 2020.
Eligible Employers To be eligible, employers must meet the following criteria:
They must be carrying on a trade or business during 2020, and
During the calendar quarter, either:
Their operations were fully or partially suspended as a result of orders from a governmental authority limiting commerce, travel, or group meetings due to COVID-19, or
Their gross receipts for the quarter were less than 50% of the gross receipts for the same calendar quarter in the prior year. The employer will remain eligible for the credit until such calendar quarter as their gross receipts equal 80% of the gross receipts for the same calendar quarter in 2019.
Qualifying Wages The wages that can be used to calculate the tax credit differ based on whether the employer has over or under 100 employees. For employers with 100 or more full-time employees on average during 2019 (as determined by IRC Section 4980H as enacted by the Affordable Care Act), only wages paid to employees who are not providing services qualify for the credit. But for employers with less than 100 full-time employees, all wages paid to employees, regardless of whether the employees are providing services, qualify for the credit. For purposes of the employee count, organizations that are under common control (using IRC Section 52(a) and (b)) or that are a member of an affiliated service group (using IRC Section 414(m) and (o)) will be treated as a single employer.
Qualified wages are based on the definition of wages used for FICA taxes, plus the amount paid by the employer for health plan expenses. But the wages cannot exceed what the employee would have been paid for working an equivalent amount of time during the preceding 30 days. In other words, wage increases do not qualify for the employee retention credit. The CARES Act does not explain how this limitation should be calculated, so IRS guidance would be helpful.
Any federally mandated sick or child care leave paid under the Families First Coronavirus Response Act (FFCRA) is specifically excluded from “qualified wages” for the employee retention tax credit, since employers receive a dollar-for-dollar tax credit for such paid leave wages.
Insight:
The employee retention tax credit cannot be taken on the same wages as other tax credits, such as Work Opportunity Tax Credit under IRC Section 51 or Employer Credit for Paid Family and Medical Leave under IRC Section 45S.
How to claim the credit Claiming the employee retention credit will track the same procedures for claiming the tax credits for providing federally mandated paid sick and child care leave under FFCRA. In IR 2020-57 (dated March 20, 2020), the IRS said that employers can immediately recoup their refundable tax credits for paid sick and child care leave by reducing their total federal tax deposit amount from all employees (not just from those who are receiving wages that qualify for the credit) by the amount of eligible credit. Specifically, employers can deduct the amount of tax credit for paid sick and child care leave from: (1) federal income taxes withheld from all employees’ pay; (2) the employees’ share of Social Security and Medicare taxes; and (3) the employer’s share of Social Security and Medicare taxes. Likewise, in IR 2020-62 (dated March 31, 2020), the IRS said that employers can follow that same process to immediately recoup their employee retention tax credit. These credits will ultimately be reconciled against the total tax liabilities when employers file their quarterly Form 941 or other employment tax returns.
In addition, the IRS has published Form 7200, Advance Payment of Employer Credits Due to COVID-19, which allows employers to request a rapid refund for both the employee retention credit and the FFCRA paid sick and child care leave tax credits. Form 7200 can be filed (by fax) to request an advance of payments at any time before the end of the month following the quarter in which the qualifying wages were paid. It can be filed multiple times during the quarter if necessary. Amounts use to offset federal tax deposits as described above should not be duplicated on a request for refund on Form 7200. Ultimately, any amounts refunded using Form 7200 will also be reconciled on the employer’s quarterly Form 941 or other employment tax returns.
Insight:
The timing of the rapid refunds is still somewhat unclear. They are supposed to be processed within two weeks after receipt of Form 7200, but the IRS’s system for processing Form 7200 does not yet appear to be fully operational and it is unclear when it will be up and running. To maximize cash on hand, employers should compare whether they might be better off offsetting their accumulated tax credits from their upcoming payroll deposits or requesting the refund on Form 7200. The result may differ for each employer, depending on their facts and circumstances.
Section 2302 Employer Payroll Tax Deferral
Insight:
This payroll tax deferral is available to all employers with no size restriction. However, any employer whose Paycheck Protection Program (PPP) SBA loan is forgiven under Section 1106 of the CARES Act is ineligible for this payroll tax delay.
Section 2302 of the CARES Act permits employers to forgo timely payment of the employer portions of Social Security and RRTA taxes that would otherwise be due from March 27 through December 31, 2020, without penalty or interest charges (as confirmed by IRS Notice 2020-22, dated March 31, 2020). Employers must pay 50% of the deferred amount by December 31, 2021, and the remainder by December 31, 2022.
Insight:
If the employer utilizes this benefit and later is approved for PPP SBA loan forgiveness, it is not clear if the payment date on accumulated deferrals is accelerated to the forgiveness date or if deferrals cease on a prospective basis.
Self-employed individuals can take an equivalent tax deferral on 50% of the OASDI tax imposed on self-employment income under IRC Section 1401 and will not be penalized for failing to make estimated tax deposits on that amount during the deferral period.
To protect third parties, such as payroll service providers and certified professional employer organizations, the CARES Act requires that the customer or client bear the ultimately responsibility for the payment of any deferred taxes if they instruct the third party to defer payment.
Insight:
It is not yet clear how these two provisions would work in tandem. At the moment, it appears that an employer could defer its deposit of payroll taxes that are otherwise due from March 13 to December 31, 2020 (using the payroll tax holiday under Section 2302 of the CARES Act) and offset against those un-remitted payroll taxes the employee retention credit (under Section 2301 of the CARES Act), and/or the tax credits for paying federally mandated FFCRA sick and child care leave, which would reduce the amount that the employer would eventually need to remit (i.e., 50% of the net amount would be owed on December 31, 2021, and the remainder would be owed on December 31, 2022).
As the number of employers and employees impacted by the novel coronavirus (COVID-19) grows each day, employers with workplace retirement plans may find that employees may be looking to those plans now more than ever to help cover financial hardships they are experiencing. The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (H.R. 748) includes several relief provisions for tax-qualified retirement plans, expands health care flexible spending accounts so funds can be used for over-the-counter items, clarifies some health insurance plan questions, and, through year-end, allows employers to reimburse employees for student loan payments tax-free. This alert explains those items. Further guidance will be needed from the IRS and DOL to answer many open questions about how these relief provisions are intended to work.
Defined Benefit (DB) Retirement Plans
Although it is not clear, based on past practices, the IRS may require employers to make an election to use the provisions described below. Plan amendments memorializing those elections would be needed by January 1, 2022.
Funding Relief. Many employers who sponsor defined benefit (DB) retirement plans (including cash balance plans) are facing large contribution requirements due to very low interest rates and a volatile stock market. The CARES Act provides short-term relief for single-employer DB plans. Specifically, employers have until January 1, 2021, to make any minimum required contributions that were originally due during 2020. The relief applies to quarterly contributions and any year-end contributions, regardless of plan year. When paid, contributions will need to include interest for the late payment.
AFTAP Relief. Also, when determining whether Internal Revenue Code (IRC) Section 436 benefit restrictions apply to any plan year that includes the 2020 calendar year, sponsors can (but are not required to) choose to use the plan’s adjusted funding target attainment percentage (AFTAP) for the plan year ending in 2019. This could help employers avoid freezing benefits and continue offering lump sums and other accelerated payment forms in 2020, even if the plan’s funded status significantly declined due to COVID-19.
RMDs Not Waived for DB Plans. DB plans are not eligible for 2020 RMD waivers (that relief is only available for defined contribution plans (see below)).
Defined Contribution (DC) Retirement Plans
Coronavirus-Related Distributions and Expanded Plan Loans. Employers who have DC plans — like a 401(k) plan or 403(b) plan — can let participants take up to $100,000 in “coronavirus-related distributions” by December 31, 2020. The distributions would be exempt from the 10% early withdrawal penalty and taxable over three years. Participants can take up to three years to repay all or any part of those distributions (and the repayment would be treated as a tax-free rollover when repaid to the plan).
From March 27 to September 23, 2020 (i.e., for 180 days after the CARES Act became law), “qualified individuals” can borrow up to the lesser of $100,000 (instead of just $50,000) or 100% of their entire vested account balance (instead of just 50%). For all new or existing plan loans to an affected participant, repayments due before December 31, 2020, may be delayed one year (but interest is charged during the delay). Also, the one-year delay would not count toward the maximum five-year repayment period for plan loans.
These special “coronavirus-related distributions” and expanded plan loan provisions are available to “qualified individuals,” which means any participant who self-certifies that he or she:
Has been diagnosed with SARS-CoV-2 or COVID-19 (with a test approved by the Centers for Disease Control and Prevention);
Has a spouse or dependent who has been diagnosed with SARS-CoV-2 or COVID-19 (with a test approved by the Centers for Disease Control and Prevention); or
Has experienced adverse financial consequences from being quarantined, furloughed or laid off; having work hours reduced; being unable to work due to lack of child care; closing or reducing the hours of a business owned or operated by the individual; or from other factors, as determined by the Treasury Secretary.
Insight
When former employees no longer have payments made via payroll deductions the loans frequently go into default, resulting in taxable income for the participant at the end of the calendar quarter following the default date and a Form 1099-R would be issued showing the loan balance as taxable income for the year. However, the CARES Act appears to provide a one-year grace period for any loans that were outstanding on or after March 27, 2020. It seems that this one-year extension could delay the income inclusion for one year if a participant with an outstanding loan would otherwise default on the loan due to nonpayment including loss of employment due to a COVID-19 related business closure. To prevent such loan defaults, employers may want to amend the loan documents and/or loan policy so that affected participants can take advantage of the one-year delay even if the participant’s employment is terminated or if the participant is laid off.
Participants that don’t qualify for “coronavirus-related distributions” may qualify for a regular “hardship” withdrawal due to an immediate and heavy financial need, if the plan allows. There are many situations that qualify a participant for regular hardship withdrawals, including expenses or loss of income incurred due to a disaster declared by the Federal Emergency Management Agency, also known as FEMA. Regular hardship withdrawals cannot be repaid to the plan, must be taken into income in the year distributed, and are subject to the 10% early withdrawal penalty (although they are not subject to 20% withholding). Generally, DC plans may also allow in-service distributions for participants who are over age 59½ and may allow vested employer contributions to be withdrawn under a “5 year” or “2 year” rule, so long as the plan document allows it (or is amended to allow it).
2020 Required Minimum Distributions (RMDs) Suspended. The CARES Act waives all 2020 RMDs from DC plans (and IRAs). That waiver includes initial payments to participants who turned age 70½ in 2019 and who did not take their initial RMD last year because they had a grace period until April 1, 2020. The RMD relief does not apply to DB plan participants.
Plan Amendments. Employers can immediately implement the provisions provided by the CARES Act but generally have until the end of the first plan year beginning on or after January 1, 2022, to amend their DC plans for this relief. Amendments to adopt provisions that are not included in the CARES Act require amendment by December 31, 2020.
Insight
This deadline appears to be the same for individually designed DC plans and for IRS preapproved DC plans
What Should Retirement Plan Sponsors Do Now?
Employers who sponsor workplace retirement plans should review plan procedures to determine if any changes are needed to implement the CARES Act. For example:
For DC plans that will allow “coronavirus-related distributions” in 2020, a new distribution code would be needed, so that those distributions are not subject to the 10% early distribution penalty tax or the mandatory 20% withholding that would otherwise apply. If employers have more than one DC plan in their controlled group, procedures are needed so that the amount of such distributions made to any individual does not exceed a total of $100,000. These procedures would be similar to those for plans that made qualified disaster distributions over the past few years for certain hurricanes, floods or wildfires. If the DC plan will allow coronavirus-related distributions to be repaid to the plan, procedures are needed to treat those as rollover contributions and to limit the amount of such repayments to the amount of coronavirus-related distributions that the employee took from all DC plans in the controlled group.
If a DC plan sponsor wants to increase the maximum plan loan amounts available under the plans during 2020, existing plan loan procedures would need to be updated to allow for that increase. Plan sponsors who limit how many outstanding loans a participant can have at any time may want to increase that limit to allow participants to use the increased loan limits. Permissible one-year delays in loan repayments should be documented (such as updating amortization schedules), so that loans will not go into default. DC plans that do not currently allow participant plan loans could be amended to add them.
DC plan sponsors will need to update their plan operation immediately for the waived 2020 RMD distributions. Plans would use similar procedures as were used when 2009 RMD payments were waived after the 2008 economic crisis.
The plan’s definitions of covered compensation should be reviewed to ensure it is aligned with the sponsor’s intent, especially with regard to determining if employee assistance and paid leave will be subject to employees’ deferral elections and employer contributions.
Employers may also want to remind participants that they can change elective deferral amounts at any time in accordance with the plan document and to inform them how to take advantage of any changes in plan operations or procedures due to the CARES Act.
Health Plans
Tax-Free Over-the-Counter Products. The CARES Act allows employees to use funds in health care flexible savings accounts (FSAs) to purchase over-the-counter (OTC) medical products, including those needed in quarantine and social distancing, without a prescription. This change also applies to Health Savings Accounts (HSAs). Employers must generally have a “high deductible health plan” (HDHP) to have an HSA for their employees. Several years ago, the Affordable Care Act (ACA) eliminated the ability to use health care FSAs for OTC products, so the CARES Act rolls back that prohibition. The CARES Act also provides that menstrual products qualify as OTC products that can be purchased with health care FSA or HSA funds.
Insight
Employers may want to consult with their vendors to ensure that debit cards or other service delivery mechanisms are updated to accommodate this change in the law, so that employees may begin using health care FSAs or HSAs immediately to purchase COVID-19 related OTC items, such as pain relievers, hand sanitizers, cleaning products, etc.
Insight
Employers may want to remind employees of change in family circumstance requirements that might allow them to change their health care elections including pretax contributions to medical FSAs. Likewise, plan administrators should prepare for an increased number of requests for change.
Health Care Services
The CARES Act requires employer-sponsored group health plans (and health insurers) to address several health care services related to COVID-19, including the following.
COVID-19 Testing. Group health plans and insurers are required to cover approved diagnostic testing for COVID-19, including in vitro diagnostic testing, without any cost-sharing to participants, at their in-network negotiated rate (or if no negotiated in-network rate, an amount that equals the cash price for such tests as publicly listed by the provider).
COVID-19 Prevention. Group health plans and insurers are required to cover any qualifying preventative services related to COVID-19 without cost-sharing to participants. Plans are required to cover these services within 15 days after the date that a recommendation is made regarding the preventative service. Preventative services includes (1) any item, service, or immunization that is intended to prevent or mitigate COVID-19 and is evidence-based with an “A” or “B” rating in the U.S. Preventive Services Task Force’s recommendations or (2) an immunization with a recommendation from the Advisory Committee on Immunization Practices of the Centers for Disease Control and Prevention.
Expanded Telehealth. Effective March 27, 2020, for plan years beginning on or before December 31, 2021, employers with a HDHP and an accompanying HSA can provide coverage for telehealth services before participants reach their deductible without disqualifying them from being eligible to contribute to their HSA. For calendar year plans, this provision would generally apply for 2020 and 2021. This is consistent with the IRS’s previous announcement that an HDHP will not fail to be an HDHP solely because it provides coverage for COVID-19 related diagnostic testing and services prior to participants satisfying their deductible.
Tax-Free Student Loan Repayments
From March 27 until December 31, 2020, employers can contribute up to $5,250 towards an employee’s student loans and such amount will be excluded from the employee’s taxable income. The employer could either pay the amount to the lender or to the employee. The amount could be applied to principal or interest for “qualified education loans” defined in IRC Section 221(d)(1). The $5,250 limit applies in the aggregate to both the new student loan repayment benefit and other employer-provided, tax-free educational assistance (e.g., tuition, fees, books).
Insight
This appears to be the first time an employer’s payment of an employee’s student loan debt can be made tax-free to employees.
Companies and individuals currently find themselves in unchartered territory as the world responds to the novel coronavirus (COVID-19). The implications of COVID-19 are having a direct impact on many people, for which the health and well-being of individuals and their families are paramount. In addition, companies are also being forced to deal with the ramifications of this pandemic on their businesses. To react to these challenges, governments around the world have been responding to COVID-19 in various ways, including enacting economic stimulus packages.
In the United States, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act)[1] was enacted into law on March 27, 2020, to respond to the economic challenges many are facing due to COVID-19. The CARES Act includes several business provisions that may impact a company’s accounting for income taxes. In addition, the impact of COVID-19 itself on businesses draws attention to certain provisions in ASC 740.
This alert will highlight observations and insights from an ASC 740 perspective that companies should consider as they confront these challenges to their businesses.
Change in Tax Law – CARES Act
President Trump signed into law the CARES Act on March 27, 2020, making this a Q1 event for calendar year companies. ASC 740 requires that an entity must recognize the effect of a change in tax law or rates in the period that includes the date of enactment.[2] The business provisions in the CARES Act need to be analyzed and the estimated impact of those provisions recorded as part of continuing operations during the quarter.
Modification for Net Operating Losses – Interim Reporting
The CARES Act provides for a five-year carryback of net operating losses generated in taxable years beginning after December 31, 2017, and before January 1, 2021.[3] As many companies now face a strain on their cash flow, the benefit from a carryback of a loss to a prior period will help with cash flow when taxes paid in prior years are refunded.
For net operating losses generated or utilized during this period, the 80% taxable income limitation for net operating losses will not apply, including losses carried back. It should be noted, however, that the 80% limitation on the usage of net operating losses is reinstated for years beginning after December 31, 2020.
Companies can elect, on a year-by-year basis, to forgo a carryback for 2018, 2019 and 2020 losses. In addition, an election under IRC Section 965(n)[4] will automatically be deemed to have been made to a Transition Tax period unless an election is made to exclude the Transition Tax year from a carryback claim. In addition, the CARES Act included a technical correction so that carryback and carryforward provisions apply to taxable years beginning after December 31, 2017. Lastly, losses that are carried forward from these years continue to be carried forward indefinitely.
For interim reporting purposes, companies may need to consider:
Any current tax benefit for 2020 losses that are expected to be carried back to prior years would be part of the company’s annual effective tax rate (AETR) calculation, including the potential benefit related to different tax rates (35% vs. 21%).
Any current tax benefit from the carryback of 2019 and 2018 losses, including the potential benefit related to different tax rates (35% vs. 21%), would generally be recorded discretely in the quarter.
A company recognizes a change in the valuation allowance in an interim period through its estimate of the annual effective tax rate if the change relates to either (a) deferred tax assets originating during the year or (b) deferred tax assets existing at the beginning of the year that are expected to be realized as a result of current year ordinary income.[5]
A company recognizes a change in the valuation allowance discretely in the interim period if the change relates to deferred tax assets existing at the beginning of the year that are expected to be realized in future years.[6]
Example – Current Year Loss Expected to be Carried Back
Facts:
Federal tax rate is 35% for 2015, 2016, and 2017 and 21% for 2018 and 2019
Calendar year company – Q1 2020
Forecasted ordinary loss in 2020 of 500K
Loss is carried back in full to 2015-2019
No valuation allowance at beginning or end of the year
Entity has one temporary difference for definite-lived book intangible assets
State taxes ignored for simplicity
Deferred Tax Asset (Deferred Tax Liability)
Deferred Tax Asset(Deferred Tax Liability)
Deferred Tax
1-Jan-20
31-Dec-20
Expense(benefit)
Intangible assets
(300.00)
(200.00)
Tax effected
(63.00)
(42.00)
(21.00)
Current tax expense
Current year ordinary loss
(500.00)
Reverse book intangible amortization
100.00
Forecasted taxable loss
(400.00)
Carryback to:
Tax Effect
2015
100.00
(35.00)
2016
200.00
(70.00)
2018
100.00
(21.00)
Current tax expense (benefit)
400.00
(126.00)
Deferred tax expense (benefit)
(21.00)
Total tax expense (benefit)
(147.00)
Effective Tax Rate
29.40%
The effective tax rate is higher than expected due to the carryback of the loss to 35% years in 2015 and 2016. For Q1 interim period, the AETR is 29% since the benefit relates to benefit from the current year loss.
The carryback of losses to prior tax years, including pre-TCJA[7] tax years, creates additional computational challenges. These include the effects of indirect impacts of carrybacks on prior year calculations, including, but not limited to, the former Domestic Production Activity Deduction, the IRC Section 250 deduction, and Uncertain Tax Positions. It would be expected that these indirect impacts due to 2020 losses carried back would be recorded as part of the 2020 AETR calculation. The indirect impacts from the carryback of 2018 and 2019 losses would be expected to be recorded discretely in the quarter.
The carryback of losses may “free up” credits that were otherwise used to reduce taxes in the carryback years. Such credits may be carried back or forward under the prevailing tax law. If some or all the credits can only be carried forward, consideration should be given to whether such carryforwards are realizable.
The carryback of losses on Form 1139[8] may re-open the statute of limitations for an otherwise closed year.[9] In such situations, consideration should be given to the recognition of a prior year uncertain tax position that had previously been reduced due to closure of the statute of limitations. In these instances, required disclosure on Schedule UTP (Uncertain Tax Position Statement) may also be impacted.
Modification of Limitation on Business Interest – Interim Reporting
The CARES Act provides for the relaxation of the limitation of adjusted taxable income (ATI) as determined under IRC Section 163(j) from 30% to 50% when determining the deduction for business interest expense for the 2019 and 2020 periods.[10] Further, for any taxable year beginning in 2020, a taxpayer may elect to substitute the ATI for the last taxable year beginning in 2019 for the 2020 ATI limitation calculation.
From an ASC 740 perspective, companies may need to consider:
Any increased deduction for interest in 2020 periods due to 50% limit would be recorded as part of the AETR calculation.
Any increased deduction for interest in 2019 periods due to 50% limit would be recorded discretely in the quarter.
In the case of partnerships, the increased IRC Section 163(j) limit from 30% to 50% of ATI does not apply to taxable years beginning in 2019, but rather it applies to taxable years beginning in 2020. In addition, 50% of any excess interest expense at the end of 2019 is deemed deductible in 2020. The remainder is subject to the provisions of IRC Section 163(j).
Example – 2020 projected with partnership interest and loss and excess interest deductions Company X, a U.S. corporation, conducts a significant part of its business in a partnership, PRS, in which it owns a 90% interest and is consolidated for financial reporting purposes. X has been allocated excess interest deductions since IRC Section 163(j) became effective (2018 year, X reports on a calendar year end for both book & tax purposes).
X had the following amounts of excess interest allocated:
2018
400
2019
500
2020
500
X has always been profitable since inception but is expecting to generate a tax loss of $300 absent any incremental benefit from the CARES Act. Due to an inability to project potential excess future Adjusted Taxable Income, X has recorded a valuation allowance against the excess interest carryovers. Under the provisions of the CARES Act, in 2020 X is able to utilize without limitation 50% of the excess interest from 2019 ($250) and an incremental $40 in 2020 due to the 50% ATI limitation (assumes ATI of $200, of which $60 of interest is inherent in the $300 loss leaving an additional $40 available from the CARES Act provisions). The result for 2020 is a potential carryback of $590.
In the instant situation, X should recognize the benefit of the utilization of the excess interest expense deduction from 2019 as a discrete item in its 2020 tax provision since it is realizable solely based on a retroactive change in tax law. The 2020 amount should be considered part of the AETR since it relates to current year amounts and is retroactive to the beginning of the year.
Additional Interim Considerations Due to COVID-19
Impairments Due to the economic impact of the COVID-19 pandemic, the possibility of impairments on assets and goodwill is increased. Significant judgement would be required to determine whether the tax impact of such impairments would be recorded discretely in the quarter or included as part of the AETR calculation. It can be argued that if impairments have occurred in the past, the impacts may be recorded as part of the AETR calculation. Alternatively, the uniqueness of the COVID-19 pandemic might also suggest that the underlying event is highly unusual and non-recurring and therefore may be considered discrete.
Goodwill impairments when tax-deductible goodwill exists presents challenges with respect to deferred taxes. In these situations, consider the following example:
Example – Goodwill Impairment X in performing its annual impairment testing for one of its reporting units determined that the fair value of the unit was $1,100 while its carrying amount was $1,200. The unit had $400 of goodwill, all of which was tax deductible, a deferred tax liability of $100 related to the Component 1 goodwill and other net assets of $900. X has adopted ASU 2017-04 Intangibles-Goodwill and other (Topic 350) -Simplifying the Test for Goodwill Impairment. The following is the calculation of the impairment based upon the above:
Carrying Amount
Fair Value
Preliminary Impairment
Deferred Tax Adjustment
Carrying Amount after Impairment
Goodwill
400
(100)
(27)
n1
273
Other assets
900
900
Deferred tax liability
(100)
27
(73)
Total
1,200
1,100
(100)
1,100
n1 $27 = $100 * ((21%/(1-21%))
X would report a $127 goodwill impairment charge partially offset by a $27 deferred tax benefit that would be recorded in the income tax line. In cases where tax deductible goodwill exists companies will need to solve the impairment via the use of the simultaneous equation as illustrated above.
Inability to Forecast ASC 740-270 requires companies to recognize income tax expense in interim periods with the view that each interim period is part of the overall annual period. Companies are generally required to forecast their AETR and apply that rate to ordinary income in each reporting period. The tax expense or benefit for all other items are individually computed and recognized discretely.[11] If an entity is unable to estimate a part of its ordinary income (or loss) or the related tax (or benefit) but is otherwise able to make a reliable estimate, the tax (or benefit) applicable to the item that cannot be estimated shall be reported in the interim period in which the item is reported.[12]
Some companies may not be able to accurately forecast income or loss due to the economic disruptions caused by COVID-19. In such situations, especially if modest fluctuations in forecasted earnings cause volatility in the AETR, companies should consider calculating their interim tax provision on a discrete basis as opposed to using the AETR approach. Careful consideration should be given to this judgement and the related disclosure requirements, especially if forecasts are used to support other parts of a company’s financial statements.
Year-to-Date Losses Exceed Forecasted Losses for the Year Prior to a company’s adoption of Accounting Standards Update (ASU) 2019-12, where the year-to-date loss exceeds the estimated loss for the year, an exception under the accounting rules limit the tax benefit in an interim period to the tax benefit of the forecasted loss. ASU 2019-12 removed this exception and allows an entity to record a benefit for a year-to-date loss when that loss exceeds its forecasted loss. Companies that are expected to be in a position where the year-to-date losses will exceed their forecasted loss for the year may want to consider early adoption of the ASU. It should be noted, however, that should a company decide to early adopt ASU 2019-12, all provisions of the ASU need to be adopted.
Valuation Allowance Assessment In general, a valuation allowance must be recognized to the extent that it is more likely than not that some or all of the deferred tax assets will not be realized.[13] Companies must assess all available evidence, both positive and negative, objective and subjective, in determining the need for a valuation allowance. Future realization of the tax benefit of existing deferred tax assets ultimately depends on the existence of sufficient taxable income of the appropriate character (for example, ordinary income versus capital gain) within the carryback, carryforward period available under the law. ASC 740[14] provides for four sources of taxable income that may be available to realize the benefit of deferred tax assets:
Future reversals of existing taxable temporary differences
Future taxable income exclusive of reversing temporary differences and carryforwards
Taxable income in prior carryback year(s) if carryback is permitted under the tax law
Tax-planning strategies
The CARES Act has placed renewed emphasis on the third source of taxable income. As described earlier, net operating losses generated in years beginning after December 31, 2017, and before January 1, 2021, can be carried back five taxable years. In addition, the changes to IRC Section 163(j) allow for the election of an enhanced deduction of interest for the years 2019 and 2020.
The ability to carryback losses is a source of income in assessing the need for a valuation allowance and will likely cause some companies to reassess their valuation allowance position. Similarly, the relaxation of the rules for interest deductibility may, in some cases, reduce valuation allowances previously recorded.
The impairment of tax-deductible goodwill may create a deferred tax asset for which a company would need to assess its realizability. Further, an impairment could reduce or eliminate a deferred tax liability that was used as a source of income for indefinite-lived deferred tax assets.
Similarly, entities that have historically relied upon reversing taxable temporary difference related to non-deductible book intangibles as a source of income to realize existing deferred tax assets may find this source of income eliminated in whole or in part as a result of impairments to the book intangibles. In the entity’s consideration of other sources of income as part of its valuation allowance assessment, specifically future taxable income, the effects of COVID-19 on projected results should be considered.
These changes may require companies to re-visit their valuation allowance considerations and reflect changes to their valuation allowances either as part of their estimated AETR, or as a discrete adjustment in the period. In addition, companies should consider the appropriate intraperiod allocation of changes in valuation allowances.
Indefinite Reinvestment Assertion – ASC 740-30 The economic pressure caused by COVID-19 has created significant strain on the cash flows of many companies. As a result, companies may need to revisit their indefinite reinvestment assertion to determine whether they can continue to maintain that certain earnings are permanently reinvested. Considerations include any contradictory evidence related to the parent or upstream entity’s ability to service debt, meet working capital needs, or make required changes to infrastructure. Companies should update cash flow forecasts to see whether sufficient cash will be generated to service its debt and working capital obligations.
If a change in assertion is made, ASC 740 requires that the change in an entity’s ASC 740-30 assertion for temporary differences accumulated in prior years be recognized in continuing operations in the period in which its intentions change.[15] Current and deferred taxes should be considered for the following items:
Foreign withholding taxes
State income taxes
IRC Section 986(c) currency impacts related to previously taxed earnings
Other Considerations
Balance Sheet Classification & Current/Deferred Tax Issues: Under the TCJA, corporate Alternative Minimum Tax (AMT) credits were refundable over a four-year period during tax years beginning in 2018-2021. Under the CARES Act, any remaining corporate AMT credit is fully refundable for tax years beginning in 2019.[16] Alternatively, a taxpayer may elect to make the credit fully refundable for the tax year beginning in 2018.
As a result, companies that have remaining AMT credits that are to be refunded would be expected to classify these amounts as a current receivable.
Global Government Assistance In the current COVID-19 pandemic, governments and institutions across the globe are introducing measures to try to alleviate the impact on businesses, individuals and families. Fiscal and financial compensation measures are evolving over time: Government-backed loans to businesses, business tax rate relief, direct business grants, support for the self-employed, the extension of tax deadlines and the relaxation of rules on the payment of sickness benefits, are just some examples.
State and Local Tax Implications (SALT)
The provisions of the CARES Act present a new round of challenges for taxpayers as states laws differ with respect to the timing and application of federal tax legislation.
Summary
As new tax law emerges to address the economic impact of COVID-19, consideration should be given to the impact of such tax law changes in the period in which they are enacted.
[4] IRC Section 965, enacted as part of the 2017 Tax Cuts and Jobs Act, requires United States shareholders (as defined under Section 951(b)) to pay a transition tax on the untaxed foreign earnings of certain specified foreign corporations as if those earnings had been repatriated to the United States.