Tag: Tax

2020 Private Equity Tax Strategy Considerations

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Key strategies for maintaining a strong offensive tax position during times of economic distress, particularly during the current COVID-19 pandemic, include finding money, preserving cash and planning for future success.

While the affiliation rules associated with the Paycheck Protection Program (PPP) precluded many private equity-backed portfolio companies from qualifying for PPP loans, it is possible to find money through three simple tax actions. First, businesses can now carry back net operating losses for five years, meaning that tax losses from 2018, 2019 and 2020 can be used to offset income from the prior five years for a quick cash refund. Second, businesses with any remaining alternative minimum tax (AMT) credits can also get a quick refund by electing to make all such credits refundable for 2018. Finally, businesses can get a tax credit of up to $5,000 per employee for employees kept on payroll during the pandemic, even if those employees are providing partial services for their compensation.

There are several ways to preserve cash at the moment, starting with deferring tax payments. Businesses can now defer employer payroll taxes otherwise payable for the period from March 27, 2020, through December 31, 2020. Half of the amount can be deferred until December 31, 2021, and the other half until December 31, 2022. Employers that received PPP loans can only defer payroll payments until the loans are forgiven, except that amounts deferred before the loans are forgiven can be deferred 50/50 until December 31, 2021 and 2022. In addition, payment (not just filing) of 2019 taxes can be deferred until July 15, 2020.

On top of these deferrals, 2019 and 2020 taxes can be reduced by taking a higher interest expense deduction than was previously allowed. Under the Tax Cuts and Jobs Act of 2017, businesses could only deduct interest expense up to 30% of adjusted taxable income (ATI), a computation that is similar to EBITDA but may differ in some important respects. For 2019 and 2020, the deductible amount has been increased to up to 50% of ATI. Not only that, 2019 ATI can be used to calculate 2020 interest expense deduction. Finally, businesses can take 100% bonus depreciation on qualified improvement property, a defined term that generally combines three previously separate categories (qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property).

To plan for future success, we recommend businesses use this time to focus on setting an action plan. Businesses should review any diligence reports from the last 12 to 24 months, address any material issues and review acquisition documents to confirm receipt of any benefits to which they’re entitled (e.g., any net operating loss carryback opportunities).

Businesses should also take this time to consult with tax advisors about state income tax credits and business incentives reviews, as well as consider a reverse sales tax audit to see if a refund of overpaid use taxes is available. In addition, this is a good time to make sure sales tax is being filed properly, especially given numerous changes to sales taxes (with some jurisdictions even taxing services) as well as the Wayfair decision, which permitted states to expand sales tax filing obligations to an economic rather than a physical basis. Sales taxes are generally accepted as a customer tax, unless the business is audited, in which case the business pays.

Although not really a tax, a reverse unclaimed property audit may also be considered. With tax revenues plummeting, states will likely be looking for sources of additional revenue and unclaimed property may be low hanging fruit. This is especially true for businesses incorporated in Delaware, an aggressive state when it comes to unclaimed property.

The government has been providing tax as well as financial aid at a ferocious pace, including additional guidance and expanded (and sometimes nuanced) benefits. While we have outlined some of the bigger benefits currently available, businesses should consult with their tax advisors about these and other tax opportunities.

Non-Residents Get Tax Relief From IRS During Pandemic

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Summary

On June 12, 2020, the IRS updated its FAQs for Nonresident Alien Individuals and Foreign Businesses with Employees or Agents Impacted by COVID-19 Emergency Travel Disruptions.
 
The FAQ provides that a nonresident alien, foreign corporation, or a partnership in which either is a partner (Affected Person) may choose an uninterrupted period of up to 60 calendar days, beginning on or after February 1, 2020, and on or before April 1, 2020 (the COVID-19 Emergency Period), during which services or other activities conducted in the United States will not be taken into account in determining whether the nonresident alien or foreign corporation is engaged in a U.S. trade or business (USTB), provided that such activities were performed by one or more individuals temporarily present in the United States[1] and would not have been performed in the United States but for COVID-19 Emergency Travel Disruptions (e.g., canceled flights and disruptions in other forms of transportation, shelter-in-place orders, quarantines, and border closures, or they may feel unsafe traveling during the COVID-19 Emergency due to recommendations to implement social distancing and limit exposure to public spaces).
 
The FAQs also provide that during an Affected Person’s COVID-19 Emergency Period, services or other activities performed by one or more individuals temporarily present in the United States will not be taken into account to determine whether the nonresident or foreign corporation has a permanent establishment (PE), provided that the services or other activities of these individuals would not have occurred in the United States but for COVID-19 Emergency Travel Disruptions.
 
In addition, the FAQs are updated to provide that an Affected Person’s income earned during the COVID-19 Emergency Period will not be subject to the 30% gross basis tax imposed under section 871(a) or section 881(a) solely because the Affected Person is not treated as having a USTB or PE under the FAQs.
 
In all events, the Affected Person should retain contemporaneous documentation to establish the period chosen as the COVID-19 Emergency Period and that the relevant business activities conducted by individuals temporarily present in the United States during the COVID-19 Emergency Period would not have been undertaken in the United States but for COVID-19 Emergency Travel Disruptions. The Affected Person should be prepared to provide that documentation upon request by the IRS.
 
Lastly, the FAQs provide Nonresident aliens and foreign corporations (including those that are partners in partnerships) may make protective filings of their annual U.S. tax returns, even if they believe they are not required to file for the 2020 taxable year because they were not engaged in a USTB, to avail themselves of the benefits and protections that arise from such filings (such as those relating to deductions, statutes of limitations, and claiming tax treaty-based relief).
 

[1] For purposes of the FAQs, an “individual temporarily present in the United States” means an individual who is present in the United States on or after February 1, 2020, and on or before April 1, 2020, and is a nonresident alien, or a U.S. citizen or lawful permanent resident who had a tax home as defined in section 911(d)(3) outside the United States in 2019 and reasonably expects to have a tax home outside the United States in 2020. In addition, to determine the nonresident status of an alien, the relief provided in Rev. Proc. 2020-20 is applicable.

PPP Loan Forgiveness and Payroll Tax Deferral Has More Flexibility

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The Paycheck Protection Program Flexibility Act of 2020 (H.R. 7010) (PPP Flexibility Act), enacted on June 5, 2020, makes welcome changes to the forgiveness rules for Paycheck Protection Program (PPP) loans made to small businesses in response to the novel coronavirus global pandemic (COVID-19). The PPP Flexibility Act greatly increases the likelihood that a large percentage of a borrower’s PPP loan will be forgiven. PPP loans (and related forgiveness) were created by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (Public Law 116-136), which was enacted on March 27, 2020. The PPP Flexibility Act also eliminates a provision that made recipients of PPP loan forgiveness ineligible to defer certain payroll tax deposits.

Insight:

The PPP Flexibility Act does not address whether employers can deduct the expenses underlying their PPP loan forgiveness. In Notice 2020-32, the IRS announced that employers could not deduct such expenses, but congressional leaders vowed to reverse the IRS’s position in future legislation. On June 3, Chairman of the House Ways and Means Committee, Richard Neal (D-MA), said that in the next COVID-19 stimulus bill he intends to clarify that the loan forgiveness expenses are tax deductible. But negotiations on that bill are still in the early stages.

PPP Loan Forgiveness Expanded

The PPP Flexibility Act makes the following changes:

1. Extends the “covered period” for PPP loan forgiveness from eight weeks after loan origination to the earlier of (i) 24 weeks after loan origination or (ii) December 31, 2020. Borrowers who received their loans before this change can elect to use their original or alternative payroll eight-week covered period.

Insight:

In connection with passing the PPP Flexibility Act, a Statement for the Record was issued by several Democrats and Republicans in the House and Senate, clarifying that the Small Business Administration (SBA) will not accept applications for PPP loans after June 30, 2020. The statement says: “Our intent and understanding of the law is that, consistent with the CARES Act as amended by H.R. 7010, when the authorization of funds to guarantee new PPP loans expires on June 30, 2020, the SBA and participating lenders will stop accepting and approving applications for PPP loans, regardless of whether the commitment level enacted by the Paycheck Protection Program and Health Care Enhancement Act has been reached.” Given this affirmation, very few loans will have fewer than 24 weeks as a covered period.

2. Replaces the June 30, 2020, date for the rehire safe harbor with December 31, 2020. 

Insight:

Additional guidance is needed to determine if a borrower who elects their original or alternative payroll eight-week covered period would also retain the June 30, 2020, date for the rehire safe harbor.

3. Expands the rehire exception based on the non-availability of former employees and applies that exception when the need for workers is reduced to comply with COVID-19 standards. Specifically, PPP loan forgiveness would not be reduced due to a lower number of full-time equivalent (FTE) employees if:

  • The employer is unable to rehire individuals who were employed by the employer on February 15, 2020, and the employer shows the inability to hire similarly qualified employees for unfilled positions on or before December 31, 2020, or
  • The employer documents its inability to return to the same level of business activity as it had before February 15, 2020, due to having to comply new COVID-19 standards for sanitation, social distancing or other safety requirements during the period of March 1 through December 31, 2020.


4. Allows up to 40% of the loan proceeds to be used on mortgage interest, rent or utilities (previously such expenses were capped at 25% of the loan proceeds), while at least 60% of the PPP funds must be used for payroll costs (down from the 75% that was noted in SBA guidance). This applies even if the borrower elects to use the eight-week covered or alternative payroll covered period. If the borrower does not use at least 60% of the loan on payroll costs, then it appears that no forgiveness would be available (i.e., the 60% would be a “cliff,” even though it was previously unclear whether the 75% limit would allow for partial loan forgiveness for payroll costs of less than 75% of loan proceeds).

Insight:

Some members of Congress are considering a “technical correction” that would provide that the new 60% limit is not a “cliff” (thereby allowing partial loan forgiveness if less than 60% of PPP loan proceeds are used for payroll costs).

5. Provides a five-year term for all new PPP loans disbursed after June 5, 2020. Loans disbursed before that date would retain their original two-year term unless the lender and borrower renegotiate the loan into a five-year term.

6. Changes the six-month deferral period for loan repayments and interest accrual so that payments on any unforgiven amounts will begin on either (i) the date on which loan forgiveness is determined or (ii) 10 months after the end of the borrower’s covered period if forgiveness is not requested.

Insight:

Although the PPP Flexibility Act doesn’t clearly say as much, it appears that the $100,000 maximum on cash compensation paid to any one employee that is eligible for PPP loan forgiveness would continue to apply, such that the $15,385 cap (for eight weeks) would now be $46,153 (for 24 weeks).

The PPP Flexibility Act does not address whether the loan forgiveness cap for “owner-employees” (i.e., 8/52 of their 2019 compensation) would change to 24/52 of their 2019 compensation.

Notwithstanding some commentary that has been released, the statute does not appear to allow borrowers to request PPP loan forgiveness as soon as they spend all of their PPP funds in the ninth to 24th weeks following receipt of their PPP funds. That is because the CARES Act has been amended to substitute “24 weeks” for “eight weeks,” so absent additional guidance, it seems that borrowers must wait until the end of the 24-week period to request PPP loan forgiveness, unless they elect to use the original eight-week period (regular or alternative payroll covered period).

These changes garnered nearly unanimous, bipartisan support in both the House and Senate because the CARES Act assumed that most businesses would be up and running in a matter of weeks. But more time is needed to incur forgivable costs, because many businesses are at or near the end of their initial eight-week loan forgiveness period, yet they remain partially or fully suspended by governmental orders.
 

Payroll Tax Deferral Expanded

In addition to PPP loan changes, the bill allows all employers, even those with forgiven PPP loans, to defer the payment of 2020 employer’s Social Security taxes, with 50% of the deferred amount being payable by December 31, 2021, and the balance due by December 31, 2022. Previously, the CARES Act prohibited such payroll tax deferral after a borrower’s PPP loan was forgiven.