How to use COVID Tax Laws to Produce Cash Windfalls for your business
Over the past year, Congress has passed a bevy of programs aimed at providing relief to businesses affected by COVID-19. Two of these programs have received significant attention from the tax and financial advisory world–the paycheck protection program (“PPP”) and the employee retention tax credit (“ERC”). With information surrounding these programs changing by the day, taxpayers and tax preparers have had little time to think strategically about how to employ or not to employ PPP and ERC as a component of their overall tax strategy.
When used with existing tax code benefits, taxpayers may be able to unlock large amounts of cash in the form of refunds and tax liability reductions. This article will provide a high-level review of how major programs and tax strategies can be synergized to provide maximum potential benefit.
Paycheck Protection Program
PPP has been both loved (for the cash it offers) and loathed (for complexity in compliance). The second round of this program allows access to a forgivable loan for businesses that experienced a 25% reduction in gross receipts from comparable quarters in 2019 and 2020. The covered period in which businesses must apply funds ranges between a minimum of eight and a maximum of twenty-four weeks. The second PPP draw puts a heavier focus on getting money to small businesses and uses a larger multiplier to calculate the loan amount. Businesses that borrowed funds through the first iteration of PPP are eligible for the second round. Applications for this program are being accepted until March 31st.
Employee Retention Credit
The recently extended ERC program provides a refundable tax credit against the employer portion of Social Security Tax of up to 70% on $10,000 of wages for each employee employed the first or second quarter of 2021 (up to $7,000 per quarter per employee). Eligible businesses include:
- Businesses that experienced a full or partial suspension of operations due to government-mandated shutdowns
- Businesses that experienced a 20% decline in gross receipts in any quarter in 2021 in comparison to the same quarter in 2019
Something important to note is a retroactive provision that allows businesses who received PPP loans to claim the ERC for wages that are not allocated towards payroll costs under a PPP forgiveness application.
Key Takeaway: Companies can utilize both PPP and ERC to their advantage through the following approaches:
- Allocating the maximum 40% of forgivable PPP funds towards non-payroll expenses
- Claiming the ERC for any payroll costs not funded by PPP amounts through the covered period of 24-weeks
For example, if a business only receives and applies PPP money to cover fifteen weeks of payroll costs, it can claim an ERC credit during any remaining pay period in the time covered by both the PPP loan and up until June 30, 2021. Thus, by tactically allocating PPP money to payroll (60% minimum) and other expenses (40% maximum) and claiming the ERC during any period when PPP funds are not being utilized for payroll, a business can generate a substantial cash windfall.
R&D Tax Credits
As mentioned, there are programs within existing tax code that can unlock substantial cash for a business, especially when paired with PPP or ERC. One of these is the R&D Tax Credit, which allows for a non-refundable credit for wages, contractor expenses, and supplies that meet the four-part test of Section 41 of the revenue code. For more info on how the R&D Credit applies to different industries, click here.
Companies performing qualified research can unlock cash through this credit in the following ways:
- Using credits to lower tax liabilities in the current year
- Amending prior year returns to claim credits and generate treasury refunds for tax overpayments
- Using credits to lower or eliminate the employer portion of payroll taxes on the next quarter’s payroll tax filing (for eligible startup businesses only).
Any payroll costs covered by forgivable PPP funds in 2020 and 2021 can still be included in the R&D Credit calculation. In general, taxpayers can realize a net benefit of about 7.9 cents for every dollar of qualified research expenses.
Owners of buildings can take advantage of a combination of provisions in both the Tax Cuts and Jobs Act (“TCJA”) and Coronavirus Aid, Relief, and Economic Security (“CARES”) Act to generate cash. Cost segregation allows building owners to accelerate depreciation schedules by reclassifying components of a building from a 39-year or 27.5-year life to a 5-year or 7-year life. This creates larger depreciation expense in a shorter amount of time, which provides a greater reduction in tax liabilities.
As part of the TCJA, building owners can take advantage of 100% bonus depreciation for property reclassified to less than 20-year life. This can potentially create net operating losses through large single-year depreciation expenses. Enter the CARES Act, which now allows businesses to carry back losses for up to five years. This means that a business could perform a cost segregation study, utilize bonus depreciation to create a net operating loss, carry the loss back to reduce taxable income in prior years, and generate refund checks for tax overpayment.
The key to successfully implementing these strategies is understanding how they complement one another and how they can be utilized based on each business’s unique circumstances. This requires consultation with tax preparers and subject matter experts on each area. If done correctly, these strategies can generate significant windfall. For example:
An ATS client in the telecommunications engineering industry has experienced a substantial reduction in revenue and is eligible for the second round of PPP and the ERC. The second draw of PPP covers payroll expenses for about one quarter. The client will use the ERC to claim payroll tax credits of up to $7,000 per employee for Q1 ($147,000 total). Once Q2 starts, PPP funds will be applied to cover payroll for 13 weeks, ending just before the 24-week covered period. The client is also performing an R&D Tax Credit study for its engineering service work performed from 2017-2020. This will generate roughly $81,000 in cash refunds at both the state and federal level for 2017-2019 while providing a $45,000 reduction in tax liability for 2020. Altogether, these programs are generating over $300,000 in cash for the client.
While COVID-19 has created a once-in-a-lifetime problem for individuals and businesses, law enacted to bolster affected businesses has created a once-in-a-lifetime opportunity. Taking advantage of these opportunities to help your business overcome the hardships experienced due to COVID requires diligent planning and expertise. Please contact the professionals at ATS to learn more about any of these strategies.