The nearly 900-page CARES act, signed this week by the President, can overwhelm small businesses and their advisers. But the new law provides small businesses with shockingly large tax breaks, attractive loan programs and just generally speaking “free money.”
Accordingly, I thought I’d point out and then briefly discuss the new law’s tax breaks for small businesses.
Note: If you want a quick overview of the new law, check out this summary of the legislation provided by Senator Grassley’s offices here: CARES Act Section by Section summary.
Section 2301 Employee retention credit for employers subject to closure due to COVID-19
The CARES act provides a tax credit based on wages. That credit equals 50 percent “of wages paid by employers to employees during the COVID-19 crisis” and it applies to “the first $10,000 of compensation, including health benefits, paid to an eligible employee.”
Example: You have ten employees who each make $2000 a month. To keep the example simple, suppose that healthcare benefits run $500 a month per employee. In total, then, each employee costs $2500 a month and over the next four months, the employer would spend $10,000 on each employee.
The Section 2301 “employee retention credit” gives you, the employer, a $5,000 tax credit. That’s per employee. With ten employees, then, you enjoy $50,000 in tax credits.
Some details to know…
The tax credit is what’s called a “refundable tax credit.” That means you get the credit regardless of whether you’ve paid taxes.
Example: Your business generates no taxable income due to the COVID-19 crisis. As a result, you pay no income taxes. You still get a $50,000 “tax refund.”
Another thing to know? Not every employer qualifies but the rules are pretty loose. An employer may use the credit if “operations were fully or partially suspended, due to a COVID-19-related shutdown order” or if quarterly revenues shrink by more than 50 percent as compared to the previous year.
An obvious comment maybe: You’ll need a real accounting system to easily determine whether you qualify based on a decline in quarterly revenues.
One other thing to note: The formula works differently for employers with more than 100 full-time employees than it does for smaller employers. For “big” small businesses, the formula looks only at ”wages paid to employees when they are not providing services due to the COVID-19-related circumstances.” Again, this means you’ll need a good accounting system operating to determine this.
For “small” small businesses, so those with 100 or employees or less, the formula just says “all employee wages qualify for the credit, whether the employer is open for business or subject to a shut-down order.”
Tip: I’ve got a longer, detailed discussion of this tax break here: The 50 percent Section 2301 Employee Retention Credit.
Section 2302 Delay of payment of employer payroll taxes
The CARES act provides another small-business-friendly tax break related to employee costs: a deferral, or delay, in when you remit payroll taxes.
As you probably know, employers pay a 6.2% Social Security on most wages. Usually during or by the end of each quarter. Note that this employer Social Security tax isn’t the only payroll-related tax an employer pays. But it’s a significant one.
Example: An employer pays $10,000 in wages for the current payroll period. As part of the payroll, the employer calculates and withholds federal and state income taxes that tally $1000, Medicare taxes paid by both the employer and employee that add up to $300 or so, Social Security taxes paid by both the employer and employee that add up to roughly $1200, and a few other state-specific taxes. The Section 2302 deferral applies to the 6.2% employer Social Security, or $620.
How long does an employer get to delay? Two years. Half in 2021 and half in 2022.
By the way? Talk with your accountant about whether or not this deferral really makes sense. I’m not sure you want to get behind on your payroll taxes…
Section 2303 Modifications for net operating losses
Perhaps the most interesting small business friendly tax break? The loosened rules for using net operating losses.
The CARES act allows a business owner to carryback a net operating loss from 2018, 2019 or 2020 to the previous five years.
Example: The COVID-19 crisis creates a net operating in your business for 2020. Say, for sake of illustration, that you lose $100,000. The new rules allow you to take this $100,000 “net operating loss” and treat it as a deduction on an amended 2016 tax return. If that year, so in 2016, you made $300,000, you’ll essentially “redo” your 2016 tax return only this time with an extra $100,000 tax deduction, which means your taxable income drops from $300,000 to $200,000. That tax deduction may create a $25,000-ish refund.
A caution: You will probably need your accountant’s help to handle the net operating loss carryback. His or her other clients will very possibly need the same help. Accordingly, if you think this tax break applies, you’ll want to get into the queue quickly.
Let me also say that historically the IRS takes a while to pay net operating loss refund claims. And the larger the claim, the longer the processing times. Probably we’re talking weeks at the minimum. I would not be surprised if these refunds take months.
I don’t want to end this blog post without pointing out that tax breaks aren’t the only resources you have available if you’re a small business owner struggling to survive the COVID-19 storm. Be sure to look at the COVID-19 loan programs too, especially the “Paycheck Protection Loans” (more information here.)