Tax Planning During the Pandemic: Provisions for Private Equity Funds and Portfolio Companies
May 27, 2020
By Ling You
The Coronavirus Aid, Relief, and Economic Security (CARES) Act, passed by Congress and signed into law by U.S. President Donald Trump on March 27, 2020 provided a $2 trillion economic relief package to protect the American people from the public health and economic impacts of COVID-19. It also revised certain sections of the Internal Revenue Code to provide taxpayers tax relief.
During a May 13 live webcast, EisnerAmper professionals discussed practical matters and tax planning considerations for private equity and portfolio companies under the CARES Act with moderator Ethan Boothe, National Private Equity Industry Leader. Panelists included:
- Simcha David, Tax Partner, Financial Services
- Alan Wink, Managing Director, Capital Markets
- Jon Zefi, Principal, Tax Advisory Services Group
Paycheck Protection Program Loans (“PPP Loan”):
The CARES Act allocates $350 billion under the first tranche of the PPP loan program to assist small businesses to keep businesses operating and workers employed amid the COVID-19 pandemic and economic downturn. Loans are 100% guaranteed by the federal government, administered by the Small Business Administration (SBA) and issued by private lenders. Eligible business must have 500 or fewer employees whose principal place of residence is in the United States, or be a business that operates in a certain industry and meets the applicable SBA employee-based size standards for that industry. Loan amount is calculated at 2.5x the average total monthly payroll costs during the one-year period before the loan is made and maximized at $10 million. The maximum loan term is two years and the interest rate is 1%. The loan can be used for: 1) payroll; 2) rent; 3) health benefits; 4)insurance premiums; 5) utilities; 6) interest on other debts or mortgages; and 7) operational costs that cannot be met as a result of COVID-19. The borrower is entitled to loan forgiveness for the amounts spent on the designated items during the eight-week covered period beginning on the day the loan was funded. To qualify for full forgiveness, no more than 25% of the loan can be used for non-payroll purposes.
Good faith certification is required from the borrower, and must include acknowledgements of: : 1) uncertain economic conditions due to COVID-19 make the loan necessary to support on-going operations; 2) loan proceeds will be used to retain workers and maintain payroll and make mortgage, lease, and utility payments; 3) the company has no application pending nor has it received Disaster Recovery Loans or Economic Stabilization Loans under the COVID-19 stimulus package; 4) from 2/15/20 –12/31/20, the borrower has not received a loan duplicative of the purpose and amounts applied for here.
- It should be noted that, as of the date of the webinar, the SBA, in consultation with the U.S. Department of the Treasury, has determined that the following safe harbor will apply to the SBA’s review of PPP loans with respect to good faith certification of need: Any borrower that, together with its affiliates, received PPP loans with an original principal amount of less than $2 million will be deemed to have correctly made the required certification concerning the necessity of the loan request in good faith.
On April 10, SBA launched the second tranche of PPP loan program with $310 billion in funding, of which $90 billion was set aside for small banks with the hope that small businesses with weak bank relationships can receive the loan.
Planning Considerations for Portfolio Companies:
- The SBA affiliation rules (Section 301 rules) made many private equity funds and their portfolio companies ineligible for the PPP loan program. Be aware of following exceptions where the CARES Act waives the SBA affiliation rules:Any business concern with not more than 500 employees that, as of the date on which the loan is disbursed, is assigned a North American Industry Classification System (NAICS) code beginning with 72 ( i.e., businesses in the accommodation and food service industry) ;
- Any business concern operating as a franchise that is assigned a franchise identifier code by the SBA; and
- Any business concern that receives financial assistance from a company licensed under Section 301 of the Small Business Investment Act of 1958 (this one is especially beneficial to many portfolio companies).
- If not eligible for PPP loan, portfolio companies should consider applying for the Economic Injury Disaster Loans, the Employee Retention Credit or the Employer Payroll Tax Deferral.
- The U.S. Treasury and Federal Reserve have launched another $600 Billion Main Street Lending Program aimed to provide liquidity for small to medium-sized companies. The Federal Reserve and Treasury Department are currently working to create the infrastructure necessary to operationalize the Main Street Lending Program.
Tax Provisions Revised by CARES Act:
The CARES Act revised a few Internal Revenue Code sections to provide taxpayers tax relief and immediate tax refund opportunities.
Net Operating Loss (NOL):
The CARES Act grants taxpayers a five-year carryback for NOLs generated in tax years beginning after December 31, 2017 and before January 1, 2021. Corporations can therefore carry back 2018, 2019, and 2020 NOLs to offset pre-2018 ordinary income or capital gains that were taxed at rates of up to 35%, generating a favorable rate differential and current refund. In addition, the Tax Cuts and Jobs Act (TCJA) imposed an 80% of taxable income limitation on the use of NOLs which applied to NOLs generated in tax years beginning after December 31, 2017. The CARES Act suspends the 80% of taxable income limitation on the use of NOLs for tax years beginning before January 1, 2021 thereby permitting corporate taxpayers to fully utilize NOLs to offset tax income in the carry back years.
- Consider filing accounting method changes for tax years 2019 and 2020 to accelerate deductions and/or defer revenue to increase NOLs generated in those years which can be carried back to generate permanent cash tax savings.
- Corporate taxpayers with significant carry back capacity (i.e., taxable income in prior years eligible for offset) that anticipate losses being generated into 2021 may want to change their tax year from a calendar year-end to a November 30 year-end to ensure that some part of the 2021 anticipated losses will be included in a tax year that begins prior to January 1, 2021.
- Utilize IRC Sec. 165(i) to deduct 2020 disaster losses in 2019. The losses have to be connected to a federally declared disaster and occur in a disaster area. Examples of disaster losses covered under IRC Sec. 165(i) include:
- Inventory impairment,
- Abandonment of leasehold improvement or equipment, and
- Permanent closure costs associated with disposition of inventory and leasehold improvement.
- The CARES Act changed the depreciation life of Qualified Improvement Property (QIP) from 39 to 15 years, which also allows QIP to qualify for bonus depreciation. Taxpayers can now amend their 2018 and 2019 return or file a Form 3115 to request change of accounting method to deduct the difference in depreciation the taxpayer would have been entitled to take in 2018 and 2019, if the return was filed, as if the assets had the shorter life from day one and continue to depreciate over the assets’ remaining life.
Business Interest Limitation:
Under the TCJA, business interest expense deduction is limited to the sum of: 1) business interest income, 2) 30% of adjusted taxable income (ATI), and 3) floor plan financing interest. The rule applies to all taxpayers and all debt. Certain trades or businesses excluded from the limitation include a real property trade or business that made the IRC Sec. 163(j)(7)(B) election, certain regulated public utilities and small businesses meeting certain gross receipts test (i.e., for 2019, taxpayers with less than $26 million average gross receipts for the prior three tax years).
The CARES Act modifies the limitation on business interest by increasing the deductible amounts from 30% to 50% of ATI for all tax years beginning in 2019 or 2020. It also allows taxpayer to elect to use 2019 ATI in 2020.
Special Rules for Partnerships:
The increase of ATI from 30% to 50% is only available for tax years beginning in 2020. To bring some parity between partnerships and non-partnerships, the CARES Act has a special rule for partnerships: For any partner that received excess business interest expense (EBIE) from a partnership in 2019 (this would be reported on line 13K of the Schedule K-1), 50% of that amount is deductible in 2020 not subject to the rules of IRC Sec. 163(j); the other 50% is still subject to the normal carryover rules (i.e., deductible when the partner receives excess taxable income (ETI) in future years).
IRC Section 461(l): Loss Limitation Rules for Taxpayers Other Than Corporations
The CARES Act repeals the excess business loss limitation rules for tax years beginning prior to January 1, 2021 (i.e., calendar years 2018, 2019 and 2020). This has the following implications to general partners of private equity funds:
- Net business loss not limited to offsetting $500,000 of nonbusiness/investment income on a joint return.
- Nonbusiness/investment income can be sheltered in the year of loss.
- Any excess loss can be carried back five years.
- Not subject to any 80% of income limitation for tax years beginning prior to January 1, 2021.