Manhattan tax and financial expert John Johansen discusses the CARES Act – including loan plans, tax incentives, and how it could affect business valuation during divorce – with Family Lawyer Magazine‘s Editorial Director, Diana Shepherd.
The CARES Act: What Family Lawyers Need to Know
Diana Shepherd: My name is Diana Shepherd and I’m the Editorial Director of Family Lawyer Magazine and Divorce Magazine. My guest today is Manhattan tax and financial expert John Johansen, and he is here to discuss what family lawyers need to know about the CARES Act. Part of the tax, accounting, and financial planning industry for over 25 years, John is a Certified Public Accountant, a Certified Financial Planner, and he also holds the AICPA’s Accredited in Business Valuation designation. John has developed a niche specialization working with divorcing individuals and matrimonial attorneys in the areas of business valuation and forensic accounting. Welcome, John – and thank you for being here today!
John Johansen: Thank you for having me, Diana. It’s my pleasure.
Let’s dive right in. Can you give us an overview of the loan plans and the tax incentives that are available now as a result of COVID-19?
Yes, well, the United States Senate and Congress passed one of the largest stimulus packages ever. It’s a package that is over $2 trillion that consists of loans and tax incentives to help lead generate the economy and help industry. So, the first part of the package was loans. There were two primary loans. One is the Paycheck Protection Loan, commonly referred to as the PPP. The primary purpose of the PPP was for us to give employers the funding that they needed to either retain their employees or bring their employees back from being laid off. The primary use for the funds is for payroll. In order to be forgiven, 75% of the funds need to be used for payroll. 25% can be used for other things like rent and utilities. The other loan is the Economic Injury Disaster Loan, sometimes referred to as EIDL, which is administered to the Small Business Administration. This is for employers with less than 500 employees. It can be for up to $2 million. It’s an actual loan, there is no forgiveness, but there is no restriction that the funds need to be used necessarily for payroll. So it can be used for other things like accounts payable to pay debt that was existing prior to the COVID-19 pandemic. It’s a low-interest loan, it’s a 3.75% loan, and its 30-year payback period has a one-year deferral on payments. But the interest accrues from day one. So those are the two major loan packages. Both loan packages ran out of money, but as we have this interview today, the Senate has approved new funding, and hopefully, Congress will approve that by the end of the week.
Since we’re talking about the loan programs right now, let’s talk for a minute about the PPP and maybe the other program as well. What went right and what went wrong here and how are you advising business owners and other clients?
Well, as you can imagine, the PPP program was a very attractive package because of the forgiveness characteristics. So some large employers in the U.S. try to take advantage of it. One that comes to mind is Shake Shack. Shake Shack is a large hamburger franchise here in the U.S. They have agreed to pay the money back. They received $10 million worth of the money, and it wasn’t really ever meant for large employers like that. Harvard University also received funding, and Harvard has one of the largest endowment, so it was very attractive for them to apply. Maybe they needed it, maybe they didn’t need it. But the forgiveness factor factored into a lot of business’s decisions to apply. And that was one of the other things that went wrong. So many businesses needed the money, and they all applied. A lot of businesses were shut out. They didn’t receive the funding. And that’s why the U.S. Senate and Congress are trying to approve new funding so that some of those businesses that were shut out can receive these loans going forward.
Yes, I’ve heard that Texas actually got more loan approvals for the U.S. Small Business Administration’s Paycheck Protection Program than any other state in the country – despite the fact that the state is #10 in terms of having been impacted by COVID-19. So it seems that there have been some geographical problems with the program as well.
Yeah, that that might be true. I didn’t hear that. But you can imagine, I sit here in New York City. Some efforts should have been made to allocate the packages by the regions that were hurt the most. We’ve been pretty much devastated. Here in New York City businesses have been closed now since mid-March. That’s going to have a tremendous effect on our economy. So I agree. Some efforts should have been made to allocate the funding to the regions that really needed it.
Let’s talk about the CARES act for a moment. What are the key points of the act? Should attorneys be aware of if their client or their client’s spouse owns a business?
In addition to the two loan programs, there were tremendous changes to the tax code. I don’t think the media has been focusing primarily on the PPP and the EIDL loans, but I have not heard a lot of discussion about the changes in the tax code, which can really generate in essence more funding than in certain situations than the loan programs. So just to touch on a couple of the changes. One of the changes is that the government has okayed the deferral of unemployment taxes. Employers here in the U.S. pay 6.2%. That’s their share of the Social Security tax on wages paid up to a certain wage base. They can defer that 6.2% until the end of the year, so between March 27 and the end of the year, they’re allowed to defer that payment and they don’t have to repay that deferral. They can also be repaid in two installments. The first installment will be in December of 2021. The second installment of the other 50% will be in December of 2022. So that can free up a lot of cash flow for a business. In addition to the deferral, the CARES act also created an employee retention credit. The thing to know about that credit is that you cannot take the credit in combination with the deferral. So if you’re going to take the credit, you don’t want to be deferring taxes. The other thing to know about the credit is that you cannot take the credit in combination with one of the loan programs. So if you take the loans, you’re not going to be entitled to take the credit. So it’s very important for employer’s businesses to sit down with their CPAs at this point and do an analysis on which way they come up better, because the credit can provide up to $5,000 per employee between now and the end of the year. That $5,000 credit can be applied directly against the employer and the employer’s share of Social Security and Medicare taxes as well as federal withholding taxes, so they could actually come back out by taking the credit. The credit is $5,000 per month. If you add that up, you have 10 employees, that’s a $50,000 credit that they can take against their employment taxes. So those two programs are very key for business owners. The other program that I think businesses should be focused on is the NOL carryback. The NOL stands for net operating losses. If a company had generated net operating losses in the years 2018 or 2019, as well as 2020, they are entitled to carry those losses back for five years. That’s important because prior to this change, they were only able to carry those losses forward. They couldn’t carry them back. So what a business could do if they’re sitting on their books with losses that they’re carrying forward from 2018 and 2019 is they can go back and amend their tax return. For those, they have by generating refunds because they’ve paid a higher level of tax based on the taxable income for that year. And they can basically amend the years up to five years back. So that could free up a tremendous amount of tax.
In addition to the NOL is also the elimination of the cap on business losses on a personal return. Right now, before these CARES changes, there was a $500,000 cap for a married couple and a $250,000 cap for an individual taxpayer. Those caps have been removed. So again, they could go back and amend returns for 2018, 2019, and 2020. Of course, you wouldn’t need to amend, but you could take unlimited business losses on those returns. And the interest deduction for businesses, that has increased from 30% to 50%. So the combination of all those factors and by going back and amending returns, you could produce a lot of cash flow right now. There’s also a form you can file with the IRS depending on whether you’re an individual or corporation. And you can file an application for an attentive refund. So you don’t have to wait for that amended return to be processed because it’s going to take a long time for that amended return to be processed. By filing this form, you’re telling the IRS that you expect that refund and they will issue it within a short period of time, so you can free up cash flow almost immediately within a very short window.
There’s also one more that I left out and I shouldn’t have left this out. The CARES act made a technical correction to something that was meant to be changed with the 2017 Tax Act, but wasn’t changed. It is the depreciation period for capital for leasehold improvement property. Leasehold improvements are things that are done by restaurants, by retail establishments, and other spaces that go in and rent spaces and do improvements to those spaces. You’ve probably heard in the news that restaurants are going to suffer a lot because of the closure of those restaurants because of the pandemic. The CARES act changed that depreciation period from 39 years to 15 years. So a business now has that option. Any property with under a 20-year time depreciation can come up to take 100% depreciation. We call that bonus depreciation. So for 2018, 2019, and 2020 they can change their depreciation method. So if they did a leasehold improvement in 2018 or 2019, and they’re depreciating that property over a 39 year period, which means they’re getting a very small expense every year for 39 years. They can go back and amend those returns, and either take 100% depreciation or depreciate the property under a 15-year schedule. That would take a larger expense, thereby reducing their profits and thereby reducing their taxes and producing a refund. So there are a lot of methods where a business can free up cash flow using the new tax methods.
Since we’ve just been talking about tax returns, what are attorneys looking at in tax returns in the future? What do they need to pay special attention to? Because it sounds like this may have changed what already existed in terms of what people claimed on their taxes.
What was very complex already has just become much, much more complex. What attorneys need to be aware of when they’re looking is: say they have a client next year that comes to them who has done some of these changes, has amended returns, and with the NOL situation, it’s five years from the year you amend, so if you go back to 2018 and amend that return, you can go back five years without NOL. So you could potentially be changing the taxable income numbers for returns from 2014, 2015, 2016, 2017, 2018, and then 2019 and 2020. So when attorneys are looking at these returns, an amended return has an X after it. So an amended individual return is a 1040-X, an amended S-corporate return is 1120-S/X. It says on the top that it was amended, and if they’re looking at an amended return, they should be aware of why it was amended. Was it amended for one of these things that I’ve discussed today? Because these changes are, first of all, temporary changes. They only affect the taxes for 2018, 2019, and 2020. Of course, if you carry it back, it’s going to affect some of those prior years, but it’s not going to affect future years. So you’re not going to hear as much about it in the future. But you should be aware of it, because it’s going to change the tax, the taxable income, and the taxes paid.
So what effect will the implementation of CARES, PPP, EIDL, and NOL possibly have on business valuations going forward?
Well, business valuation is based on cash flows. So if we take a look at the loan programs, for example, the EIDL loan is a true loan program. So it would probably be on the books going forward as a loan. But the PPP program is sort of like a hybrid, and for a loan that becomes a grant, if you use the money in the ways that the government has said to use it, it could be forgiven. So you get this chunk of cash coming into a business, which would affect their cash flow statement, but it’s not really true cash flow. It’s not cash flow from operations. You’re not going to see a car funding loan on the books. It’s basically going to be a grant that they get one time. So I believe that adjustments will be necessary in the future to the financial statements for 2020 because of the PPP program, also, because of these tax issues that I pointed out, they’re going to have a tremendous effect on cash flow as well. If people go back and amend returns, and they produce these large refunds, that’s kind of an artificial cash flow. It’s a good cash flow, unnecessary cash flow. But it’s not one that was generated to the business itself.
So how has COVID-19 affected business valuations for business owners who are currently going through a divorce now that their income in January and February would be completely different from March, April, and May? If somebody had a business valuation done even two months ago, do they need to go back and do another one? How is it going to reflect a true value, for settlement purposes, for spousal support, and for child support?
That’s a very good question, because from a business valuation perspective, there’s a rule in business valuation that says that you’re not supposed to take into account things that were not knowable or known or knowable at the date of valuation. So for example, in your example, say we were doing a valuation that had a valuation date of January 31 that we may not have finished. We’re not really supposed to as business valuation analysts supposed to take into account facts that happened after January 31. If they weren’t known or knowable on January 31, we’re not supposed to take that into account. Now, it’s up to the attorneys, the two attorneys in a divorce case, to negotiate that because I think there’s going to be some flexibility that needs to be necessary, maybe to change the date of the evaluation to make it a different day. Or to make some adjustments to the valuation after it’s performed with the January 31 date, but we’re not really supposed to. The famous example of business valuation is if you’re doing a valuation on January 31, and the building burns down or the business closes up. You’re not supposed to take those factors into account unless there was a way for you to know them in advance. So it’s going to be interesting. I think the court cases are going to determine how we actually treat those going forward.
Okay, we may check in with you again in a few months and see because I think this is evolving, and who knows how this will play out. Nobody knows how long this will last. Who knows what will happen? So I guess there’s a bit of a wait and see at the moment.
Sure. It’s already changed a couple of times, especially the PPP program. It has already changed several times.
My guest today has been Manhattan tax and financial expert John Johansen, who has a niche specialization in working with divorcing individuals and matrimonial attorneys in the areas of forensic accounting, business valuation, and taxes. John, thank you so much for taking the time to be with us and answer these questions about the CARES Act today!
It’s my pleasure. Thank you very much for having me.