The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) provides emergency assistance to those affected by the coronavirus pandemic. From expanded unemployment benefits to small-business loans and tax considerations, this comprehensive package seeks to mitigate the impact of the viral outbreak on individuals, businesses, and the health-care system.
Considering how the new law affects individuals and business owners, here are five planning ideas to consider under the CARES Act.
1. No RMD in 2020? Consider a Roth IRA conversion
The CARES Act lifts the rule for retirees to take a required minimum distribution (RMD) from their retirement accounts. Individuals may want to consider a Roth conversion for the amount of their suspended RMD amount in 2020.
- Converting what would have been the amount of their RMD to a Roth IRA can provide a source of tax-free income in retirement or for their heirs.
- The SECURE Act ushered in new rules requiring most, non-spouse beneficiaries to distribute inherited IRA funds within 10 years. Leaving Roth funds to the next generation, who may be in a higher tax bracket, may be more tax efficient.
- Of course, realizing additional taxable, ordinary income may result in other tax issues, so it is critical to consult with a tax expert.
2. If itemizing tax deductions, consider lumping charitable contributions
- The CARES Act temporarily, for 2020 only, allows taxpayers to deduct a maximum of 100% of Adjusted Gross Income or AGI (cash contributions to a public charity), instead of the established maximum 60% of AGI.
- Allocating more funds to charity in 2020 may make sense in light of the increased limit on deductions as a percentage of AGI.
3. Business owners may use a net operating loss in 2020 to offset a Roth conversion
- Given the economic impact of the pandemic crisis, it’s likely that a significant number of businesses will incur tax losses in 2020.
- The CARES Act provides more options for business owners to use net operating losses (NOLs). For example, businesses may carry back a NOL to prior tax returns, a maximum of five years.
- The Act temporarily removes the taxable income limitation to allow an NOL to fully offset income. Prior to this change, taxpayers were generally limited to applying an NOL against 80% of taxable income. The 80% limitation will be reinstated beginning in 2021.
- In consultation with their tax professional, business owners with large NOLs this year may consider converting traditional IRA assets to a Roth IRA before the end of the year. They can use the NOL to offset the additional ordinary income generated by the Roth conversion.
4. Establish a separate account when seeking a PPP loan
- Business owners seeking a Paycheck Protection Program (PPP) loan may want to set up a separate account to hold the loan proceeds. A key feature of these new loans is the forgiveness feature. After receiving loan proceeds, certain qualified expenses including payroll, rent, utilities, and mortgage interest over the next eight weeks can be forgiven (if certain requirements around maintaining employee headcount and compensation are met).
- When applying for forgiveness, business owners will need to provide documentation of the amount of the qualified expenses over the period, details on headcount and payroll, and verification that the loan was applied to qualified expenses. Establishing a separate bank account to hold PPP loan funds may make it easier to provide a track record for the loan forgiveness process.
5. Affected self-employed individuals may want to compare the PPP loan to unemployment benefits
- For 2020, the CARES Act extends unemployment benefits to those who were not typically eligible under state programs, including self-employed individuals, sole proprietors, and independent contractors.
- Alternatively, these individuals could apply for a PPP loan. According to the Small Business Administration (SBA), the amount of the loan that can be secured is generally equal to their net earnings from 2019 (line 31 of IRS Schedule C, Profit or Loss From Business, Sole Proprietorship) multiplied by 2.5 (with earnings are capped at $100,000 annually).
- The amount of loan forgiveness is based on the same figure (2019 Schedule C, line 31) multiplied by 8/52, which represents compensation replacement for eight weeks, plus qualified certain qualified expenses associated with the business such as rent, mortgage interest, and utilities. The amount of the loan forgiveness cannot exceed the principal amount.
- Self-employed individuals may want to compare both options – a PPP loan or unemployment benefits. State unemployment benefits vary, and the federal government is providing an additional $600 per week through the end of July.
- Additionally, while unemployment benefits are considered taxable income, the amount of loan forgiven through the PPP is not considered taxable income to the business.
- The U.S. Chamber of Commerce published a guide for more information on how the CARES Act can help those who are self-employed.
Consult an advisor
Individuals and business owners impacted by the crisis may want to reach out to a financial advisor to identify which provisions may apply to their situation. It is important, however, to research these considerations quickly as most provisions of the CARES Act have limited resources and are temporary.
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