Congress's response to the economic impact of the COVID-19 pandemic is unprecedented, including the broad tax relief provided to businesses and individuals. While this tax relief has been welcomed by taxpayers experiencing financial turmoil, IRS scrutiny will also follow for years to come. Tax controversy professionals should not wait, but should be thinking now about the issues that likely will arise in future examinations. These issues will range from the interpretation of rapidly enacted legislation, to ensuring that there is adequate substantiation to support the steps that taxpayers are taking to avail themselves of relief offered by that legislation.

As of this writing, Congress has enacted two key pieces of legislation—Families First Coronavirus Response Act ("FFCRA"), enacted on March 18, 2020,1 and the Coronavirus Aid, Relief, and Economic Security ("CARES") Act, on March 27, 2020.2 It is worth looking now at key provisions of these statutes, both in anticipation of potential litigation over certain ambiguities in the language and implementation of the legislation, as well as the steps that the IRS may take as it seeks to prevent potential abuse of the tax relief provisions.

In particular, the FFCRA provided employers with a payroll tax credit to offset a portion of the costs of new sick and family paid leave. As discussed below, the IRS may seek to disallow those credits if employers fail to comply with document retention requirements, including obtaining information from employees.

The CARES Act included a payroll credit for eligible employers that retain their workforce. To date, the IRS has narrowly interpreted key eligibility requirements to limit applicability of the credit, arguably in conflict with the plain language of the statute. The CARES Act also allowed employers to defer payroll tax for the remainder of 2020, with payments due at the end of 2021 and 2022. Employers that fail to repay the deferred amounts will face IRS Collections. The Service may also impose penalties and interest, and use the Trust Fund Recovery Penalty to assess and collect the tax against responsible persons. Additionally, the CARES Act expanded the availability of net operating losses ("NOLs"), which has already had a significant impact on corporate tax planning, and is a likely target for future IRS examination.

The IRS quickly issued guidance intended to clarify certain aspects of these provisions. In some instances, however, parts of guidance created confusion over the meaning of key provisions, and have already been identified by lawmakers as setting up a potential conflict with legislative intent. Much of the guidance was published on the IRS's website in the form of FAQs, which are being revised, supplemented, and expanded weekly. This type of guidance is not given heightened deference by courts. The IRS stated that it will not formally publish the FAQs, and some practitioners fear the FAQs could be removed from the IRS's website at any time. Taxpayers and their advisors should take care to monitor the guidance closely as it develops.3

The IRS separately took steps to provide relief to taxpayers. In March 2020, it announced the "IRS People First Initiative" which changed how the agency approached enforcement and collection in light of the challenges stemming from the pandemic. At the same time, the IRS has been encouraging those that are outside of the tax system to take this opportunity to become compliant. Again, tax controversy practitioners need to give careful consideration of the implications for their clients.

New Payroll Tax Credits

The FFCRA required certain employers to provide paid sick leave4 or family and medical leave5 for specified reasons related to COVID-19. The FFCRA provided covered employers6 with a payroll tax credit for qualifying wages.7 Employers can claim the credit on leave wages paid until the end of 2020.8

Employers claiming the credit must maintain the following documentation for four years:

  • Certain records and documents supporting each employee's leave, including the reason the leave was requested and a statement that employee was unable to work;
  • Forms 941, Employer's Quarterly Federal Tax Return; >
  • Forms 7200, Advance Payment of Employer Credits Due to COVID-19; and
  • Any other filings made with the IRS requesting the credit.9

Employers should anticipate that those records will be requested immediately in an exam. As such, employers should maintain the records separately from all other workpapers, tax opinions, and any other confidential or privileged materials, in a form that can be easily provided to the IRS. The IRS may attempt to disallow the credit on the basis that the employer failed to maintain the records in a sufficiently useable form and detail.

Additional Tax Relief Under The CARES Act

The CARES Act provided nearly two trillion dollars in aid and relief to individuals, businesses, and other entities in response to COVID-19.10 The CARES Act also provided broad tax relief, including:

  • A payroll tax credit (the "retention credit");
  • A payroll tax holiday that allows employers to defer their portion of Social Security taxes due in 2020; and
  • Temporary repeal of certain portions of the 2017 Tax Cuts and Jobs Act, including expanding the availability of net operating losses ("NOLs").

As discussed below, certain key parts of these provisions remain unclear. That uncertainty will need to be resolved, including through possible litigation with the IRS as it seeks to prevent what it may view as misapplication or abuse of the relief provisions. Taxpayers and practitioners need to prepare now to defend their positions.

The CARES Act also included a loan program for small businesses, referred to as the Payroll Protection Program ("PPP"). Recipients of PPP loans may have a portion of the loan forgiven equal to two months of payroll expenses, plus two months of rent, mortgage interest, and utilities.11

The legislation—which has already been amended once—specifically provided that the forgiveness of a PPP loan does not create cancellation of indebtedness (COD) income to the recipient.12 However, the IRS announced that no deductions will be allowed for the expenses paid with the forgiven loan.13 In other words, under the IRS's interpretation, taxpayers are effectively in a net zero position, with no COD income inclusion, but also no ability to deduct the expenses. A bipartisan group of lawmakers announced their disagreement with the IRS's guidance, and introduced legislation to enable taxpayers to deduct their expenses even if they received a PPP loan that was later forgiven.14 The CARES Act is silent on whether or not taxpayers may deduct such expenses. Unless this issue is resolved by subsequent legislation or a change in the IRS's position, taxpayers who avail themselves of PPP loan forgiveness may need to litigate the availability of true relief under the statute.

Footnotes

1 Families First Coronavirus Response Act, P.L. 116-127 (2020) [hereinafter FFCRA].

2 Coronavirus Aid, Relief, and Economic Security Act, P.L. 116-136 (2020). Congress enacted the Paycheck Protection Program and Health Care Enhancement Act on April 24, 2020, to appropriate additional funds for loan programs under the CARES Act, and provide emergency funds for hospitals and for COVID-19 testing. The PPP provisions of the CARES Act have already been amended once by the Paycheck Protection Program Flexibility Act, enacted on June 5, 2020.

3 States have also provided relief, largely conforming to the federal changes to tax filing and payment deadlines. However, states are still working out how much they will conform to major tax provisions of the CARES Act, with some states, including California and New York, publicly announcing their intention not to conform with changes, allowing taxpayers to take inconsistent positions at the federal and state levels.

4 Specifically, under the FFCRA's new emergency paid sick leave program, covered employers with less than 500 employees are required to provide two weeks of paid leave to employees affected by the COVID-19 and unable to work. FFCRA §5102.

5 The expansion of FMLA leave requires those same-sized employers to provide two weeks of unpaid leave to employees who cannot work because they need to care for a child whose school or place of care has been closed due to COVID-19. Id. §7005. Following the two unpaid weeks, employers must provide up to 10 weeks of paid leave.

6 Public employers, including the federal government, state governments, and any subdivision, agency, or instrumentality of those governments, must provide paid leave under the FFCRA, but are not eligible to receive the tax credits available to nonpublic employers.

7 FFCRA §§7001–7005. For sick leave wages, the credit is limited to $511 per day per employee ($200 per day if the employee is caring for a family member). Id. §7001(b)(1). For leave wages under the expanded FMLA, the credit is limited to $200 per day per employee ($10,000 in the aggregate per employee). Id. §7003(b)(1). The credit also includes both allocable qualified health plan expenses, and the employer's share of Medicare tax that are paid under the FFCRA paid leave provisions.

8 Id. at §§7001–7005; IRS Notice 2020-21.

9 IRS FAQ on FFCRA, at "How Should an Employer Substantiate Eligibility for Tax Credits for Qualified Leave Wages?", available at www.irs. gov/newsroom/covid-19-related-tax-credits-forrequired-paid-leave-provided-by-small-andmidsize-businesses-faqs.

10 The estimated total cost is between $1.8 trillion and $2 trillion. Congressional Budget Office, Preliminary Estimate of the Effects of H.R. 748, the CARES Act, Public Law 116-136, Revised, with a Correction to the Revenue Effect of the Employee Retention Credit (2020).

11 CARES Act §1106.

12 CARES Act §1106(i).

13 IRS Notice 2020-32.

14 Hon. Charles Grassley, Hon. Richard E. Neal, Hon. Ron Wyden, Letter to Hon. Steven Mnuchin (May 5, 2020), available at www.grassley.senate.gov/ sites/default/files/2020-05-05%20CEG%2c%20 RW%2c%20RN%20to%20Treasury%20 %28PPP%20Business%20Deductions%29.pdf

Originally published 03 July, 2020

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