The CARES Act (they have to spend a decent amount of time making these law names sound good… right?) was officially signed into law on March 27th.
There are a significant number of provisions within the CARES Act. If you’re bored, you can read the full bill here. This blog focuses on the following provisions of the CARES Act:
- The “recovery rebate” or that $1,200 check that you’ve probably heard about
- The impact on student loan borrowers
- Relief to people who are financially affected by the Coronavirus
- The impact to small business owners
- Tax planning opportunities
Ready? Let’s go!
Will you be receiving that check from the government?
Maybe. It depends on your adjusted gross income, or AGI. If you have no idea what AGI means, look at line 8B on the 1040 form of your most recently filed tax return. This means your 2019 tax return if you already filed or your 2018 tax return if you have not yet filed.
How much can I expect to receive?
The “recovery” rebate will pay $1,200 per person, or $2,400 if you file taxes jointly. In addition, you will receive $500 for each child that you claim as a dependent on your tax return.
However, this amount has some AGI limits which makes sense. If you are making a ton of money, you probably don’t need this extra check from the government. Here are the limits:
- If you are filing your taxes jointly, the benefits will be reduced by 5 cents for every dollar that your AGI exceeds $150,000. So, if your AGI is $180,000, it means that your $2,400 check is reduced by ($180,000 – $150,000) * .05 = $1,500. Therefore, your check will be $2,400 – $1,500 = $900. If your AGI exceeds $198,000, then you will not receive a check, even with kids.
- If you are filing your taxes as single, the benefits will be reduced by 5 cents for every dollar that your AGI exceeds $75,000. So, if your AGI is $85,000, it means that your $1,200 check is reduced by ($85,000 – $75,000) * .05 = $500. Therefore, your check will be $1,200 – $500 = $700. If your AGI exceeds $99,000, then you will not receive a check.
What should you do with the check?
There are so many different options and it will vary for each person, but here is a good framework to start with.
- Do you have less than 3 – 6 months of living expenses saved up in your bank account? If yes, then I recommend socking it into a checking or savings account, especially if your income has been affected by the Coronavirus. If no, then move onto question 2.
- Do you have any high yielding outstanding debt like credit cards? If yes, then I recommend paying down the debt. For example, if you have outstanding credit card debt at 15%, then paying down the debt is a “guaranteed” rate of return of 15% on your money. If no, then move onto number 3.
- At this point, it completely depends on your personal situation. I recommend either further paying down debt, investing in the stock market or donating the money to a charity/family member/small business that needs it.
How does this affect your student loans?
President Trump previously announced that student loan interest is suspended, but the CARES Act takes this to the next level.
All Direct federal student loans will have their payments automatically suspended until September 30th. As previously announced, your student loan interest will not accrue during this period. This is a significant relief for student loan borrowers.
Should you continue making payments?
This depends on your financial situation. I recommend you go back through the question 1 and question 2 that I posed earlier.
If you want to keep making payments, you will need to contact your loan servicer and ask them to remove the automatic payment suspension. Any payments you now make will result in you paying down your student loan balance faster than you originally anticipated.
What if you are pursuing student loan forgiveness?
There are two types of forgiveness programs – tax-free public service loan forgiveness (PSLF) and taxable loan forgiveness.
You can qualify for PSLF by making 120 qualifying payments with the right type of loans, on the right type of repayment plan, while working for the right type of employer, with the right type of recordkeeping.
Yeah – that’s why 99% of borrowers have been denied PSLF. However, if you do meet the strict criteria, as long as you are still working full-time at a nonprofit or government agency during this time, the next six months will still count towards the 120 payment requirement, even though you aren’t making payments. Unfortunately, if you lost your job or your status went below full time, then you will not earn PSLF credit during the student loan payment suspension.
This means if you are pursuing PSLF, you do not want to make any payments. However, you do want to make sure that you are keeping up with your employment certifications so that all your ducks are in a row for when you officially apply for PSLF.
On the other hand, you can actually qualify for taxable student loan forgiveness if you still have a loan balance remaining after 20 or 25 years of payments on an income-based repayment plan. As with PSLF, the next 6 months will count toward that 20 or 25 year requirement even if you don’t make any payments.
This means if you are pursuing taxable student loan forgiveness, you do not want to make any payments.
What if you are an employer?
The CARES Act also provides the opportunity for employers to help their employees pay down their student loan balance for up to $5,250/year without the $5,250 being treated as earned income.
However, this only applies for 2020, not subsequent years. If employers pay down their employees’ student loan balance after 2020, that amount is taxed as income to the employee which also means payroll tax to the employer and the employee.
This is a big reason why many employers do not offer this employee benefit. My hope is that this tax provision will change in the future, so more employers can help their employees with their student loan balances.
What if you have been financially affected by the Coronavirus?
Fortunately, there are many provisions that can help people that are financially struggling as a result of the Coronavirus.
Temporary removal of the 10% early withdrawal penalty
IRAs and qualified plans typically carry a 10% early withdrawal penalty (and tax, but that’s still in play here) if you withdraw funds before the age of 59.5, unless a specific exclusion occurs.
For example, let’s say you have $100,000 in your 401(k). If you find yourself in financial hardship and have to withdraw money from your 401(k), typically you would pay income tax plus a $100,000 *10% = $10,000 penalty. This is pretty steep.
However, this 10% early withdrawal penalty for up to $100,000 of withdrawals is removed for 2020 if any of these provisions occur:
- You were diagnosed with Coronavirus
- A spouse or dependent was diagnosed with Coronavirus
- You experience adverse financial consequences as a result of being quarantined, being furloughed, laid off or having work hours reduced. This interpretation is pretty broad…
In addition, any income tax from the distribution will, by default, be spread evenly over a 3-year time period as opposed to all being taxed in 2020. This means that the income tax that you owe on that $100,000 withdrawal would be spread out evenly between 2020, 2021 and 2022.
However, I would carefully consider whether that is the best strategy for you tax wise. Your tax rate may be lower this year than in subsequent years, so it may actually be better to elect all of the taxation to occur in 2020.
Permitted 401(k/403(b) loan amounts temporarily increased to $100,000
Typically, you are limited to the lesser of $50,000 or ½ your vested account balance in your 401(k)/403(b) when you take out a loan. This means if you had $200,000 in a 401(k), the maximum loan you could take is $50,000.
As part of the CARES Act, you now have the ability to borrow $100,000 from your 401(k).
Now, this doesn’t mean you should take out the maximum loan amount (especially given the fast market decline), but it’s a nice option to have on the table if you are experiencing financial hardship.
Unemployment benefits are increased
If you are eligible to collect unemployment benefits, your weekly unemployment benefit should increase by $600. So, if you were previously collecting $400/week from your state, you will now start collecting $1,000/week.
This is a significant increase and may actually exceed the income you were receiving while working…
How are small business affected?
Small businesses have been hit the hardest from the Coronavirus. Nearly all non-essential businesses are closed for the foreseeable future. My focus here is on small businesses with less than 100 employees.
Payroll tax credit
Employers and employees pay payroll tax on any earned income. There are two parts of this tax – 6.2% on earned income up to $137,700 and then 1.45% on an unlimited amount of earned income.
As part of the CARES Act, the employer receives a credit for their portion of the 6.2% + 1.45% = 7.65% of payroll tax for up to $10,000 of wages per employee if the following criteria is met:
- The business is fully or partially suspended during the quarter due to orders from the government as a result of rules from COVID-19 precautions, or
- Gross receipts (aka revenue) is <50% compared to the same quarter in 2019
This means that they could save $10,000 * 7.65% = $765 of tax per employee which helps with a small business’s cash flow if the business meets the above criteria.
Payment of payroll tax is delayed
While the credit is nice, small businesses will very likely still owe payroll tax for earned income. However, the payment of this payroll tax may now be suspended, so 50% can be paid in 2021 and 50% can be paid in 2022.
As with the payroll tax credit, this will significantly help a small business’s cash flow for the foreseeable future.
Access to small business loans
Small businesses (in this case classified as <500 employees) may have access to a small business loan from the U.S. Small Business Administration if they have been financially impacted by the Coronavirus. Here is the link to apply.
However, you can’t use this loan to go expand your business. It must be used to retain workers, payroll, lease payments, utilities, etc. Or said differently, use the loan to keep your business afloat during this difficult time.
You may also be able to qualify for tax-free loan forgiveness for the portion of the loan between March 1st, 2020 and June 30th, 2020. The amount that could be forgiven is the amount that it costs for you to maintain payroll during that specified period.
In other words, let’s say you receive a $1 million loan and the cost for you to maintain payroll between March 1st and June 30th is $200,000. If you meet the criteria for loan forgiveness (too in the weeds for this blog), then that $200,000 could be forgiven tax-free. This is a big potential benefit and one to review with your CPA.
What tax planning opportunities may exist?
If your head doesn’t already hurt… it will start hurting now. As a result of the CARES Act, there are a few tax planning opportunities for you to be aware of.
If you haven’t filed your taxes, you may want to wait until the new deadline of July 15th
You likely heard that the infamous April 15th tax filing date has now been moved to July 15th at a federal level. Most states are adopting this as well, although it’s best practice to check with each state. You may want to consider delaying filing your taxes if:
- Your 2018 AGI would make you eligible for 100% of your stimulus check, but your 2019 AGI would not. Remember, your stimulus check starts to phase out once your AGI exceeds $75,000 for single filers and $150,000 for married filers. Let’s say you are filing jointly with your spouse and your 2018 AGI is $140,000 and your 2019 AGI is $175,000. If you wait to file your 2019 taxes until after you receive the stimulus check, then you will receive the full $2,400. However, if you file your 2019 taxes before the stimulus check arrives, then you will only receive $1,150.
- You will likely end up owing the government, you could now wait to file until July 15th and delay paying the tax.
There is a new permanent $300 tax deduction for charitable contributions
Most people are accustomed to receiving a tax deduction for charitable contributions, but that completely changed when the new tax law was enacted in 2017. As a result of the tax law, the standard deduction doubled which means most taxpayers actually no longer use itemize deductions.
Without getting too granular, you can either use the standard deduction ($24,800 for married couples and $12,400 for single filers in 2020) or itemized deductions. Unless your itemized deductions exceed your standard deduction, then you will, by default, use the standard deduction.
The most common itemized deductions are:
- State and local property tax which is now limited to $10,000 (which is why high-income tax states like NY and CA are pissed)
- Mortgage interest
- Charitable contributions
- Medical expenses
Let’s say you are a married couple with an adjusted gross income of $200,000. When determining your taxable income, you subtract the higher of the standard deduction ($24,800) or your itemized deductions.
For most people, the standard deduction is higher which means you receive no tax benefit for any of the itemized deduction pieces (including charitable contributions).
As part of the CARES Act, you can now deduct up to $300 of contributions if the contributions are made in cash (not appreciated securities) and you do not itemize.
While this may not be huge, every small tax savings counts!
- There is a lot here. I know. I tried to keep it short, but it’s hard. I recommend reading this a few times to best digest the information.
- The CARES Act has several provisions that are meant to help bring short-term cash flow relief to taxpayers and small business owners. It’s important for you to determine which ones are appropriate for you.
- If you are working with a financial professional (financial planner, CPA, etc.), I highly recommend that you lean on them to help you determine the impact the CARES Act has on you. If you have not worked with a financial planner before, here is an article that talks through how to find the right one.
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