2020 Private Equity Tax Considerations
Key strategies for maintaining a strong offensive tax position during times of economic distress, particularly during the current COVID-19 pandemic, include finding money, preserving cash and planning for future success.
While the affiliation rules associated with the Paycheck Protection Program (PPP) precluded many private equity-backed portfolio companies from qualifying for PPP loans, it is possible to find money through three simple tax actions. First, businesses can now carry back net operating losses for five years, meaning that tax losses from 2018, 2019 and 2020 can be used to offset income from the prior five years for a quick cash refund. Second, businesses with any remaining alternative minimum tax (AMT) credits can also get a quick refund by electing to make all such credits refundable for 2018. Finally, businesses can get a tax credit of up to $5,000 per employee for employees kept on payroll during the pandemic, even if those employees are providing partial services for their compensation.
There are several ways to preserve cash at the moment, starting with deferring tax payments. Businesses can now defer employer payroll taxes otherwise payable for the period from March 27, 2020, through December 31, 2020. Half of the amount can be deferred until December 31, 2021, and the other half until December 31, 2022. Employers that received PPP loans can only defer payroll payments until the loans are forgiven, except that amounts deferred before the loans are forgiven can be deferred 50/50 until December 31, 2021 and 2022. In addition, payment (not just filing) of 2019 taxes can be deferred until July 15, 2020.
On top of these deferrals, 2019 and 2020 taxes can be reduced by taking a higher interest expense deduction than was previously allowed. Under the Tax Cuts and Jobs Act of 2017, businesses could only deduct interest expense up to 30% of adjusted taxable income (ATI), a computation that is similar to EBITDA but may differ in some important respects. For 2019 and 2020, the deductible amount has been increased to up to 50% of ATI. Not only that, 2019 ATI can be used to calculate 2020 interest expense deduction. Finally, businesses can take 100% bonus depreciation on qualified improvement property, a defined term that generally combines three previously separate categories (qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property).
To plan for future success, we recommend businesses use this time to focus on setting an action plan. Businesses should review any diligence reports from the last 12 to 24 months, address any material issues and review acquisition documents to confirm receipt of any benefits to which they’re entitled (e.g., any net operating loss carryback opportunities).
Businesses should also take this time to consult with tax advisors about state income tax credits and business incentives reviews, as well as consider a reverse sales tax audit to see if a refund of overpaid use taxes is available. In addition, this is a good time to make sure sales tax is being filed properly, especially given numerous changes to sales taxes (with some jurisdictions even taxing services) as well as the Wayfair decision, which permitted states to expand sales tax filing obligations to an economic rather than a physical basis. Sales taxes are generally accepted as a customer tax, unless the business is audited, in which case the business pays.
Although not really a tax, a reverse unclaimed property audit may also be considered. With tax revenues plummeting, states will likely be looking for sources of additional revenue and unclaimed property may be low hanging fruit. This is especially true for businesses incorporated in Delaware, an aggressive state when it comes to unclaimed property.
The government has been providing tax as well as financial aid at a ferocious pace, including additional guidance and expanded (and sometimes nuanced) benefits. While we have outlined some of the bigger benefits currently available, businesses should consult with their tax advisors about these and other tax opportunities.
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