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How the CARES Act can benefit the hospitality industry

Apr 09, 2020

As the economy slows and non-essential business and travel remain paused, few industries have felt the impact as severely as hospitality. 

COVID-19 has stripped away the hospitality industry’s ability to provide social experiences and caused an abrupt and significant suspension of revenue.  In an effort to stabilize businesses across all industries, extensive legislation has been passed with the goal of providing them with the additional cash flow needed for short-term survival.  

For many businesses, this additional cash flow will be directed toward maintaining their most valuable resource – employees. This article introduces some of the legislative provisions that have been put in place to smooth the loss of revenue for businesses and how those provisions can specifically benefit the hospitality industry as it adapts to the unique level of disruption caused by COVID-19.

Paycheck protection program

The Paycheck Protection Program (PPP) was signed into law as part of the Coronavirus Aid, Relief and Economic Security (CARES) Act and is administered by the Small Business Administration (SBA) under its 7(a) loan program.  The objective of this program is to provide short-term funding for small businesses to cover their fixed operating costs while in the midst of this crisis, with a primary focus on retaining employees.  

Given the extreme urgency of the current situation, this program has been structured to simplify the normally arduous SBA loan process.  The simplified process includes a streamlined application process, applicants will work with their bank rather than directly through the SBA, personal guarantees and collateral are not required, no fees are assessed on applicants, and applicants are not required to show that they could not obtain financing elsewhere.  An applicant must still meet the SBA size requirements (generally, must have no more than 500 employees) and certify that (a) the loan is necessary to support their ongoing business operations and (b) that funds will be used for employee retention and operations.  

A key aspect of these loans provides that if the proceeds are used for qualifying expenses during the eight-week period following loan closing, up to 100% of the loan may be forgiven.  Business owners should contact their local lenders immediately to determine if the lenders are a participating SBA preferred lender as a high demand is expected for these loans and they will be issued on a first come, first served basis.  A business may also use the lender matching tool at http://www.sba.gov/funding-programs/loans/lender-match.   

However, many banks have indicated that they will not work with businesses that are not already current bank customers in order to prioritize the significant number of applications being received.

Recognizing that hospitality businesses (NAICS code 72) have been hit hardest by this crisis, a specific provision of the PPP specifies that the normal SBA affiliation rules do not apply to such businesses.  Businesses that fall under NAICS code 72 include accommodations (such as hotels, B and B’s, RV parks and campgrounds) and food services (restaurants, mobile food services, bars, caterers, and food service contractors).  Therefore, when determining whether such businesses have no more than 500 employees, the test applies per each physical location, not in total.  SBA-designated franchises are also eligible for this same exclusion from the affiliation rules.

The maximum PPP loan amount for a non-seasonal employer is equal to the lesser of $10 million or 2.5 times their average total monthly payroll costs for the 12 months prior to the loan date.  The payroll costs to be used in the average calculation include:

  • Compensation paid through salaries, wages, commissions and bonuses
  • Cash tips or equivalents
  • Payments for vacation, parental, family, medical or sick leave
  • Payments for dismissal or separation
  • Payments for group health care benefits, including insurance premiums
  • Payments of any retirement benefits
  • Payments of state or local tax assessed on compensation of employees

The following payments are then excluded from the above calculation:

  • Individual compensation in excess of annual salary of $100,000, as prorated for the period of Feb.15, 2020 to Jun 30, 2020.
  • Compensation of employees whose principal residence is outside of the U.S.
  • Payroll taxes and income taxes
  • Qualified sick leave wages or qualified family leave wages for which a credit is allowed under the Families First Coronavirus Response Act

As indicated above, loans made under the PPP may be forgiven to the extent those loan proceeds are used by the recipient for qualifying expenses during the eight-week period after the loan closes.  Qualifying expenses include payroll costs (as generally defined above), interest on debts secured by real or personal property, interest on debt obligations incurred prior to Feb. 15, 2020, and qualified rent and utilities. However, recently-issued guidance indicates that only 25% of the forgiven amount may consist of non-payroll costs.

An important caveat regarding the loan forgiveness provision is that the employer must maintain pre-crisis employment levels, which unfortunately creates an issue for accommodations with minimal occupancy levels and food service businesses that have shut down completely, are only operating with carryout or delivery options requiring significantly reduced staff levels.  

Employment level for purposes of forgiveness is measured both by the number of employees and the amount of compensation.  If there has been a reduction in either the number of employees or compensation, the total loan amount otherwise eligible for forgiveness will be reduced accordingly.  However, to encourage employers to bring back employees that were previously laid off, an employer that brings back such employees or restores reduced compensation by June 30, 2020 will not have a reduction in the amount of their calculated debt forgiveness. 

To the extent that hospitality businesses can be re-opened and bring back enough employees by this date, there is some hope.  However, the combination of concerns regarding how soon customers will actually return (due to either fear or their lack of discretionary funds) and the 25% limit on non-payroll expenses when calculating the forgivable amount may serve to dash that hope.  The hospitality industry is already lobbying for changes to the rules that would therefore specifically address these concerns.

Any PPP debt that remains unforgiven will have an interest rate of 1%, a deferral in required payments of 6 to 12 months, and an amortization period of ten years.

Business tax provisions in the CARES Act

The CARES Act also provides numerous pro-taxpayer income and payroll tax provisions intended to provide additional cash flow for businesses.  Interestingly, many of the income tax changes are partial or even full reversals of several significant income tax changes that were recently made by the Tax Cuts and Jobs Act (TCJA).

Qualified Improvement Property

One change that will be of significant benefit to the hospitality industry is the long overdue technical correction to the depreciable life of Qualified Improvement Property (QIP).  QIP is generally defined as an interior improvement made by a taxpayer to a non-residential building, where the improvement is placed in service after the building is placed in service any taxpayer.  This change reclasses QIP to 15-year property for depreciation purposes, making the cost of such improvements now eligible to be 100% written off in the year placed in service, using the new 100% bonus depreciation rules.  Prior to this correction, QIP had to be written of over a 39-year period. This correction is retroactive to Jan. 1, 2018.

There are two alternatives for capturing the tax benefits of this retroactive change available to corporations: 

  • Amended income tax returns can be filed for tax years 2018 and 2019, assuming those returns are already filed, to obtain a refund of taxes paid in those years.This will result in an acceleration of the cash benefit of this QIP change as compared to the second alternative below.
  • A Form 3115 may be included in the next income tax return filed, whether that is the taxpayer’s 2019 return or the 2020 return. Form 3115 accumulates past year differences and recognizes them in the current year, effectively allowing a “catch up” deduction equal to the amount that could have been deducted in prior years under the new rule versus the amount that was actually claimed in those years.

Due to changes to the net operating loss rules discussed below, amending a previously filed return can provide an additional benefit.  If the amended tax return claiming the additional depreciation deduction results in a net operating loss, the taxpayer can then carry that loss back five years to obtain a refund of taxes paid in those prior years.

Taxpayers organized as partnerships, rather than corporations, may also take advantage of the retroactive change to QIP depreciable life.  However, the logistics of amended returns are more complicated, and each taxpayer’s unique circumstances needs to be reviewed to determine the best alternative available.

Net operating losses

As mentioned above, a significant change has been made to net operating losses (NOL).  As a result of the TCJA,  carrybacks were eliminated and the carryforward of NOLs could only reduce taxable income in subsequent years by 80%.  The CARES Act now allows corporations and individuals to carryback their NOLs from 2018, 2019, and 2020 to their prior five tax years.  It also allows NOLs from those years to completely eliminate taxable income. While C corporations will benefit from this change directly, the benefit for passthrough businesses (S corporations, partnerships, and LLCs taxed as partnerships) will be recognized  at the individual level.  This newly-allowed carryback of losses to prior years with taxable income will allow taxpayers to receive refunds of taxes previously paid.

Deductibility of business interest

While the TCJA imposed a new restriction on the deduction of business interest, limiting the deduction to 30% of adjusted taxable income, the CARES Act now retroactively increased that 30% limitation to 50%, for tax years beginning in 2019 and 2020.  As a result, amended returns can be filed for impacted individuals and entities, excluding partnerships.  In addition, the CARES Act will allow taxpayers to use their 2019 adjusted taxable income as the basis for deductibility for their 2020 interest expense.  Since most, if not all, hospitality businesses will have had higher income in 2019 than they will have in 2020,  this rule will allow for a larger 2020 interest deduction.  For entities organized as partnerships,  more complicated rules apply.

Payroll tax provisions

The Act provides two additional payroll tax provisions. 

The first is the Employee Retention Credit, which is a refundable payroll tax credit equal to 50% of qualified wages and health benefits, capped at $10,000 per employee.  Employers are eligible for this credit during any calendar quarter in 2020 where either (a) operations have been either fully or partially suspended due to a COVID-19 shutdown order or (b) where gross receipts for a quarter declined by more than 50% when compared to the same quarter in the prior year.  Eligible wages depend upon the number of employees.  For employers with over 100 employees, eligible wages include only those wages paid to employees who are not providing services (i.e., furloughed employees).  For employers with 100 or fewer employees, all wages are eligible for the credit.  Wages where a credit has been allowed for paid leave are not eligible for this credit.

The second payroll tax provision is the opportunity to defer the payment of employer-paid social security taxes (not Medicare) for the time period of March 23, 2020 through December 31, 2020.  These payments may be made by qualified employers in two equal installments, one by December 31, 2021 and the other by December 31, 2022. 

The Families First Coronavirus Response Act

The Families First Coronavirus Response Act was enacted on March 18, 2020 and took effect on April 1, 2020. This act serves to support employers with 500 or fewer employees, as well as the employees themselves.  However, businesses with fewer than 50 employees may be able to obtain an exemption from these mandates. The Act mandates two weeks paid sick leave and a paid expansion of family medical leave for those who qualify, but provides reimbursement of the employer through a refundable credit against payroll tax.  

1. Emergency paid sick leave

The Emergency Paid Sick Leave Act is effective as of April 1, 2020 and does not provide for retroactive sick leave reimbursement.  Full time employees may receive up to 80 hours of paid sick leave and part time employees may receive an average of their work hours for a two-week period.  The Act details two types of sick leave which are covered by these new rules.  The first is leave for an employee for one of the following 3 reasons: (a) the employee is subject to a governmental quarantine or isolation order due to Covid-19, (b) the employee is advised to self quarantine by a health care provider due to COVID-19, or (c) the employee is experiencing symptoms of COVID-19 and is seeking a medical diagnosis. This leave is paid at the higher of their regular pay or minimum wage, capped at $511 per day and $5,110 in total.

The second type of leave is for the care of others, specifically for the care of (a) a spouse or child who is subject to a governmental quarantine or isolation order or (b) the care of the employee’s child whose school or place of care has been closed. Both must be due to COVID-19.  This leave pay structure is paid at the higher of 2/3 of their regular wage or 2/3 of minimum wage, capped at a maximum of $200 per day and $2,000 in total.

2. Emergency expansion of Family Medical Leave

The Emergency Expansion of Family Medical Leave is the second component of this legislation that provides support for businesses and their employees.  This provision provides for a 12- week expansion of family medical leave for employees who must care for their minor child due to school or place of care closing because of COVID-19.  The first two weeks are unpaid (the employee may elect to use PTO or have those first two weeks covered under The Emergency Paid Sick Leave Act).  The remaining 10 weeks have the same two-thirds pay structure as described above.

Employers will receive a payroll tax credit equal to the costs expended for the paid leave. The costs are offset against payroll tax liabilities that would normally be paid to the Treasury.  If the costs expended for leave are in excess of the payroll tax liability, an advance refund can be requested. 

Leave wages that are used for a credit against payroll taxes may not be used as a qualifying expense to determine the total loan forgiveness under the 7(a) SBA loan discussed above. Therefore, it is essential to perform a benefit analysis to determine which program is likely to provide the greatest benefit for your business.

3. Outsourced management and employees

An emerging employment structure for the hospitality industry is for the management and employment of staff to be outsourced to a third party, who then charges the direct costs back to the hotel owner. The ramifications of this particular management/employment structure were not explicitly addressed in the most recently-passed legislation and thus remains an open question for many owners and management groups. It would be prudent for the hotel owner and the third party to review the specific language of their management agreement and begin discussing the proper calculation of direct costs to be charged by the third party to the hotel owner in situations where the third party receives benefits from the provisions detailed above.

How Wipfli can help

Although there are many details outside the scope of this article, we hope it has provided you a launching pad to begin having conversations with your trusted advisors. From assessing your unique circumstances to implementing recovery strategies, Wipfli can help your organization. We also continue to monitor all legislation and guidance for impact on the hospitality industry.  Please reach out to our hospitality team or visit our online COVID-19 Resource Center to obtain the latest information.

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Author(s)

David Hanyzewski
David Hanyzewski, CPA
Senior Accountant, Tax
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Christenson_Crystal
Crystal Christenson, CPA, MST
Partner
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