HEROES Act First Bid to Provide Phase 4 Relief for Businesses and Individuals

Federal Tax

The Health and Economic Recovery Omnibus Emergency Solutions (HEROES) Act, a draft released Tuesday by Democrats in the U.S. House of Representatives, is the first bid to provide additional economic relief to individuals and businesses affected by the coronavirus pandemic and economic downturn. The bill is projected to cost about $3 trillion—a third greater than the nearly $2 trillion spent in the Coronavirus Aid, Relief, and Economic Security (CARES) Act passed by Congress in March.

We previously wrote about the state and local government provisions of the bill. In this post we discuss the raft of new provisions for businesses and individuals and the key tax implications.

Individual Revenue Provisions

The HEROES Act would provide another round of rebates to individuals, following the Recovery Rebates disbursed through the CARES Act. These rebates would follow a similar design to the recovery rebates, but raise the dependent amount from $500 to $1,200 (up to three dependents). The rebates would also be extended to adult dependents (such as college students and disabled adults) who were left out of the original rebate. The Recovery Rebates also see some changes, as they are protected from garnishment and would no longer be subject to reduction for past-due child support, in addition to allowing those with any dependents to claim the $500 originally allocated to qualifying children.

The HEROES Act also would expand both the Child Tax Credit (CTC) and the Earned Income Tax Credit (EITC), making the CTC fully refundable and increasing its value to $3,000 ($3,600 for qualifying children under 6). The CTC would be advanced on a monthly basis to help families with children through the crisis. The Child and Dependent Care Tax Credit (CDCTC) is also made fully refundable for tax year 2020 and the maximum credit is increased from $3,000 to $6,000 for a qualifying individual. The EITC is given a more generous phase-in (15.3 percent from 7.65 percent) and the earned income amount and phaseout maximum amounts are raised, increasing the benefit of the EITC for low-income individuals.

In addition, flexible spending arrangements (FSAs) for health expenses would be more flexible, building in longer grace periods, permitting changes in elections, and increasing permitted carryovers. Workers also see additional relief for expenses through a new above-the-line deduction for first responders and a new 50 percent employer-side refundable Social Security payroll tax credit (30 percent for nonessential employees) for pandemic-related employee expenses paid by employers (up to $5,000 per calendar quarter). New above-the-line deductions up to $500 are created for first responders purchasing supplies and equipment and for COVID-19 front-line employees.

Finally, individual taxpayers in higher-tax states would see a benefit through the elimination of the state and local tax deduction (SALT) limitation for the 2020 and 2021 tax years.

Business Revenue Provisions

The HEROES Act expands the Employee Retention Tax Credit (ERTC) established in the CARES Act by increasing the refundable payroll tax credit from 50 percent of qualifying wages to 80 percent, increasing the per-employee limitation to $15,000 per calendar quarter ($45,000 per year), and phasing in the credit for firms with gross receipts for the year that are between 50 percent and 90 percent of prior levels.

The Paycheck Protection Program (PPP) is reformed, extending the amount of time borrowers can use to spend the loans—extending the covered period from June 30 to December 31, 2020—and eliminating a Treasury-instituted rule that firms must use at least 25 percent of loans provided on payroll. Additionally, firms would be able to defer payroll tax beyond the point of loan forgiveness through PPP and could deduct related expenses from their taxable income after receiving forgiveness of the PPP loan. PPP would also be made available to a greater pool of firms, including nonprofit organizations.

The bill creates two new refundable Social Security payroll tax credits too. First, employers may claim a credit for 50 percent of qualified fixed expenses (matching what is covered in the PPP) up to expenses paid in calendar year 2019: $50,000, or the greater of 25 percent of wages paid or 6.25 percent of 2019 gross receipts. Second, self-employed individuals may claim a business interruption credit up to 90 percent of qualified self-employment income up to $45,000, reduced by income earned over $60,000 single ($120,000 joint) in 2020 and claimed against income loss that exceeds a 10 percent reduction from 2019 to 2020.

Changes also would be made to the net operating loss (NOL) provisions in the CARES Act. Firms would not be able to apply NOLs to tax years prior to 2018, preventing them from applying the losses to higher tax rates that prevailed before the Tax Cuts and Jobs Act. The bill would also reinstate the excess business loss limitation, meaning that individuals could not offset non-business income using pass-through business losses over $250,000 single ($500,000 joint).

Other Sources of Relief

The HEROES Act extends Federal Pandemic Unemployment Compensation benefits (including the $600/per week federal benefit) provided through the CARES Act through January 31, 2021, and would continue to provide 13 additional weeks of unemployment benefits for those who have exhausted state benefits through that period, which could extend the benefit to as late as March 31, 2021.

Setting the Stage for Phase 4 Negotiations

While the HEROES Act is an opening bid in the ongoing negotiations between the parties in Congress and the White House, it is expected that the final Phase 4 relief package—if one is agreed to—may look very different.

The most promising new provisions are the changes to the PPP and the expansion of the Employee Retention Tax Credit, which should improve their efficacy for small and medium-sized businesses seeking relief. Expanding business relief to cover fixed costs outside of payroll is a concrete improvement over the existing relief (for PPP and the new payroll tax credits).

Other ideas should be abandoned in Phase 4, such as eliminating the SALT deduction limitation and expanding the EITC and CTC. The former proposal would disproportionately benefit high earners while not targeting economic relief. Reforming the EITC and the CTC is a good long-term idea for policymakers to consider but is not a well-targeted change for an economic crisis. Building on the individual rebates or unemployment insurance would be a timelier method of relief for individuals and families. 

The changes to NOLs would limit the ability of firms to obtain liquidity. While it makes sense to apply all NOL carrybacks at current law tax rates, limiting carrybacks to tax years starting on January 1, 2018 deprives firms already in the middle of filing for refunds from liquidity that may keep them from going under during the crisis. Policymakers instead should retain the time frame set in the CARES Act (five-year carrybacks for 2018, 2019, and 2020 tax years). Attaching conditions such as limiting executive compensation or prohibiting buybacks or dividends for carrying back losses also limits liquidity available to struggling firms, and these policies should not be made a condition for economic relief in Phase 4.

Bringing back the excess business loss limit is also not a good idea. Instead, policymakers should shore up passive loss rules if the concern is that the provision could be taken advantage of. Ideally, these issues could be resolved in Phase 4 by accelerating NOLs for firms that do not have taxable income in previous years.

Finally, some ideas will require careful design and consideration to ensure they work properly. State and local fiscal relief may make sense in Phase 4, but the HEROES Act does not do enough to curb the impulse for fiscal irresponsibility. Policymakers should carefully design state and local relief to balance the need for aid with prudent allocation methods, ample flexibility, and an aid amount that ensures all levels of government participate in the fiscal response.

The need for a second round of individual rebates may prove controversial, but the HEROES Act builds on the experience policymakers, Treasury, and the Internal Revenue Service (IRS) had in sending out the recovery rebates. The disbursement of a second round of rebates would hopefully be smoother and quicker now that the infrastructure has been built and policymakers have identified the legislative fixes needed (e.g., automatically including non-filing beneficiaries of federal programs like Social Security or Supplemental Security Income).  

The HEROES Act provides a starting point for provisions that could earn bipartisan support at a time when individuals and businesses remain vulnerable. Policymakers will have to balance speed with thoughtful policy design if they wish to see the results of Phase 4 match or exceed the results of the CARES Act.

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