Explaining the Major Provisions of the Phase III Response to COVID-19

Americans are still trying to figure out what to make of the COVID-19 pandemic. Only a few weeks ago, the American economy was doing well, and employers were hiring. Today, many governors have essentially shut down commerce and effectively suspended some protected civil liberties by mandating the practice of social distancing in their states.

The human impact of COVID-19 has been harsh. As of today, more than 2,600 Americans have died as a result of the virus, and there are nearly 140,000 active cases in our country. The economic impact has also left people hurting. Last week, jobless claims surged by a record 3.28 million, breaking the previous record of 695,000 set in 1982.

Last week, Congress passed and President Donald Trump signed the Coronavirus Aid, Relief, and Economic Security (CARES) Act, H.R. 748. Although the Congressional Budget Office hasn’t provided a cost-estimate of the CARES Act, based on the debate in the Senate last week, the bill has been estimated to cost between $2.2 trillion and $2.3 trillion. Implementation of the CARES Act is currently underway.

Of course, there are budgetary concerns with the CARES Act. The budget deficit for FY 2020 was already expected to exceed $1 trillion. At this point, it will almost certainly exceed at least $2.5 trillion, if not $3 trillion, and this is before any additional phase(s) that Congress may consider. An approach like that offered by Rep. Andy Biggs (R-Ariz.), who emphasizes regulatory relief, tax reforms for small businesses, and flexibility of health savings accounts, is a better path.

The CARES Act, known as the “Phase III” response to COVID-19, is unlikely to be the last package Congress considers. Speaker Nancy Pelosi (D-Calif.) has already mentioned House Democrats’ priorities for a “Phase IV” bill. Those priorities include expanded infrastructure spending, expanding family leave, additional direct payments, free treatment for COVID-19, and more money for hospitals.

Considering the amount of misinformation and confusion, many are undoubtedly wondering what the CARES Act does and how it will impact them during this time of uncertainty. As our friends at the Committee for a Responsible Federal Budget explain, the CARES Act includes $610 billion for households, $600 billion for large businesses, $600 billion for small businesses, and $175 billion for state and local governments. In this blog post, we’ll summarize the various major sections of the CARES Act and try to explain what they mean.

Direct Payments to Tax Filers: Although we had strong reservations about this provision considering the unlikelihood of a stimulative effect, the CARES Act does include direct payments to tax filers under certain income thresholds. An individual tax filer with an adjusted gross income (AGI) of up to $75,000 may receive $1,200. A joint filer with an AGI of up to $150,000 may receive $2,400. An additional $500 per child under the age of 17 is also available. These direct payments will be on top of a tax refund for tax year 2020. Apart from the income thresholds, the tax filer can’t be a dependent and must have a valid Social Security number.

There is not a minimum income threshold to qualify for a direct payment. There is, however, an income phase-out. Individual tax filers who have with an AGI that exceeds $75,000 and joint filers with an AGI that exceeds $150,000 will see a $5 reduction per $100 of income over the threshold. Individuals with an AGI exceeding $99,000 and joint filers with an income exceeding $198,000 will not receive any direct payments.

The income levels are based on filings for tax year 2019 if the return has been filed. If the 2019 return hasn’t been filed, the filing for tax year 2018 will be used. It’s likely most taxpayers will see the direct payment show up in their bank accounts through direct deposit. Others will receive the payment in the form of a physical check.

Expanded Unemployment Benefits: The CARES Act includes an additional $600 weekly payment on top of the unemployment benefits provided by a state for up to four months, regardless of an eligible person’s prior income level. This provision expires at the end of 2020. This part of the CARES Act also includes immediate funding to pay for the first week of unemployment benefits, rather than waiting a week. Individuals who aren’t usually eligible for unemployment benefits, such as those who are self-employed and independent contractors, would be eligible if they’ve been directly impacted by COVID-19 disruptions.

There have been some concerns raised about the additional $600 weekly unemployment benefits. Sens. Ben Sasse (R-Neb.), Lindsey Graham (R-S.C.), Tim Scott (R-S.C.), and others noted that this level of assistance could discourage some people from working. This is a valid concern that could seriously hamper economic recovery. Sasse offered an amendment that would have limited unemployed workers’ wages to 100 percent of their previous earnings. Unfortunately, that reasonable amendment failed. It’s possible that the Department of Labor attempts to employ a similar policy upon regulatory implementation of the law, though.

Loans and Grants for Small Businesses: Small businesses have been hit particularly hard by the economic disruptions caused by COVID-19. In the CARES Act, Congress included loan guarantees for businesses with 500 or fewer employees, 501(c)(3) nonprofits, sole proprietors, independent contractors, and self-employed individuals through the Small Business Administration’s 7(a) loan program for the covered period of February 15, 2020 through June 30, 2020. Affiliation rules for restaurants and hospitality businesses, which could boost the number of employees above 500, are waived.

In order to qualify for a loan, the business must have been in operation on the first day of the covered period, February 15, 2020, and paid salaries and payroll taxes for employees. Creditworthiness isn’t a factor in determining eligibility. The size of the loan is capped based on a formula or $10 million. According to the text of the relevant section, the formula is “the average total monthly payments by the applicant for payroll costs incurred during the 1-year period before the date on which the loan is made, except that, in the case of an applicant that is seasonal employer, as determined by the Administrator, the average total monthly payments for payroll shall be for the 12-week period beginning February 15, 2019, or at the election of the eligible recipient, March 1, 2019, and ending June 30, 2019” multiplied by 2.5.

The loans may be used only for specific purposes, such as employee salaries, insurance premiums, mortgage or rent, and utilities. The borrower must certify in good faith that the loan is necessary and that they will use the loan for its intended purpose, as well as that they don’t have another loan application pending for the same purpose, nor have they received another loan. All fees are waived, and the maximum interest rate is set at 4 percent.

Up to the principle of the loan can be forgiven after eight weeks from the origination date and turned into grants for expenses related to payroll, mortgage interest, rent, and utilities. A borrower would be penalized through reductions in loan forgiveness because of layoffs or reductions in pay of more than 25 percent. A borrower who rehires laid off workers won’t be penalized.

Loans for Large Businesses: There are a host of tax-related provisions for businesses, including a delay for payroll tax payments and modifications for net operating losses, but a major aspect of the CARES Act is $500 billion in loans and loan guarantees for large businesses domiciled in the United States, of which $454 billion will be available for lending. (We’ll explain why in the next section.)

The loan program here differs from the SBA 7(a) loan program. Essentially, the federal government functions as a lender of last resort. The loan, the term for which may not exceed 60 months, must be secured and have an interest rate that reflects the risk. A large business that receives a loan is prohibited from stock buybacks, unless it has a contractual obligation to do so, or paying dividends for at least one year from the date of the loan. Employments levels on March 24, 2020 must be maintained “to the extent practicable” through September 30, 2020. A borrower has to retain at least 90 percent of its employees until September 30, 2020 or rehire at least 90 percent of its employees based on a February 1, 2020 baseline four months after the end of the public health emergency. Loans under this aspect of the CARES Act can’t be forgiven.

Now, the loans will be provided by the Federal Reserve under Section 13(3) of the Federal Reserve Act. The money ultimately serves as leverage for significantly greater lending capacity. This is why some have said that this is actually a $6 trillion package.

One provision of this part of the CARES Act places limitations on salaries for officers of large businesses. The compensation of an officer or employee who isn’t covered by a collective bargaining agreement in place before March 1, 2020 and earns more than $425,000 may not be increased for one year after the loan is paid back. Officers and employees who earned more than $3 million in 2019 may receive compensation above $3 million plus 50 percent. Compensation is defined as salary, bonuses, stock, and other financial benefits.

Grants to Airlines: The same part of the CARES Act that provides loans for large businesses also provides $25 billion in loans to commercial airline carriers and $4 billion to cargo air carriers. Another provision, however, provides $25 billion in grants to commercial airlines $4 billion for air cargo contractors, and $3 billion for airline contractors to salaries and benefits. The terms and details for these grants likely haven’t been set by the Department of the Treasury, but there has been some speculation that airlines may opt for the grants over the loans because the latter is likely to have stricter requirements.

Other Changes You Should Know About: There’s a lot in the CARES Act, and it’s hard to cover it all. Some other potentially important changes in the tax code that one should know about in these tough times are the special rules for the use of retirement funds and the expansion of health savings accounts (HSAs), as well as changes to charitable contribution limits. These changes are only temporary but are nonetheless important.

The 10 percent early penalty for withdrawals from a retirement account that exceeds $100,000 has been waived and the tax liability for those withdrawals will be spread out over three tax years. The funds can be contributed without regard to the contribution cap.

A $300 above-the-line deduction for charitable contributions will be added for tax year 2020. This is an additional deduction that individuals and joint filers can tax advantage of on top of the standard deduction increased under the Tax Cuts and Jobs Act. The limits for charitable giving for individuals and corporations have also been changed. The limit for individuals was previously 50 percent of AGI. That limit will be suspended for tax year 2020. The limitation for corporations is increased to 25 percent from 10 percent.

Finally, HSAs connected to a high-deductible health plan (HDHP) may be used for telehealth services. Those with an HSA or flexible spending account (FSA) may also use those funds to purchase over-the-counter medical products.