The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was not intended as tax legislation, but it utilizes tax changes to create additional liquidity for taxpayers and their businesses. Unlike many of the programs established in the CARES Act, the tax provisions are not tailored in a way to limit their application to companies specifically impacted by COVID-19. Therefore, it is important that all business owners and their advisors – even if you are one of the few unaffected by the pandemic – clearly understand the changes.
In many ways, the changes roll back of some of revenue generating provisions of the Tax Cuts and Jobs Act (TCJA) that many taxpayers are still trying to fully process. Therefore, without proper guidance, taxpayers could easily get lost between the old and the new.
Below are several of the provisions that will have a direct impact on the income tax owed by businesses as well as those that could generate a refund for prior taxable years.
Net Operating Losses
Prior to the TCJA, Net Operating Losses (NOLs) could be carried back two year and forward twenty years; however, the TCJA eliminated the ability to carry back most NOLs for taxable years ending after December 31, 2017, and opted for an unlimited carry forward of NOLs. Additionally, for net operating losses arising in tax years beginning after December 31, 2017, the deductibility of NOLs was limited to 80 percent of taxable income in a given year.
The CARES Act revises the NOL statute to allow for the carryback of losses arising in taxable years ending after December 31, 2017 and before January 1, 2021 to each of the five taxable years preceding the taxable year of such loss while retaining the unlimited carry forward provided in the TCJA. The CARES Act also removed the limitation that NOLs could offset no more than 80 percent of taxable income.
Typically, a carryback claim must be filed within one year of the NOL year or must be claimed on an amended income tax return. In order to avoid having this limit the ability for some taxpayers to file a carryback claim (primarily for the 2018 tax year), the CARES Act provided a special rule that deems a carry back claim timely filed if it is filed no later than 120 days after the enactment of the Act.
While the NOLs changes are sometimes seen as only impacting timing (i.e., carrying the tax back means that the deduction will not be used in a future year), to the extent that NOLs are carried to tax years prior to January 1, 2018, taxpayers may be able to offset income at higher effective rates (14 percent higher in the case of many C corporations). Furthermore, while 2018 and 2019 were generally rather profitable years for many taxpayers, the expansion of bonus depreciation in the TCJA means that even taxpayers with strong productivity and income in those years may be had an NOL for the year depending on their capital expenditures.
Business Interest Limitations
Another product of the TCJA was the business interest limitation. This limitation has had a significant impact on many business that rely on leverage to maintain profitability in low-margin businesses. For 2020, the allowable deduction for business interest is increased from 30 percent to 50 percent of adjusted taxable income for corporate taxpayers. Additionally, to address concerns that many taxpayers may have limited adjusted taxable income in 2020, taxpayers may elect to substitute 2019 adjusted taxable income for 2020 adjusted taxable income. For 2019, the same increase from 30 percent to 50 percent applies to corporate taxpayers and partially applies to partnerships.
Excess Business Losses
The CARES Act removed the limitation on excess business losses for non-corporate taxpayers for tax years beginning after December 31, 2017, and before January 1, 2021. This will allow for a temporary return to the pre-TCJA law where business losses in excess of $250,000 (or $500,000 in the case of a joint return) can be used to offset non-business sources of income for non-corporate taxpayers.
Qualified Improvement Property
A final change that will have a profound impact on taxpayers is the correction of a technical error related to the depreciation of qualified improvement property.
Qualified improvement property generally includes improvements to a building's interior excluding enlargement of the building, elevators or escalators, or internal structural framework of the building. As written in the TCJA, these improvement expenses, when connected to non-residential real estate, would have had a recovery period of 39 years. The correction ensures that qualified improvement property is included in the definition of 15-year property subjecting these expenditures to accelerated depreciation and, more important in the post-TCJA world, 100 percent bonus depreciation.
Bringing it All Together
The business tax changes incorporated in the CARES Act present a significant source of potential relief for taxpayers that are having current liquidity issues. However, taking advantage of these benefits will generally require significant changes to returns. Furthermore, quick action is necessary to avoid falling further behind in the IRS’s ever-growing backlog. That being said, before implementing changes to prior years, the taxpayer and his advisors must have a clear understanding of how these changes will flow through years of prior tax returns and the cumulative impact on unrelated deductions and credits.