CARES Act Key Changes to Tax Provisions
March 31, 2020 - On Friday, March 27th, President Trump signed the CARES Act into law providing emergency assistance to individuals and businesses impacted by the coronavirus pandemic. In addition to emergency aid provisions, the $2 trillion bill contains both tax and non-tax provisions designed to stimulate the economy and increase liquidity.
READ MORE: CARES Act Employee Retention Credit
READ MORE: CARES Act Paycheck Protection Program
READ MORE: CARES Act SUMMARY – Senate Passes CARES Act
There are a few key tax provisions in the bill that retroactively change the tax law and provide potential refund opportunities for certain individual and business taxpayers.
Net Operating Losses
The Tax Cuts and Jobs Act (TCJA), which was passed into law on December 22, 2017, significantly changed the Net Operating Loss (NOL) rules. Under the TCJA, individuals and C Corporations could generally only utilize NOLs to offset future taxable income beginning with tax years ending after December 31, 2017. Additionally, NOLs generated after 2017 could only offset 80% of taxable income in a future tax year(s).
The CARES Act provides that NOLs generated in a tax year beginning after December 31, 2017 and before January 1, 2021 can be carried back to each of the five tax years preceding the tax year of such losses. Furthermore, the 80% taxable income limitation rules for NOLs is also suspended for tax years beginning before January 1, 2021. Once reinstated for taxable years beginning after December 31, 2020, the 80% taxable income limitation will again apply for any NOLs arising from taxable years beginning after December 31, 2017.
Redpath Insight: Taxpayers that sustained an NOL in 2018 or 2019 need to carefully evaluate the opportunity for federal tax refunds as a result of the revised carryback rules. Any losses sustained in 2020 can also be carried back when your 2020 returns are filed. Minnesota (as well as other states) will need to address conformity to this and other provisions from the CARES Act.
Excess Business Losses
The excess business loss rules, another provision of the TCJA, has been retroactively postponed to tax years beginning after December 31, 2020. The excess business loss rules apply to taxpayers other than C Corporations and limit trade or business losses in excess of trade or business income to $250,000 (single filer), or $500,000 (married filing jointly).
Here is a simple illustration of the rules previously in effect under the TCJA for a joint filer that is an active owner in S Corporations X and Y:
|2018 K-1 Income S Corporation X||$200,000|
|2018 K-1 Loss from S Corporation Y||($1,000,000)|
|Actual Loss Incurred||($800,000)|
|*Allowable 2018 Business Loss||$500,000|
|2018 Excess Business Loss||($300,000)|
|*The $500,000 loss would be allowable against other non-trade or business sources of income, such as wages, interest, dividends, capital gains, etc. Any loss in excess of other sources of income was treated as an NOL and subject to the carryforward rules.|
The CARES Act also provided language that employee wages and capital losses are not included in the calculation of excess business losses.
Redpath Insight: Under prior law, the $300,000 excess business loss would have been carried forward to 2019 as an NOL. The CARES Act delayed these rules allowing a 2018 tax deduction for the full $800,000 loss. If the loss creates an NOL for the taxpayer, it can now be carried back to the preceding five tax years due to the NOL revisions from the CARES Act. The delay of the excess business loss rules creates refund opportunities for any taxpayer previously subject to the limitation.
Section 163(j) Business Interest Expense Limitation
The TCJA created a new limitation on the deductibility of business interest expense for tax years beginning after December 31, 2017. There were several exceptions to the interest expense limitation rules, including the election to opt out for electing real property trades or businesses, electing farming businesses, and certain utility businesses. In addition, businesses with average gross receipts of $25 million or less (indexed for inflation) were excepted from the rules.
Under IRC 163(j), the business interest expense deduction allowed for the tax year is limited to the sum of:
- Business interest income,
- 30% of the adjusted taxable income, and
- floor plan financing interest expense.
The CARES Act eases the limitations on the interest expense deduction for 2019 and 2020 by increasing the adjusted taxable income limit from 30% to 50% for businesses other than partnerships. For taxpayers that have already filed their 2019 tax return, an amended return may be required.
Additionally, taxpayers may elect to use their 2019 adjusted taxable income when determining their 2020 adjusted taxable income limitation—potentially increasing the amount of interest expense allowed as a deduction.
Special rule for partnerships
Partnerships can only use the limit of 50% of adjusted taxable income for 2020. For 2019, partnerships will continue to use the limit of 30% of adjusted taxable income with any disallowed interest passing out to the partners. The partners can elect to deduct 50% of the 2019 disallowed business interest expense on their 2020 return, with the remaining 50% continuing to be treated under the normal rules.
Redpath Insight: If you generate excess taxable income in 2019 or 2020 because of the new increased limitations, this could free up prior year disallowed business interest expense, increasing cash flow for your business.
Qualified Improvement Property
The TCJA created a new asset class, Qualified Improvement Property (QIP), which is defined as follows:
Any improvement to an interior portion of a building which is nonresidential real property if such improvement is placed in service after the date such building was first placed in service.
The following improvements are excluded from the definition of QIP:
- The enlargement of the building,
- any elevator or escalator, or
- the internal structural framework of the building.
The intent was for QIP to have a 15-year depreciable life for tax purposes and thus be eligible for 100% bonus depreciation. However, due to an oversight in the drafting of the TCJA, QIP was not referenced as 15-year property and was therefore not eligible for bonus depreciation and was depreciable over 39 years.
As a result of the CARES Act, this error has finally been corrected making QIP 15-year property and eligible for 100% bonus depreciation. The change is retroactive to QIP acquired and placed in service after December 31, 2017.
Redpath Insight: Since this technical correction is retroactive, taxpayers with QIP placed in service in 2018 or 2019 may have an opportunity for refunds.
Lawmakers have created a huge opportunity for taxpayers to reduce taxes and make claims for refunds for 2018 through 2020 tax years. We will be working with all impacted clients for the most advantageous result related to this legislation.