On March 27, 2020 the Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law to provide financial and emergency relief to the U.S. economy. The CARES Act contains major changes to the tax code for businesses that should be reviewed and incorporated into current tax planning strategies by all businesses.
NOL CARRYBACK PROVISION
Under the CARES Act, federal net operating losses (NOLs) generated after December 31, 2017 and before January 1, 2020 may be carried back to each of the 5 preceding tax years of such loss. This gives corporate taxpayers the ability to fully utilize federal NOLs generated in the 2018 through 2020 tax years (for calendar year taxpayers). In addition, 2018 through 2020 federal NOLs can now offset 100% of federal taxable income (subject to some restrictions).
In contrast, under the Tax Cuts and Jobs Act (TCJA) passed in December 2017, federal NOLs could not be carried back but could be carried forward indefinitely. In addition, the TCJA imposed a limitation where only 80% of federal taxable income could be offset using a federal NOL.
As a result of changes under the CARES Act, federal NOLs are now only limited to 80% of taxable income for tax years beginning after 2020. This provides an opportunity for eligible corporate taxpayers to receive federal refunds for taxes paid as far back as 2013. Attention should be drawn to another benefit of carrying back an NOL to a tax year before 2018 – the corporate tax rate for years prior to 2018 was based on graduated taxable income, and for many corporate taxpayers, their pre-2018 corporate tax rate was higher than the current corporate flat tax rate of 21%. Meaning, a corporation could carryback a loss from a federal 21% tax rate year to a federal 35% tax rate year.
As a caveat, there are special rules applicable to real estate investment trusts (REITs), life insurance companies and U.S. corporations that own controlled foreign corporations that must be considered when applying the provisions in the CARES Act. In addition, the rules become more complex for taxpayers filing consolidated tax returns as they must factor in the computation of consolidated NOLs, allocation of NOLs to members leaving a consolidated group and separate return loss year (SRLY) rules.
BUSINESS INTEREST DEDUCTION
The CARES Act modifies Internal Revenue Code (IRC) Section 163(j) which limits the amount of business interest expense that may be deducted for business taxpayers. This change is applicable for tax year 2019 and 2020.
The old rule under TCJA requires businesses to calculate a potential limitation on the deduction of business interest expense. The business interest expense limitation is calculated based off the sum of the following:
- The taxpayer’s business interest income for the year,
- 30% of the taxpayer’s adjusted taxable income (ATI) for the year, and
- The taxpayer’s floor plan financing interest expense for the year.
The CARES Act increases the 30% as it relates to adjusted taxable income to 50%. As a result, businesses who may have been subject to the original provisions of IRC 163(j) under TCJA may now potentially deduct more business interest expense as a result of the CARES Act for tax year 2019 and 2020.
This change presents several opportunities that business taxpayers should consider such as using 2019 taxable income to compute adjusted taxable income (rather than using 2020 taxable income assuming 2020 taxable income is lower due to the impact of COVID-19) in order to reduce the limitation imposed by IRC 163(j). In addition, the additional business interest deduction may allow companies to generate larger NOLs for 2019 and 2020 tax years and carry those losses back to the preceding 5 years to free up cash flow.
ALTERNATIVE MINIMUM TAX
The TCJA repealed the Corporate Alternative Minimum Tax (AMT) effective for tax years beginning after December 31, 2017. If a corporate taxpayer has AMT credits available for AMT paid prior to January 1, 2018, they can first apply the AMT credit against their regular tax liability. If there are excess AMT credits, these credits were considered refundable credits released incrementally from 2018 to 2021.
Under the CARES Act, these AMT credits are eligible for a full refund in either 2018 or 2019. Corporate taxpayers who have historically paid AMT tax should review their tax situation for any AMT credit carryovers which may be refunded in full on their 2018 or 2019 tax returns.
There are substantial changes made by the CARES Act which require careful planning to ensure your business can take full advantage of the relief benefits. We suggest performing a full review of your business tax returns dating back to 2013 as well as estimate your tax position in 2020 to evaluate a plan for how to take advantage of these relief provisions.
Please contact us with any questions.