Our team is closely monitoring the developments of the COVID-19 pandemic and are working to keep you informed of the implications to you and your business. We have dedicated teams and resources to focus on all aspects of the CARES Act so that we can provide you with meaningful guidance and concise information.
PLEASE NOTE: Virginia tax law conforms to the Federal tax law as of December 31, 2019. As of this writing, many of the tax provisions discussed here are not allowable under Virginia law. We will need to wait for the Virginia General Assembly to pass legislation conforming Virginia tax law to these Federal tax law changes.
If you have questions about how these changes impact your unique individual or business tax situation, please contact your Keiter advisor. We are here to listen and provide sound advice.
What are the CARES Act tax provisions for businesses?
The following is a summary of provisions relevant to businesses. At times we’ll use various tax terms (such as “adjusted taxable income”) whose definitions are beyond the scope of this analysis. Accordingly, be sure to consult with your tax advisor.
Frequently we will refer to the CARES Act individual provisions, you can refer to our article, Individual Tax Provisions Contained in the CARES Act, for a summary.
NET OPERATING LOSS (NOL) CARRYBACK RULES CHANGED
As echoed in the individual discussion, the Tax Cuts and Jobs Act (TCJA) provided that NOLs incurred in tax years beginning after 2017 could no longer be carried back to a prior tax year of the taxpayer. Instead, they must be carried forward to offset 80% of taxable income in future years.
The CARES Act (CARES) makes some critical changes to these carryback and carryover rules. NOLs incurred in tax years 2018-2020 may be carried back five years. If carried over to future years, the NOLs can be used to offset 100% of taxable income but only through 2021; 80% after that.
The rules before TCJA required carryback first, then carryover unless the taxpayer made an irrevocable election to forgo the carryback. The same rules now apply for taxpayers who incur an NOL in tax year 2018 or 2019. In many cases, it will make sense to carryback the NOL, not only for the refunded taxes but also when the taxpayer’s effective income tax rate in past years (as high as 38%) exceeded the current rate of 21%. Note that the use of an NOL for the 2017 tax year or earlier may result in the imposition of alternative minimum tax. That tax, however, may then be recovered via the refundable AMT credit (see that discussion later in this article).
Presumably, the states will permit a similar procedure for freeing-up state NOLs, but we do not know that at this point.
CHARITABLE CONTRIBUTION DEDUCTION INCREASED TO 25%
Just as is the case for individuals, businesses can increase their allowable charitable contributions. Before 2020, deductible charitable contributions by C-corporations were limited to 10% of taxable income before the effect of charitable donations. For the 2020 calendar year only, the allowable contribution is increased to 25%. There are also enhanced contributions for food inventory. C-corporations will elect the 25% in the appropriate tax year return(s). For pass-through entities (S-corporations and partnerships), the individual partners/shareholders will have to elect the 25% individually.
100% OF AMT CREDIT NOW AVAILABLE
While the alternative minimum tax no longer exists, many corporations still have refundable AMT credits available. Under the old rules, 50% of the remaining AMT was refundable each year, with the remaining portion fully refundable in 2021.
CARES allows the AMT credit to be fully refunded in 2019 via “normal” corporate income tax return filing. Corporations may also elect to recover the entire credit in 2018, made by way of filing Form 1139.
Note that the carryback of an NOL might result in a corporation paying additional alternative minimum tax, which can be recovered here.
INTEREST LIMITATION INCREASED
For many businesses, under Section 163(j), deductible interest expense was limited to 30% of “adjusted taxable income”. We saw several businesses exceed this limit in 2018. For pass-through entities, any excess business interest expense (the non-deductible interest) passes to the individual owners. They can then apply “excess business interest income” or “excess taxable income” from the pass-through against the excess business interest expense.
Under CARES, the C-corporation and S-Corporation limit is increased to 50% for 2019 and 2020. Given that many businesses’ 2019 taxable income will decrease while debt levels rise, this is a welcome development.
For Partnerships, however, the limitation stays at 30% for 2019, increasing to 50% for 2020.
Section 163(j) is quite complicated; however, this provision should result in an increase in the deductibility of interest expense.
QUALIFIED IMPROVEMENT PROPERTY
Finally, the qualified improvement property fix. Qualified improvement properties (QIP) are interior common areas of non-residential buildings and were intended by Congress to be 15-year depreciable property, eligible for 100% expensing through bonus depreciation. Due to the rushed passing of the TCJA, the depreciable lives of QIP remained at 39-years, ineligible for bonus depreciation.
CARES fixes the error, retroactive to QIP placed in service in 2018, and keeps the 15-year life for QIP placed in service through 2023.
If the taxpayer has not yet filed its 2019 return, it can amend its 2018 tax return. Alternatively, it can submit a Form 3115, requesting an automatic accounting method change, so that it can claim the additional depreciation in 2019. If a 2019 return has already been filed, Form 3115 can also be filed, but currently, the change will not be automatic with the possible charging of user fees. We are awaiting further guidance from the IRS on all aspects of correcting or revising the QIP treatment.
Note that the expensing of QIP in 2018 vs. 2019 will require the weighing of several factors such as cash need, otherwise taxable income in 2018 vs. 2019, passive vs. nonpassive income, and the basis situation of individual partners and shareholders. Because of passive activity limitations or the lack of basis, individuals may not see a reduction in taxable income. Also, many states, including Virginia, do not permit bonus depreciation, although the change of 39-year lives to 15-year lives may result in lower taxable income.
Please consult your tax advisor for guidance specific to your business situation. We hope that the IRS will show flexibility in implementing these changes, given that we’re already well into the 2019 filing season.
We are closely monitoring this evolving and unique economic situation. We will keep you updated and informed on how to respond to these and additional tax and regulation changes as they are announced.
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.