Top CARES Act Tax Changes for Business Owners
The CARES Act includes several taxpayer-friendly provisions that will impact millions of American businesses and their owners.
The Coronavirus Aid, Relief and Economic Security (CARES) Act enacted in March includes several changes to the tax code. In particular, the CARES Act (and subsequent guidance) will significantly impact business owners in four key areas:
- net operating losses (NOLs)
- qualified improvement property
- business interest expense limitation under IRC Section 163(j);
- and excess business losses limitation.
Business owners need to understand these provisions and should consult with their tax professionals to determine the best course of action to benefit from these changes.
Net operating losses may be carried back 5 years
A net operating loss (NOL) occurs when a business has allowable deductions that exceed its taxable income within a tax year. Prior to the enactment of the CARES Act and under The Tax Cuts and Jobs Act of 2017 (TCJA), taxpayers were not able to carryback NOLs arising after December 31, 2017; however, they were able to carry them forward indefinitely. In an effort to provide economic relief, the CARES Act granted taxpayers a five-year carryback period for NOLs arising in tax years beginning after December 31, 2017, and before January 1, 2021.
This extended carryback period provides taxpayers with the opportunity to carryback NOLs generated in tax years 2018, 2019 and 2020. Businesses and individuals can now amend or modify tax returns for tax years dating back to 2013 in order to take advantage of the carryback. This carryback could offset pre-2018 taxable income, which was originally taxed at higher rates, and could generate a refund at a favorable tax rate differential.
The IRS has enabled a dedicated fax line where taxpayers can send their refund claim forms, which will allow processing to continue, despite office closures. It’s important to note that these changes may require a recalculation, so business owners should discuss the most beneficial avenue with their accounting professionals and tax advisors.
Suspension of the 80% of taxable income limitation on the use of NOLs
The TCJA imposed an 80% of taxable income limitation on the use of NOLs arising in tax years beginning after December 31, 2017. One of the major provisions of the CARES Act is the temporary suspension of this limitation on the use of NOLs for tax years beginning before January 1st, 2021. The temporary suspension of this limitation will allow taxpayers to use NOLs to fully offset taxable income during the allowed tax years regardless of the year in which the NOL was generated. This change will be especially beneficial for taxpayers with significant amounts of NOLs generated after December 31, 2017. These taxpayers will now be able to reduce their taxable income to zero (if they have enough NOLs) for tax years 2018 through 2020.
Qualified improvement property
Qualified improvement property (QIP) is any improvement made by a taxpayer to the interior of a non-residential building that is placed in service after the building’s initial place in service date, with some exceptions such as improvements related to elevators, escalators, or the building’s internal structural framework.
When Congress drafted the TCJA, it allowed for 100-percent bonus depreciation rules to apply to all modified accelerated cost recovery system (MACRS) property with a recovery period of 20 years or less. However, as a result of a Congressional oversight, qualified improvement property is still depreciated as 39-year property and not qualified for bonus depreciation applicable to 15-year property. The CARES Act corrects this situation by defining qualified improvement property as 15-year property, thus allowing 100 percent of improvements to be deducted in the year incurred.
This change is not only significant because of the decrease in the cost recovery period, but also because new QIP is eligible for bonus depreciation. And it retroactively applies to property acquired and placed in service after December 31, 2017.
Another important aspect of the QIP change is its interaction with the interest expense limitation under Section 163(j) – see details below.
Business interest expense limitation
The CARES Act increases the Section 163(j) limitation on the amount of allowable deductions for business interest (regardless of the type of entity) to 50 percent of the taxpayer’s adjusted taxable income for 2019 and 2020. Additionally, it allows taxpayers to use adjusted taxable income for 2019 in calculating the limitation for 2020. (Note: For 2020, the limitation does not apply to taxpayers with average annual gross receipts for the prior three years below $26 million.)
This change is particularly notable as it closely interacts with the qualified improvement property change. Under Section 163(j), taxpayers in real property or farming trades or businesses could elect out the interest expense limitation if they depreciate certain property more slowly using the alternative depreciation system, which is not eligible for bonus depreciation.
Now that 100% bonus depreciation can extend to QIP, businesses that elected out of the interest expense limitations may wish to change their minds, especially if their recalculated depreciation expense under the new rules exceeds their interest expense. Taxpayers in the real property and farming trades or business should reevaluate their election out of the interest expense limitation in light of the new QIP rules.
Excess business losses limitation
Individual taxpayers who own businesses should pay attention to changes to the excess business loss limitation. Under the TCJA, taxpayers could not deduct aggregate trade or business losses in excess of $250,000 for single taxpayers or $500,000 for married taxpayers filing jointly.
Under the CARES Act, this limitation is repealed for tax years 2018, 2019 and 2020. To note, the CARES Act also changed how the overall limitation will be calculated starting in 2021.
State and local tax impact of CARES Act
It’s important for business owners to also be aware of potential state and local tax implications of the CARES Act. Most states incorporate the IRC provisions into their tax codes and/or regulations, however, some of the states adopt changes automatically via rolling conformity while other states need to adopt the changes via legislative action (i.e., fixed date or static conformity). For example, Florida is a state that would need to take legislative action in order to adopt the income tax provisions of the CARES Act.
Since most states have either suspended or adjourned their legislative sessions for 2020 as a result of the COVID-19 closures, only time will tell whether they will conform to the income tax changes of the CARES Act or if they decide to take a different direction.
In addition to the changes outlined above, the CARES Act includes many other tax provisions for businesses and individuals. Kaufman Rossin’s tax professionals continue to monitor the federal, state and local tax impacts of COVID-19 and the CARES Act. If you have any questions or concerns, reach out to one of our tax professionals today.