In recent weeks, the United States Congress has passed, and the President has signed into law, two significant pieces of legislation in connection with the government’s response to COVID-19. These bills are known as the Families First Coronavirus Relief Act (FFCRA) and the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). Changes in three important loss provisions, plus one technical correction, are designed to provide cash flow to business owners through amended return opportunities.
NOLs and NOL carrybacks
The Tax Cuts and Jobs Act (TCJA), signed into law by President Trump September 2017, generally prohibited the carry back of Net Operating Losses (NOLs), instead permitting an indefinite carryforward period for NOLs incurred in tax years beginning after December 31, 2017. The TCJA also limited current year NOL utilization to 80% of taxable income (pre-2017 losses carried to future years were not subject to this limitation).
Recent COVID-19-related legislation rolls back the NOL carryback provisions and now allows for NOLs arising in tax years beginning after December 31, 2017, and before January 1, 2020, to be carried back to each of the five tax years preceding the tax year in which the loss was incurred. Taxpayers must carry the NOL back to the earliest tax year within the five-year window. This is particularly attractive to corporate taxpayers who can carry back NOLs to years subjected to higher tax rates. Alternatively, taxpayers may elect to forego the five-year carryback period and choose instead to carry the full amount forward.
The legislation also removes the 80% limitation and reinstates it for tax years beginning after December 31, 2020. Both provisions allow for taxpayers to amend prior year tax returns and claim an immediate refund that may result from the additional NOL carryback and utilization threshold.
As an example, assume the following facts:
- Taxpayer has projected taxable loss of $200,000 in 2020.
- Taxpayer has taxable income of $210,000 in 2019.
Under the TCJA, the taxpayer could not carry back the $200,000, but could only carry it forward indefinitely. Further, the taxpayer could only offset 80% of future years’ taxable income with the NOL from 2020. The new COVID-19-related legislation affords the taxpayer the opportunity to carry back the $200,000 to 2019 and utilize the entire $200,000 loss, resulting in a refund of $42,000 ($200,000 x 21% tax rate) for a corporate taxpayer.
Enhanced business interest expense provisions
Internal Revenue Code (IRC) §163(j) limits the amount of business interest expense that may be deducted in a tax year to the sum of (1) the taxpayer’s business interest income for the year; (2) 30% of the taxpayer’s adjusted taxable income (ATI) for the year; and (3) the taxpayer’s floor plan financing interest expense for the year. For the years in question, ATI can be roughly compared to the financial concept of earnings before interest, taxes, depreciation, and amortization (EBITDA). Recent legislation increases the 30% limitation enacted by the TCJA to 50%, but only for tax years beginning after December 31, 2018, and before January 1, 2021. The new legislation enables taxpayers to opt out of the 50% limitation and also allows them to elect to use 2019 ATI in lieu of 2020 ATI. This option may prove beneficial for taxpayers who can expect less ATI in 2020, enabling them to capitalize on the higher ATI from 2019 and resulting increased business interest expense for 2020.
Suspension of excess business loss disallowance rule
Another unfavorable TCJA provision was the disallowance of excess business losses incurred by individuals and other non-corporate taxpayers in tax years beginning after December 31, 2017, and before January 1, 2026. Excess losses are defined as those greater than $250,000, or $500,000 for a married joint-filing couple, adjusted annually for inflation.
The CARES Act suspends the business loss disallowance rule for tax years beginning after December 31, 2017, and before January 1, 2021. Amending a 2018 or 2019 tax return in which excess losses were disallowed either could result in additional income offset in the year of those losses, reducing the associated tax liability, or might create an NOL that could be carried back to an earlier tax period to recover taxes paid. See the NOL section of this article for more details on the revised NOL carryback provision in recent COVID-19-related legislation.
Technical fix for qualified improvement property
One of the less publicized, and from a taxpayer perspective, more favorable components of the COVID-19 response legislation was the correction of a technical error from the TCJA that resulted in qualified improvement property (QIP) going from a 15-year to a 39-year useful life. This error had resulted in less tax depreciation expense for the taxpayer, particularly because it had prevented the taxpayer from taking bonus depreciation on the qualified property. With this technical correction, the definition of QIP was restored to its pre-TCJA meaning, allowing for a depreciable life of 15 years and more importantly, qualifying it for bonus depreciation. The correction is retroactive, meaning taxpayers can amend prior year 2017 and 2018 tax returns and claim additional depreciation deductions on property that qualifies under the regulations.
If you have any questions about these provisions or need assistance in amending returns to take advantage of the benefits, contact one of our PYA executives below at (800) 270-9629. For additional COVID-19 guidance, visit PYA’s COVID-19 hub.
