On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (CARES Act) was signed into law by President Donald J. Trump. Representing “Phase III” of the sweeping economic stimulus and public health measures currently being undertaken by the U.S. federal government, the CARES Act includes a number of tax-related provisions designed to reduce the compliance burden for taxpayers and/or stimulate growth by putting more money in the hands of taxpayers. Several of these provisions are discussed in more detail below:
Modifications for Net Operating Losses (Sec. 2303)
The Tax Cuts and Jobs Act (the “TCJA”) of 2017 generally eliminated net operating loss (“NOL”) carrybacks arising after 2017. NOLs could generally be carried forward indefinitely, but were limited to 80% of taxable income in a given taxable year.
The CARES Act changes these NOL limitations to allow NOLs arising in tax years 2018, 2019, and 2020 to be carried back five years; additionally, the 80% limitation on NOL carryforwards has been eliminated for tax years beginning before January 1, 2021. Accordingly, taxpayers with unused NOLs arising in tax years 2018, 2019, or 2020, and that paid tax in at least one of the preceding five taxable years, may file amended returns seeking a refund of taxes paid. Amended returns must be filed by the due date, including extensions, of the taxpayer’s return for the first taxable year ending after enactment of the CARES Act (i.e., for a calendar year taxpayer filing a Form 1120, March 15, 2021, without taking into account individual taxpayer extensions, or any potential broadly applicable extensions due to future COVID-19 legislation). For fiscal-year-end taxpayers that generated an NOL in tax year ending in 2018 (i.e., a 2017-2018 tax year) but who may have waived their carryback period, the CARES Act provides that such taxpayers have 120 days from the enactment of the legislation (i.e., July 27, 2020, given that July 25 falls on a Saturday) to file a carryback claim and revoke such election. These NOLs are subject to the pre-TCJA two-year carryback rules.
Special provisions are applicable for taxpayers required to were required by the TCJA to recognize a “toll charge” on certain types of deferred foreign income of subsidiaries (specifically, the taxpayer will be deemed to make an election to not have the NOL carryback offset the toll charge inclusion), and NOL carrybacks are denied for real estate investment trusts (“REITs”) for any year that the taxpayer qualified as a REIT.
Modification of Limitation on Losses for Taxpayers Other than Corporations (Sec. 2304)
The TCJA limited the ability of non-corporate taxpayers (e.g., individuals, estates, and trusts) to deduct “excess business losses,” which are generally defined as the excess of aggregate business gross deductions over aggregate business gross income. The availability of such deductions was limited to $250,000 annually ($500,000 annually individual taxpayers using a married, filing jointly status). Unused excess business losses could be carried forward as NOL (see the discussion of NOL limitation changes above).
The CARES Act delays the application of the excess business loss limitation until tax year 2021, meaning that non-corporate taxpayers may deduct all excess business losses through the end of the 2020 tax year. Taxpayers may amend their 2018 and (if filed) 2019 returns to take advantage of deductions previously disallowed due to the excess business loss limitation rules. For taxpayers in the real estate business, this may provide significant advantages, removing limitations on losses arising from the “full expensing” (i.e., 100% bonus depreciation) allowed by the TCJA. Passive real estate investors, however, should exercise caution, as the CARES Act does not override passive loss and at-risk limitations, and guidance on such topics has not yet been released.
Modification of Credit for Prior Year Minimum Tax Liability of Corporations (Sec. 2305)
The TCJA eliminated the alternative minimum tax (“AMT”) for corporate taxpayers. Corporate taxpayers were able claim refundable AMT credits in tax years 2018 to 2021, subject to a limitation that, in effect, limited taxpayers to claiming 50% of their remaining AMT credits in a given taxable year (e.g., a taxpayer with $10 million in refundable AMT credits generated pre-TCJA was limited to a $5 million refund in 2018, $2.5 million in 2019, and so on).
The CARES Act removes this limitation, allowing corporate taxpayers to accelerate their entire refundable AMT credit to tax years 2018 and 2019 (a taxpayer may elect to claim the entire AMT credit in tax year 2018). The CARES Act additionally provides for accelerated refund procedures related to claiming the accelerated refundable AMT credit specifically. For the purposes of the AMT credit, a taxpayer may file an application for a tentative refund with the Internal Revenue Service, which must review the application and issue a refund (if applicable) within 90 days.
Modifications of Limitation on Business Interest (Sec. 2306)
Under the TCJA, taxpayers were limited with respect to deductions for interest expense paid on loans, with such deductions limited to 30% of the taxpayers “adjusted taxable income” (“ATI,” generally equivalent to EBITDA) for taxpayers with average gross receipts of an inflation-adjusted $25 million or more ($26 million for tax years beginning in 2019 and 2020).
The CARES Act generally increases this 30% limitation to 50% for taxable years 2019 and 2020. In the case of partnerships specifically, the TCJA 30% limitation continues to apply for taxable year 2019 only, and a partnership must apply the existing 30% limitation for the 2019 taxable year. However, partners allocated excess business interest in a tax year beginning in 2019 will be treated as having fully deductible business interest in the following tax year equal to 50% of such allocated business interest amount, and the remaining 50% of excess business interest will continue to be deductible under the existing rules of the TCJA (unless a partner elects out of the application of these provisions).
Additionally, the CARES Act allows taxpayers to elect to use their 2019 ATI for the purposes of calculating their 2020 interest expense limitation. This increase in the interest expense limitation should be particularly useful for highly leveraged businesses, and any businesses expecting to take an earnings hit in 2020 that would otherwise be constrained by the TCJA’s 30% limitation. This may additionally create additional NOLs during taxable year 2020, which may be carried back due to the previously discussed NOL adjustments made by the CARES Act.
Technical Amendments Regarding Qualified Improvement Property (Sec. 2307)
The CARES Act makes an important technical correction to the TCJA to allow businesses to fully deduct the cost of improvements to the interior of a non-residential building (so called qualified improvement property, or “QIP”) back to the 2018 taxable year. QIP includes the installation or replacement of drywall, ceilings, interior doors, fire protection, mechanical, electrical, and plumbing (excluded from the definition are improvements attributable to internal structural framework, enlargements to a building, elevators, and escalators).
When the TCJA was enacted, the availability of expensing (through the mechanism of 100% bonus depreciation) was expanded to cover not only equipment and certain other capital assets, but also improvements made to commercial property. However, due to a drafting error that was beyond the authority of Treasury to correct, this expansion did not cover QIP, as the recovery period for QIP was tied to the 39-year ordinary life of a building, and the expanded expensing provisions of the TCJA covered only property with a recovery period of 20 years or less (this drafting error is referred to as the so-called “Retail Glitch”). The CARES Act retroactively fixes the Retail Glitch by rendering QIP 15-year property eligible for 100% bonus depreciation, back to taxable year 2018. This technical correction should be particularly useful to businesses in the retail, restaurant, and hospitality industries given the rate at which these sectors have brought new, improved real estate assets online during 2018 and later.
Temporary Exception from Excise Tax for Alcohol Used to Produce Hand Sanitizer (Sec. 2308)
Taxpayers subject to regulation by the Alcohol and Tobacco Tax and Trade Bureau (“TTB”) (e.g., manufacturers and distributors of alcohol for beverage, scientific, medical, and industrial uses) are subject to federal excise on the sale of alcohol (such excise taxes are administered by the TTB on a slide scale based on the concentration of alcohol in the finished product and on the overall production volume of the taxpayer). The CARES Act suspends these excise taxes for distilled spirts “removed” (that is, removed from the control of the taxpayer’s warehouses/distribution centers, or from a U.S. customs facility) after December 31, 2019, and before January 1, 2021, and are for us in or contained in a hand sanitizer product that is produced and distributed in compliance with the COVID-19 guidance promulgate by the U.S. Food and Drug Administration (which incorporates formulation guidelines from the World Health Organization, and requires that denatured ethyl alcohol or isopropyl alcohol is the active ingredient).
Forgiven Loan Amounts under U.S. Small Business Administration Paycheck Protection Program Not Included in Taxable Income (Sec. 1106(i))
Title I of the CARES Act, the Keeping American Workers Paid and Employed Act, appropriates $349 billion to the Small Business Administration (“SBA”) to be made available as loans to small business under the “paycheck protection loan” (“PPP”) program. Under the PPP program, SBA loans are eligible for forgiveness up to an amount equal to the total of certain costs incurred and/or payments made during the eight-week period following the origination of the loan, including compensation and other payroll cost, payment of interest on certain mortgage obligations, payment of certain rent obligations, and payment of certain utilities. The CARES Act specifies that any PPP loan amounts so forgiven are excluded from the gross income of the taxpayer otherwise obligated under such loan.
Note: State Conformity with CARES Act Tax Provisions
For states with “rolling conformity” (i.e., those states which conform to the Internal Revenue Code, or IRC, as currently in effect), their tax statutes generally will update automatically to incorporate the tax provisions of the CARES Act unless a state adopts legislation to opt out of one or more of the provisions. States with “static conformity” (i.e., those states which generally conform to the IRC as enacted on a specific date) will need to adopt legislation conforming with one, some, or all of the CARES Act tax provisions. States with “selective conformity” (i.e., those states which conform only to specific IRC provisions and on a rolling, static, or combined basis) may or may not need to adopt legislation, depending on whether they have conformity with one or more of the IRC sections that the CARES Act tax provisions amend and, if they do, whether they want to act differently from what otherwise will occur automatically.
Minnesota, for example, is a static conformity state. The most recent conformity date is as of December 31, 2018. As such, unless Minnesota enacts legislation relating to the CARES Act tax provisions, none will apply for purposes of determining Minnesota income taxes.
Taxpayers should monitor in their relevant states legislative developments for tax conformity to the CARES Act tax provisions.