Business Tax Provisions of the CARES Act
By: Nelson Toner, Bryce Morrison and Andrew Wells
The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was enacted to provide relief to individuals and businesses from the economic effects of the Coronavirus pandemic. In particular, the two provisions discussed below permit taxpayers to potentially claim refunds for federal income taxes paid in prior years.
Net Operating Losses
Under the CARES Act, taxpayers have a greater opportunity to utilize net operating losses. The Tax Cuts and Jobs Act of 2017 (the “TCJA”) placed limits on deducting net operating losses starting in 2018. The TCJA limited the deduction to 80% of a taxpayer’s adjusted taxable income. Any excess deduction over the limitation may be carried forward to future years but it may not be carried back.
The CARES Act removes the 80% limit for deducting net operating losses in 2020. In 2020, taxpayers may deduct net operating losses up to 100% of taxable income. For tax years 2021 and later, the net operating loss deduction is allowed up to 100% of adjusted taxable income for net operating losses that arose prior to 2018 and for up to 80% of adjusted taxable income (except in 2020, as noted) for post-2017 losses.
The CARES Act also allows net operating losses arising in 2018 through 2020 to be carried back 5 years. However, if a taxpayer does not want to carry back the losses (perhaps because the taxpayer also had losses in these earlier years), the taxpayer must waive the loss carry-back provision for 2018 or 2019 prior to October 15, 2021. If the loss carry-back provision is waived, the losses may still be carried forward.
The CARES Act will allow many taxpayers to file amended returns to carry-back their net operating losses, which could generate a large number of amended returns and refund claims. Additionally, losses carried back to pre-2018 tax years will result in a greater tax reduction because income tax rates were higher in those years. For example, taxpayers taxed as C corporations might utilize net operating losses to seek refunds in tax years where their income tax rate was 35%, in contrast to the current C corporation tax rate of 21%.
Qualified Improvement Property
Qualified improvement property is eligible for bonus depreciation retroactive to January 1, 2018. The TCJA allows a taxpayer to take a current deduction for all the cost of purchasing “qualified property”. The permitted amount of the deduction decreases starting in 2022. Due to an error in the TCJA, qualified improvement property was not included in the definition of “qualified property” and was not eligible for bonus depreciation. Under the CARES Act, though, qualified improvement property is included in the definition of “qualified property” and is eligible for bonus depreciation.
Qualified improvement property consists of improvements made by the taxpayer to the interior of a nonresidential building after the building was placed in service. It does not apply to enlargement of the building, installation of an elevator or escalator, or work on the structure of the building. It does include, for example, installing or replacing drywall, ceilings, interior doors, electrical and mechanical systems, and fire protection systems. A common example of where it would likely apply is to renovations done by hotels and restaurants and other businesses.
Since the change to qualified improvement property is retroactive to January 1, 2018, taxpayers may have an opportunity to amend their 2018 and 2019 returns to claim bonus depreciation. Amending a return may generate a refund depending on each taxpayer’s circumstances. When analyzing whether to file an amended return and claim bonus depreciation, though, taxpayers need to consider the impact such a claim will have on other tax items on their return, such as the interest expense limitation, uniform capitalization rules, the foreign derived intangible income deduction (FDII), and the global intangible low tax income (GILTI) inclusion. If the taxpayer is an electing real property trade or business under Code section 163(j) (an election which makes qualified improvement property depreciable under the alternative depreciation system and ineligible for bonus depreciation treatment), the taxpayer is permitted to withdraw the election if an amended return is filed on or before October 15, 2021.
The business tax provisions of the CARES Act are intended to provide taxpayers with economic relief from the effects of the Coronavirus pandemic by providing them with additional liquidity. Since each taxpayer’s circumstances are unique, each taxpayer will need to consider whether any of the business tax provisions in the CARES Act, when weighed against the risks and costs of utilizing those provisions, results in an actual advantage to the taxpayer.
To learn more, visit our Tax Team webpage.
This information is provided by Bernstein, Shur, Sawyer & Nelson P.A. for educational and informational purposes only. It is not intended to be, nor should it be construed as, legal advice.