Summary of Business Income Tax Provisions in the CARES Act
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was signed into law. The CARES Act includes corporate and other business tax relief, including permitting carrybacks of (and the lifting of the taxable income limitation on the use of) net operating losses (“NOLs”), increased business interest deductibility, and accelerated recovery of alternative minimum tax credits, among other forms of relief. The following paragraphs summarize those provisions.
Increased NOL Carryback and Utilization (CARES Act. § 2303; Internal Revenue Code (“I.R.C.”) § 172)
The CARES Act expands taxpayers’ ability to deduct NOLs arising before the 2021 taxable year.
Temporary Lifting of 80% Limitation on NOLs. The Tax Cuts and Jobs Act of 2017 (“TCJA”) limited NOL deductions for taxable years beginning after December 31, 2017 to 80% of taxable income in the year of the deduction. The CARES Act lifts the 80% taxable income limitation on the use of NOLs for taxable years beginning before January 1, 2021. However, NOLs carried forward from 2018, 2019 or 2020 to taxable years beginning after December 31, 2020 will be subject to the 80% limitation.
Carryback of NOLs. The TCJA generally disallowed the use of NOLs against the income of prior tax years. The CARES Act allows an NOL incurred by a corporation in tax years beginning after December 31, 2017 and before January 1, 2021 to be carried back to each of the five tax years preceding the tax year of the NOL. An NOL arising during this period that a taxpayer elects to carry back must be carried back to the earliest year within the five-year period in which the taxpayer has taxable income. As under pre-CARES law, a taxpayer may elect to waive the carryback period.
REIT limitations. A taxpayer that is a real estate investment trust (“REIT”) for a given tax year may not carry back NOLs incurred during that tax year to any preceding tax year. Similarly, any NOL incurred in a taxable year in which a taxpayer is not a REIT may not be carried back to a preceding tax year in which the taxpayer was a REIT.
Life Insurance Companies. For life insurance companies, any NOL carryback to a tax year beginning before January 1, 2018 will be treated in the same manner as an operations loss carryback under the rules existing before TCJA (repealed IRC § 810).
Treatment of E&P Deemed Repatriated under Section 965. TCJA required certain U.S. shareholders of a foreign corporation to include in gross income their share of the foreign corporation’s earnings that were not previously subject to U.S. tax (“Section 965 income”). Under the CARES Act, Section 965 income may not be taken into account in determining the amount of an NOL or the amount of taxable income that may be reduced by any NOL carryback. Further, the taxpayer may elect to exclude from the five-year carryback period all years in which the taxpayer included income under Section 965. Such an election must be made by the filing return deadline for the first taxable year ending after March 27, 2020.
Elections. Taxpayers considering whether to make the election to relinquish the carryback period or to exclude taxable years in which the taxpayer had Section 965 income from the carryback period for their 2018 or 2019 taxable years have until the due date (including extensions) for filing their tax returns for the first taxable year ending after the date of enactment (March 27, 2020).
Modification of Limitation on Use of Excess Business Losses (CARES Act. § 2304; I.R.C. § 461(l))
Relief from Excess Business Loss Disallowance. The CARES Act lifts the disallowance of “excess business losses” for individuals and flow-through entities for taxable years beginning before December 31, 2020. Under the TCJA, noncorporate taxpayers were permitted deductions attributable to a trade or business only up to the amount of the income or gain attributable to that trade or business for the tax year plus $250,000 ($500,000 for joint filers). This TCJA limitation applied to tax years beginning after December 31, 2017 and before December 31, 2026. The CARES Act lifts this limitation for tax years beginning in 2018, 2019, and 2020, permitting deduction of business losses in excess of the above threshold. For tax years beginning in 2021 through 2026, taxpayers may treat excess business losses as NOLs for purposes of determining a net operating loss carryover in the following year.
Technical Corrections. The CARES Act also makes certain technical corrections to the TCJA with respect to the calculation of excess business losses.
- The determination of excess business losses takes into account the lesser of (i) capital gain attributable to a trade or business or (ii) net capital gain income.
- Excess business losses are determined without regard to any capital losses or any deductions, gross income, or gains attributable to any trade or business of performing services as an employee.
- Deductions allowable under Sections 172 and 199A are not taken into account in determining excess business losses.
Modifications of Limitation on Deductibility of Business Interest (CARES Act. § 2306; I.R.C. § 163(j))
Increase in Business Interest Expense Limitation. The CARES Act increases the business interest expense limitation of Section 163(j) (as amended by the TCJA) from 30% to 50% of adjusted taxable income (i.e., effectively EBITDA) for tax years beginning in 2019 and 2020. For these tax years, taxpayers subject to the limitation (generally, taxpayers with average annual gross receipts for the prior three tax years below $26 million) may now deduct business interest expense up to 50% of their adjustable taxable income. However, taxpayers may still elect to apply the 30% limitation. In the case of a partnership, the election must be made by the partnership.
Special Rules for Partnerships. The increased limitation does not apply to partnerships for tax years beginning in 2019. 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 that allocated excess business interest amount. The remaining 50% of such allocated excess business interest will be subject to the customary limitations for excess business interest, such that it can only be applied against subsequent tax years’ excess taxable income from the partnership.
Election to Use 2019 Taxable Income to Compute Limitation. For tax years beginning in 2020, taxpayers may elect to use their 2019 adjusted taxable income to determine the limitation amount (prorated if the taxpayer’s 2020 tax year is a short tax year). This election must also be made at the partnership level.
Accelerated AMT Credit Recovery (CARES Act § 2305; I.R.C. § 59)
The CARES Act allows for accelerated recovery of corporate alternative minimum tax (“AMT”) refundable credits. TCJA repealed the AMT and allowed corporations to recover AMT credits, including via refund, in years 2018 through 2021.
The CARES Act accelerates the recovery and refund of such credits to the taxable years beginning in 2018 and 2019. Further, corporations may elect to recover the full amount of refundable AMT credits in the first tax year beginning in 2018. The application must be filed prior to December 31, 2020 and must state the amount of the refund claimed.
Technical Amendments Regarding Qualified Improvement Property (CARES Act. § 2307; I.R.C. § 168)
The CARES Act makes qualified improvement property eligible for bonus depreciation. Qualified improvement property is any improvement to an interior portion of a building which is nonresidential real property. This provision corrects a drafting error in TCJA that caused qualified improvement property (“QIP”) to be depreciated over 39 years as opposed to the intended 20 years, rendering qualified improvement property ineligible for bonus depreciation. The CARES Act sets the depreciable life of qualified improvement property at 20 years, allowing taxpayers to take advantage of bonus depreciation.
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This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.