If you’re a business with significant debt service or that incurred losses since the beginning of 2018, congress has tailored specific benefits for you. These provisions translate into taxable savings and possibly even refunds for prior taxable years. The rules are complex to navigate, and affirmative action is required to reap the benefits of some of these provisions.
Negative Earnings or Business Losses in 2018, 2019 or 2020.
As a result of the CARES Act, Taxpayers with losses in 2018, 2019 and 2020 can now apply those losses against taxable income in the preceding five years to obtain a refund.
Section 2303 of the CARES Act amends Section 172 of the Internal Revenue Code so as torequire net operating losses (“NOLs”) to be carried back to each of the five taxable years preceding the NOL. Qualifying NOLs are those net taxable losses that are incurred for taxable years after December 31, 2017, but before January 1, 2021 (e.g., essentially NOLs generated in the taxable years of 2018, 2019 and 2020). Carrybacks of NOLs had been eliminated by the 2018 Tax Cuts and Jobs Act. This new provision will allow taxpayers to carry back qualifying NOLs to offset up to 100% of taxable income in the prior five taxable years, and obtain an immediate refund if taxes have already been paid for these prior taxable years. It seems likely that most corporations would favor carrying back NOLs to prior years where the top corporate rate of 35% was considerably higher than the current corporate tax rate of 21%. As an aside, taxpayers can continue to carry NOLs forward indefinitely to future taxable years to offset up to 80% of the taxable income in those future years. If a taxpayer does not want to carry back NOLs, then the taxpayer must file an election no later than the due date for its tax return (including extensions) (attention should be paid to the statute of limitations for the carryback). The CARES Act excludes this five-year carryback benefit from being used by insurance companies, REITS and taxpayers subject to deemed repatriation (of foreign sourced income) under Internal Revenue Section 956.
This carryback of NOLs is available for C corporations and owners of pass-through entities alike, although the benefits for individual owners can be a bit more complex to follow. Corporations will file for refunds directly, but the refund procedure for pass-through entities could be more complex. Certain pass-through entities will need to amend their returns so as to entitle their individual owners to file for refunds. Those entities are partnerships and limited liability companies (“LLC”) that are treated as a “BBA partnership.” A BBA partnership is any entity taxed as a partnership (e.g., including many LLCs) that has not made an election to have centralized partnership audit procedures apply.
Additionally, for the 2018 – 2020 taxable years, the CARES Act suspended the application of “excess business losses” under Internal Revenue Code Section 461(l)(1), which was recently introduced by the Tax Cuts and Jobs Act and severely limited the ability of individual taxpayers to use losses from pass-through entities. By suspending the limitation imposed on such “excess business losses”, individual taxpayers can maximize their deductions, which in turn creates or increases individual NOLs, permitting such individuals to file for refunds. Previously, this excess business loss limitation effectively reduced the ability of individual owners of pass-through entities to use NOLs.
For taxpayers who sold their business after January 1, 2018, the legal documents from the transaction may need to be reviewed. These deal documents may specify whether NOL carrybacks are required and if so, who is entitled to the benefit. Additionally, for M&A deals currently on the table, who is entitled to receive a refund opens another item for negotiation. For instance, buyers will want to ensure that they retain the right to receive any refunds attributable to the losses arising after the closing.
Suspended Credits under the Alternative Minimum Tax (“AMT”) Regime
Section 2305 of the Act allows corporations with unused AMT credits to take the entire amount of such unused credit in 2018 and/or 2019, with an expedited process for receiving a tentative refund (typically refunds in excess of $5 million have more scrutinized review by the Joint Committee on Taxation with lengthy delays). Previously under the Tax Cuts and Jobs Act, the AMT rules were changed so that the AMT no longer applied to corporations. However, if a corporation had an unused credit, then it could only use such credit over the 2018 – 2021 taxable years (generally according to a 50% declining balance type of amortization of the unused credit – e.g., 50% in 2018, 25% in 2019, 12.5% in 2020, 12.5% in 2021).
Increased Deductibility of Business Interest
This provision temporarily increases the amount of interest expense businesses are allowed to deduct on their tax returns, by increasing the 30% of taxable income limitation to 50% of taxable income (with adjustments) for 2019 and 2020. As businesses look to weather the storm of the current crisis, this provision will allow them to increase liquidity with a reduced cost of capital, so that they are able to continue operations and keep employees on payroll.
Deductions For Qualified Improvement Property Costs
Section 2307 of the CARES Act enables businesses, especially in the hospitality industry, to immediately write off costs associated with improving facilities instead of having to depreciate those improvements over the 39-year life of the building. The provision, which corrects an error in the Tax Cuts and Jobs Act, not only increases companies’ access to cash flow by allowing them to amend a prior year return, but also incentivizes them to continue to invest in improvements as the country recovers from the COVID-19 emergency.
The CARES Act creates monetary rewards for businesses, entrepreneurs and investors into small businesses. However, the rules are complex and there are deadlines, before which taxpayers must file amended returns. It also goes without saying that the sooner amended returns are filed, the sooner taxpayers will receive these refunds to which they are entitled under the CARES Act. Moreover, to capture the full benefits of these complex opportunities, which are factually specific to each situation, taxpayers will most likely need to work closely with their accountants and attorneys. The CARES Act was drafted quickly, and many provisions are subject to regulatory guidance, and this guidance has been updated and/or changed frequently, sometimes on a daily basis.
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