On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act, H.R. 748 (the “CARES Act”) was approved by Congress and signed into law by President Trump. The legislation is approximately 880 pages in length and sets forth a wide range of policy measures designed to provide economic relief to individuals and businesses affected by the coronavirus (“COVID-19”) pandemic.
Below we provide an initial overview of, and observations regarding, selected tax relief provisions of the CARES Act aimed at business taxpayers, including:
As we discuss below, consistent with the general tenor of the CARES Act, certain of these tax provisions may provide relatively immediate cash relief to various businesses; however, others may fall short of such goal.
The Tax Cuts and Jobs Act that was signed into law at the end of 2017 (the “TCJA”) substantially limited the ability of corporate taxpayers to use NOLs arising after December 31, 2017 to offset taxable income. Under the TCJA, corporate taxpayers could use NOLs arising in 2018 or subsequent tax years to offset no more than 80 percent of their taxable income and could not carry back NOLs to prior years. The bill removes the 80 percent limitation for taxable years beginning before January 1, 2021, and allows taxpayers to carry back NOLs arising in tax years beginning after December 31, 2017 and before January 1, 2021 over a five-year period. The bill contains certain exceptions and special rules. For example, consistent with prior law, REITs cannot carry back NOLs to non-REIT years.
The temporary reprieve from the 80 percent limitation, combined with the generous five-year carryback period, may allow many corporate taxpayers to obtain relatively quick, and possibly substantial, refunds by filing amended tax returns. Corporations that were limited in their ability to use NOLs by the 80 percent cap for their 2018 and 2019 taxable years will obviously stand to benefit, as will corporate taxpayers with NOL pools in excess of 100 percent of taxable income in those years that can carry back such excess amounts to profitable prior years. For corporate taxpayers that did not have material NOLs in 2018 or 2019, but expect to generate losses in 2020, the benefits will not be as immediate, as those losses will not be effectively available to carry back to prior tax years until the filing of tax returns for such year in 2021 (unless the taxpayer files an application for a tentative carryback adjustment under applicable provisions of the Code). With the potential for widespread losses throughout many sectors of the economy in 2020, this change could provide additional liquidity to corporations in 2021.
With this provision and others in the CARES Act, taxpayers may need to balance the acceleration of losses and the acceleration of income to maximize the benefits available to them. For example, taxpayers with significant prior taxable income may want to maximize the size of an NOL generated in 2020 to carry such NOL back for a refund, and avoid accelerating income into the current taxable year. In addition, the significant benefit of generating losses this year rather than in subsequent years may encourage some taxpayers to accelerate expenses, including capital expenditures that may be fully expensed under the “bonus depreciation” rules, to the greatest extent possible under the current climate.
The carryback of NOLs could be disadvantageous for certain multinationals that are required to include in gross income their share of “global intangible low-taxed income” (“GILTI”) derived by certain non-U.S. subsidiaries. Under the GILTI regime, domestic corporations are entitled to a deduction of 50 percent of their GILTI, bringing the effective tax rate on GILTI from 21 percent to 10.5 percent. This deduction is limited if a domestic corporation’s GILTI exceeds the corporation’s U.S. taxable income, taking into account its NOLs. If the NOL completely offsets taxable income, then GILTI will reduce the NOL dollar-for-dollar. As a result, if a domestic corporation carries back its NOLs to 2018 or 2019, it could find that its NOLs, which could have been used to offset future income otherwise subject to U.S. income tax at the full corporate rate (currently 21 percent), have instead been utilized to offset GILTI income that would be taxed at a lower rate due to the 50 percent deduction. Multinational taxpayers may encounter other hiccups in their ability to take advantage of the new NOL rules, including with respect to the “BEAT” and “FDII” provisions of the TCJA and the ability to utilize foreign tax credits. As a result, some multinational corporations may elect to waive the carryback period with respect to their NOLs.
Under Section 163(j), enacted by the TCJA, taxpayers may deduct business interest expense only up to 30 percent of their “adjusted taxable income” (a concept similar to EBITDA). The CARES Act increases the limitation to 50 percent for taxable years beginning in 2019 and 2020, and allows taxpayers to elect to use their 2019 adjusted taxable income to calculate their Section 163(j) limitation for their 2020 taxable year.
For partnerships, the Section 163(j) limitation applies at the partnership level. The 30 percent limitation will continue to apply to partnership interest expense in 2019; however, 50 percent of any excess business interest allocated to a partner and carried over from 2019 will be treated as business interest paid by the partner in 2020, and will not be limited to the partner’s business interest income for 2020. The remaining 50 percent will continue to be subject to such limitations.
The increase in the Section 163(j) allowance should generally allow many taxpayers with interest deductions that were limited in their 2019 taxable year to claim a refund of taxes paid. At the same time, although corporate borrowing may increase in 2020 as companies draw down existing loan facilities to meet operating expenses, if companies otherwise experience large losses, taxpayers may not realize any immediate current-year benefit from this provision because it may only serve to increase NOLs in the short-term. Moreover, real estate businesses, which could include hotel or restaurant property owners that may be particularly hit hard by COVID-19, will not benefit to the extent such businesses elected out of Section 163(j) to begin with (and are unable to unwind such election).
Prior to the enactment of the TCJA, corporations were subject to AMT at a rate of 20 percent. AMT taxes were treated as a tax credit that could be carried forward to offset non-AMT taxes in subsequent years. The TCJA eliminated the corporate AMT, and provided that any AMT credits carried forward were refundable. However, no more than 50 percent of the AMT credits were refundable each year (after offsetting the corporation’s regular tax liability) for tax years beginning in 2018, 2019, and 2020. Any remaining AMT credits were fully refundable for tax years beginning in 2021.
The bill permits corporations via an election to claim a refund for 2018 equal to the full amount of their excess AMT tax credit carryforwards. For corporations that do not elect this refund, the CARES Act eliminates the 50 percent limit on AMT tax credits for taxable years beginning in 2019.
This provision will benefit corporations with excess AMT tax credits by permitting refunds of 2018 taxes.
The CARES Act puts in place a temporary moratorium on the payment of an employer’s share of Social Security taxes for the tax periods ending before January 1, 2021. The deferred tax payments must be paid over the following two years: 50 percent by December 31, 2021 and the remaining 50 percent by December 31, 2022.
In addition, for businesses whose operations were all or partially suspended due to orders from a governmental authority as a result of COVID-19, or who experienced a significant decline in gross receipts as determined under a qualitative test set forth in the bill, the CARES Act provides a refundable payroll credit for 50 percent of the wages paid or incurred from March 13, 2020 through the end of the year.
This provision will ease the strain on employers’ cash flow and may encourage employers to retain current employees. In particular, to the extent affected businesses expect business disruption to be temporary, the refundable payroll credit for wages paid during COVID-19 may help companies to retain and pay employees during this time.
Present law disallows a deduction for “excess business losses”, with any disallowed deduction being permitted to be carried forward as a net operating loss. The bill suspends this limitation for tax years beginning before 2021.
As with the changes to NOLs for corporate taxpayers, the suspension of the limitation on excess business losses provides a similar benefit to non-corporate taxpayers, some of whom may be able to claim a refund for their 2018 taxable year.
Under current law, a taxpayer can deduct the full cost of certain depreciable property placed in service or acquired by the taxpayer in a taxable year before January 1, 2027 (“bonus depreciation”). Improvements to building interiors made by a taxpayer (“qualified improvement property”) were not included in the list of property eligible for bonus depreciation. The bill includes a technical correction which identifies qualified improvement property as “15-year property” eligible for bonus depreciation.
This provision may allow taxpayers to file amended returns and claim refunds for the 2018 and 2019 tax years if they placed qualified improvement property into service during those years, and may also encourage taxpayers to make needed improvements in the coming years as the economy recovers from the COVID-19 pandemic. However, many real estate taxpayers may have elected out of the application of Section 163(j), which came at the cost of less favorable depreciation, on the assumption that bonus depreciation was unavailable for qualified improvement property. It remains to be seen whether and how such taxpayers could unwind such election to take advantage of the technical correction.