[co-authors: Robert Friedman, Mark Goldsmith, Joel Post]*
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) has significantly changed the use of net operating losses (NOLs), interest deductions, and other business-related losses.
NET OPERATING LOSSES
My business will have a net operating loss for 2020. Can I carry it back to claim a refund of federal income taxes previously paid?
The Act permits losses incurred in 2018, 2019 and 2020 to be carried back five years. Since 2018, losses could only be carried forward, not carried back. The five-year carryback period could provide additional tax benefits for taxpayers with capacity to carry back losses to 2017 (or a prior year), as these losses would reduce taxable income that was generally taxed at a 35 percent corporate tax rate (rather than the current 21 percent corporate tax rate). For example, if a corporation has a loss of $2,000 in 2020, and had income of $1,000 in each of 2019 and 2018, the loss can be carried back to 2019 and 2018 to wipe out the federal income tax liability for those years, and the corporation could claim a corresponding income tax refund.
Does the 80 percent taxable income limitation on the use of NOLs continue to apply?
No, not for tax years beginning before January 1, 2021. Available NOLs can be used to offset 100 percent of taxable income, assuming the NOL is not otherwise limited by changes in ownership, etc.
Can I use the NOL carryback to offset the income inclusion I had in 2017 under section 965 — the inclusion of the income of my foreign subsidiaries?
No.
What is the impact of the NOL carryback on a business’s inclusion of global intangible low tax income (GILTI)?
If you reduce your taxable income with an NOL carryback, there may be an increase in your GILTI inclusion because the GILTI inclusion is limited by taxable income.
What is the impact of these changes on M&A transactions in the pipeline?
The parties to an M&A transaction need to consider which party should get the benefits of the NOL and corresponding refunds. Parties should also consider who controls the preparation of relevant income tax returns and management of relevant income tax audits.
DEDUCTING INTEREST EXPENSE
Can a business now deduct more of its interest expense?
Prior to the Act, if the business met a threshold of more than $25 million in revenue, interest deductions were limited to the taxpayer’s business interest income plus 30 percent of the taxpayer’s “adjusted taxable income” (ATI). The Act changes the ATI limit to 50 percent for corporations for 2019 and 2020. Further, under the Act, for 2020, taxpayers may use 2019 ATI to calculate the interest deduction limit. Any interest expense in excess of the limit is carried forward to a future taxable year.
The 30 percent ATI limitation will continue to apply to a partnership’s interest expense in 2019. However, 50 percent of any 2019 excess business interest expense (i.e., business interest expense exceeding 30 percent of the partnership’s ATI) allocated to a partner and carried over from 2019 will be treated as business interest paid by the partner in 2020, and corresponding deductions will not be limited in 2020 by the pre-Act deduction limitations. The remaining 50 percent of disallowed interest expense will remain suspended until the partnership allocates excess taxable income to the partner.
How do the changes to the amount of interest deductions interact with the NOL rules?
The temporary 50 percent ATI threshold and the ability to use 2019 ATI for 2020 is expected to significantly increase the ability of taxpayers to deduct interest in 2019 and 2020. To the extent that an NOL arises in 2019 or 2020 on account of an increased interest expense limitation, that NOL is now available for carryback and is not subject to the 80 percent taxable income limitation, as discussed above.
CORPORATE ALTERNATIVE MINIMUM TAX CREDIT
My corporation has an unused AMT credit. Do I need to do something to claim it?
The corporate alternative minimum tax (AMT) was repealed under prior law, but corporate AMT credits were made available as refundable credits over several years, ending in 2021. The Act accelerates the ability of corporations to recover those AMT credits. If the full refundable credit is taken in 2018, the claim for the credit or refund must be filed by December 31, 2020.
EXCESS BUSINESS LOSSES
I’m a noncorporate taxpayer — am I still limited on deducting my current-year “excess business losses?”
Previously, deductions for “excess business losses” by noncorporate taxpayers were disallowed for tax years beginning after December 31, 2017 and ending before January 1, 2026. Generally, an "excess business loss" is the excess of the (1) taxpayer's aggregate trade or business deductions for the tax year over (2) the sum of the taxpayer's aggregate trade or business gross income or gain plus $250,000. The Act temporarily modifies the loss limitation for noncorporate taxpayers so that they can deduct excess business losses arising in 2018, 2019 and 2020.
For example, T, an individual taxpayer, conducts a business as a sole proprietorship. For 2020, T has gross business income of $300,000, nonbusiness income of $300,000, and business deductions of $600,000. T has an excess business loss of $50,000 ($600,000 deductions – [$300,000 business income + $250,000 threshold] = $50,000 excess business loss). Under the Act, the $600,000 loss fully offsets both the business and nonbusiness income of $600,000. T’s taxable income would thus be $0. Under old law, the $50,000 excess business loss would not be deductible and T's taxable income for 2020 would consist of $50,000 of nonbusiness income. Further, under old law, the disallowed $50,000 excess business loss would be treated as an NOL.
To which taxpayers does this rule apply?
Entities other than C corporations. This includes individuals, trusts and estates. In the case of a partnership or S corporation, these limitations are applied at the partner or shareholder level. Note further that “excess business losses” that are disallowed are treated as NOLs. See the rules above regarding the NOL operating rules.
DEPRECIATION FOR QUALIFIED IMPROVEMENT PROPERTY
My business is a restaurant and I just refitted the dining room. Are there any benefits for me?
The Act makes a technical correction to prior law to provide a 15-year depreciation period for “qualified improvement property” (QIP), which includes certain improvements to the interior portions of nonresidential real property. This technical correction would make the property eligible for bonus depreciation. Additionally, for taxpayers electing not to claim 100 percent bonus depreciation, QIP is depreciated over 15 years rather than 39 years (as previously allowed).
* Troutman Sanders
