When it was signed into law in late March, the Coronavirus Aid, Relief and Economic Security (CARES) Act was the largest stimulus package in U.S. history. The law contains numerous provisions designed to help mitigate the economic impact of the novel coronavirus (COVID-19) pandemic, including welcome tax relief for businesses that is potentially relevant for all of 2020 and, in some cases, for past or future years, too.
A win on losses
The CARES Act temporarily eases restrictions on net operating loss (NOL) carrybacks, allowing eligible businesses to claim an immediate refund of taxes paid in previous years. At one time, businesses could carry back NOLs up to two years and forward up to 20 years to offset taxable income in those years. But the Tax Cuts and Jobs Act (TCJA) eliminated NOL carrybacks and permitted NOLs to be carried forward indefinitely. It also limited NOL deductions to 80% of taxable income in a given year.
The CARES Act allows businesses with NOLs arising in 2018, 2019 or 2020 to carry back those losses up to five years. It also temporarily removes the 80% cap on deductions, enabling businesses with sufficient losses to fully offset taxable income in a carryback year. The cap generally will be reinstated for tax years beginning in 2021.
The ability to carry back NOLs is particularly valuable in light of the TCJA’s reduction of corporate and individual income tax rates. Under the CARES Act, it’s possible to use an NOL from a year with a lower tax rate to offset taxable income from a previous year that was taxed at a higher rate, providing some tax relief.
For example, a C corporation that incurs a $1 million NOL in 2020 could use the loss to offset up to $1 million in taxable income in 2015 that was originally taxed at a 35% rate, even though the same income would have been subject to only a 21% rate beginning in 2018.
A rise in interest deductions
The CARES Act relaxes limits on business interest deductions, enabling many businesses to reduce their tax bills. The TCJA imposed a cap on deductions of business interest (for example, interest on business-related loans, lines of credit or mortgages) generally equal to 30% of a taxpayer’s adjusted taxable income (ATI). Small businesses — generally, those with average annual gross receipts of $25 million or less for the preceding three years — are exempt from the limit.
Under the CARES Act, businesses subject to the limit may deduct interest up to 50% of ATI for the 2019 and 2020 tax years (subject to special partnership rules for 2019). In addition, businesses may elect to use their 2019 ATI to calculate the 2020 limit, which will increase interest deductions for many businesses whose income declines this year.
A retroactive fix for qualified improvement property
Before the TCJA took effect, certain interior improvements to retail, restaurant and leased buildings generally were depreciable over 15 years and entitled to 50% bonus depreciation in Year 1. The TCJA consolidated these properties into a single, comprehensive category of qualified improvement property (QIP).
Congress’s intent was for QIP, which encompasses most improvements to nonresidential buildings after they were first placed in service, to be depreciable over 15 years and to be eligible for 100% bonus depreciation. However, because of a drafting error, QIP was classified as 39-year property ineligible for bonus depreciation.
The CARES Act corrects this error by reducing the cost recovery period for QIP from 39 to 15 years, making it eligible for bonus depreciation. The law also clarifies that, to be eligible for these tax advantages, the improvements must have been made by the taxpayer. These changes are retroactive to the beginning of 2018, as if they’d been part of the TCJA when it was enacted.
Eligible businesses that have made qualified improvements since that time may now file amended returns or applications for a change in accounting method to capture the bonus depreciation or other depreciation deductions they missed.
Are you eligible for payroll tax relief?
The Coronavirus Aid, Relief and Economic Security (CARES) Act provides tax benefits to employers that retain their employees during the COVID-19 crisis. If you haven’t already taken advantage of this relief, be sure to check whether you’re eligible:
Payroll tax deferral. You can defer the employer’s share of the 6.2% Social Security tax on wages paid from March 27, 2020, through the end of this year. The tax is then due in two installments: 50% on December 31, 2021, and 50% on December 31, 2022. Similar benefits are available to partners and sole proprietors for the “employer’s half” of self-employment tax. Note that deferral is unavailable to employers that receive loan forgiveness under the CARES Act’s Paycheck Protection Program. Subsequent guidance, however, clarified that the deferral would be eligible for amounts incurred prior to the time of the loan forgiveness.
Employee retention credit. You can claim a refundable payroll tax credit equal to 50% of up to $10,000 in compensation (including health care benefits) paid to eligible employees from March 13, 2020, through the end of 2020. To qualify, your business must have experienced either 1) full or partial suspension of operations due to a COVID-19-related shutdown order, or 2) a decline in gross receipts by more than 50% compared to the same quarter in the previous year.
If you have more than 100 employees, the credit is available only for compensation paid to employees who aren’t working or have had their hours reduced for one of the reasons listed above. If you have 100 or fewer employees, the credit is available even for compensation paid to employees who continue to work.
Additional rules and limits apply, so check with your tax advisor for more details.
Don’t be surprised if Congress passes additional tax legislation to help businesses affected by COVID-19. Some may even have been passed by the time you’re reading this article. We can help you make the most of the tax relief available to your business.