When the Coronavirus Aid, Relief, and Economic Security (CARES) Act was first passed in late March to help alleviate financial strains from the Coronavirus pandemic, a lot of the media coverage focused on stimulus checks and business loans. The CARES Act also changed many tax laws to be responsive to taxpayer needs, and reversed some of the more onerous provisions that went into effect in 2017 and 2018 as part of the tax reform law more commonly known as the Tax Cuts and Jobs Act (TCJA).
Changes in the CARES Act will have a federal tax impact and a state tax impact. Many states conformed to federal tax laws, some selected only certain provisions to adopt, and others may apply state-specific modifications to the federal provisions adopted. When determining state taxable income, most states start with federal taxable income and then add back or subtract the federal provisions that don’t apply or are modified by state law. Depending on your organization’s state filing requirements, the CARES Act tax changes may impact your tax obligations differently.
Business Interest Limitation
The CARES Act reduced the business interest expense limitations that were imposed by the TCJA. Under Section 163(j) of the tax code, business interest expense was limited to the sum of business interest income and 30% of adjusted taxable income (ATI) beginning in 2018. In prior years, business interest expense was usually fully deductible. The CARES Act did not bring back the full deduction, but it allowed for larger deductions by increasing the limitation to 50% of ATI.
The business interest expense limitation was introduced in the TCJA and was further modified by the CARES Act. Most states with rolling conformity to the Internal Revenue Code did not enact legislation to decouple from the federal provisions under TCJA, and now automatically adopt the revised provision under the CARES Act. This means that over half of all states (including Colorado, Kansas, and Rhode Island) allow the new 50% of ATI threshold, and do not require further adjustment to their laws. A handful of states (like Arizona and New York) will continue to apply the 30% threshold set by the TCJA, and an even smaller group of states (including California and Texas) will disregard both the TCJA and the CARES Act and allow its filers to deduct 100% of their business interest expense.
Net Operating Losses
Beginning in 2018, the TCJA restricted the use of net operating losses (NOLs). NOLs could no longer be carried back and applied against prior year taxable income, and corporate NOLs were only permitted to offset up to 80% of current-year taxable income, compared to 100% offset allowed in years past.
Under the CARES Act, Congress temporarily reversed and modified this provision. For 2018, 2019, and 2020, taxpayers can carry back their NOLs up to five tax years and can use NOL carryovers to offset 100% of taxable income. Beginning with tax year 2021, the NOL statutes revert back to the provisions set forth by the TCJA.
Historically, quite a few states decoupled from federal NOL laws by either changing the number of carryback/carryforward periods, or enacting unique state limitations based on filing position or state fiscal situation. Some states that partially adopt the CARES Act (e.g., Colorado and Washington, D.C.) allow NOLs to offset 100% of taxable income but do not conform to the CARES Act’s five-year carryback. Other states (e.g., Florida) still conform to the provisions of TCJA, while states like California disregard both the TCJA and the CARES Act NOL provisions, and continue to apply their own state laws.
Qualified Improvement Property (QIP)
A noteworthy provision in the CARES Act was the validation that qualified improvement property (QIP) should have a 15-year recovery period. When the TCJA was passed at the end of 2017, a legislative error made QIP depreciable over 39 years rather than 15 years; a change which also made those expenditures ineligible for bonus treatment. It was a major setback and for years, business owners waited for Congress to pass a correction bill.
The CARES Act made the correction. Retroactive to 2018, qualified improvement property became a 15-year asset eligible for bonus depreciation.
Only a few states automatically conform to federal bonus depreciation provisions, so most will require an affirmative adjustment to their laws in order to adopt this rule. Florida, for instance, requires taxpayers to spread a single year’s bonus depreciation deduction over seven years. But bonus depreciation is not the only adjustment that may be needed. Because the CARES Act changed the class life of QIP from 39 to 15 years, some states will need to adjust for this change as well. Almost all states conform to the federal depreciable life classifications under the Modified Accelerated Cost Recovery System (MACRS) and Alternative Depreciation System (ADS), but some states must pass a conformity statute for this to change. There are a lot of moving parts, so it’s important for taxpayers to keep abreast of their filing states’ tax laws surrounding QIP, depreciation, and bonus allowances.
Other Tax Concerns
Many of the CARES Act’s changes are retroactive to 2018, which means that taxpayers may need to amend previously filed returns in order to capture the full amount of benefit available to them. The IRS has released some guidance on how to amend returns for CARES Act tax law changes, but taxpayers must remember that amending a federal return may require them to amend their state returns, as well. Even if not required, it is often wise to amend both federal and state returns in order to save the most tax and preserve the taxpayer’s right to a refund.
Ann Brown is a Senior Tax Manager in the New England State and Local Tax Practice. She can be reached at email@example.com or 617.761.0658.
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