The COVID-19 pandemic of 2020 has resulted in a flurry of legislation that the federal government hopes will assuage the negative economic impact of temporary business closures across the U.S. Most notable of these efforts is the historic $2 trillion stimulus package in the Coronavirus Aid, Relief, and Economic Security, or CARES, Act passed in late March.
While stimulus checks to individuals and loans to affected companies have garnered much of the attention surrounding the CARES Act, there are several tax provisions in the act that have received less coverage but could result in significant tax refunds for some taxpayers even if those taxpayers have not been negatively impacted by the pandemic. In many cases, utilization of the changes in the tax law may result in tax refunds for tax paid in prior years. That means that taxpayers can file amended tax returns now to obtain refunds and improve liquidity relatively quickly. Below are four examples of such provisions.
Changes to Net Operating Loss Rules
Prior to the Tax Cuts and Jobs Act, or TCJA, passed in 2017, net operating losses, or NOLs, could generally be carried back two years and forward 20 years and could offset up to 100% of taxable income. The TCJA changed the rules by (1) disallowing all carrybacks of NOLs arising in tax years after 2017, (2) providing for an indefinite carryforward period, and (3) limiting post-2017 carryforwards to offsetting 80% of taxable income.
The CARES Act temporarily reverses the TCJA changes. Losses from 2018, 2019, and 2020 will now be permitted to be carried back for up to five years to offset up to 100% of taxable income. Further, losses carried forward to 2019 and 2020 will be permitted to offset 100% of taxable income, rather than the 80% provided for under the TCJA. These changes can be beneficial for taxpayers who had significant taxable income in prior years but suffered a loss in tax years 2018, 2019, or 2020. Taxpayers may now be able to amend prior year returns to carryback NOLs and offset taxable income to generate tax refunds.
Changes to Net Business Loss Rules
The TCJA added Internal Revenue Code § 461(l), which generally limits an individual’s ability to use losses from a business to offset other sources of income. That provision provides that the amount of “net business loss” an individual may use in a year to offset other sources of income is capped at $250,000 for a single taxpayer and $500,000 for a married taxpayer filing jointly. Any business losses above the cap are converted into a net operating loss, which is subject to certain limitations. The CARES Act temporarily postpones the application of Section 461(l) until tax year 2021. That means the Section 461(l) limitations no longer apply to tax years 2018, 2019, or 2020. As a result, a taxpayer who had a loss limited by the provision in 2018 or 2019 may be able to file an amended return to claim a refund.
Changes to the Interest Limitation Rules
The TCJA also added Internal Revenue Code § 163(j), which generally limits a business’s ability to deduct its interest expense to the sum of (1) its business interest income, (2) 30% of its adjusted taxable income, or ATI, and (3) its “floor plan financing interest.” (1) Any excess interest expense above the limit can be carried forward. The CARES Act increases the limit to 50% of ATI for 2019 and 2020. Additionally, a business can elect to use its 2019 ATI in computing its 2020 limitation. As a result, if a business has a net operating loss in 2020 but had a high adjusted taxable income in 2019, it can use its 2019 ATI to calculate the interest expense limit for 2020. So, for example, if a business had ATI of $5 million in 2019 but had a net operating loss in 2020, it could elect to deduct up to $2.5 million (50% of $5 million) of interest expense in 2020, resulting in a larger NOL. That NOL can then be carried back to 2019 (under the new NOL rules) to offset taxable income, which could result in a refund to the taxpayer for tax year 2019.
Changes to Qualified Improvement Property Rules
Qualified improvement property, or QIP, is generally defined as any improvement made to the interior of a non-residential building any time after the building was placed into service. The CARES Act reduces the depreciable life of QIP from 39 years to 15 years and makes that change retroactive to January 1, 2018. Since 100% bonus depreciation is available for all assets with a life of 20 years or less, the change allows a taxpayer who has spent substantial amounts renovating the interior of a non-residential building to claim an immediate deduction for those costs. Further, if those renovations were done in 2018 or 2019, then the taxpayer may be able to file an amended return to obtain the benefits of accelerated depreciation for those years.
Taxpayers may be able to take advantage of the tax provisions in the CARES Act discussed above to obtain tax refunds for tax paid in prior years even if they have not been negatively impacted by the COVID-19 pandemic. In some instances, such refunds could be substantial. For those taxpayers able to utilize these provisions, it may be possible to improve liquidity in the short term if amended tax returns are filed.
CLINT L. TAYLOR
is a shareholder in Stutzman, Bromberg, Esserman & Plifka in Dallas. He specializes in federal tax matters as well as mergers, acquisitions, commercial restructurings, and other business transactions. Taylor can be reached at email@example.com.
1. For an entity taxed as a partnership, the rules are considerably more complicated and beyond the scope of this article.