The Coronavirus Aid, Relief, and Economic Security Act, also known as the CARES Act, is a law meant to address the economic fallout of the 2020 coronavirus pandemic in the United States.
With the CARES Act in place there are several things to consider as a business owner. Below are a few things that should be considered when filing your tax returns over the next few years, especially for those who utilize federal and tax credits such as the Research Tax Credit.
- Net Operating Losses or “NOLs” can now temporarily be carried back five years prior to the tax year filed
- Business Interest Deduction limitations have been increased from 30% to 50% of Adjusted Taxable Income (ATI)
Research Tax Credits
Before claiming an NOL carryback, corporate taxpayers should consider how tax attributes like Research Tax Credits were used in a prior year could be displaced as a result of the carryback. The scenario below is likely to be a common one for tax year 2020. This scenario illustrates a company who was profitable in 2019 and utilizing their R&D tax credit but then experienced large losses due to the COVID-19 pandemic in 2020. This company would be able to carryback their losses generated in 2020 to tax year 2019 to claim a refund and carryforward the now unutilized R&D tax credit.
Please see the chart below:
|TJCA (As Originally Filed)||CARES ACT (If Amended)|
Net Taxable Income
NOL Carryback (2020)
Federal Taxes Owed (21%)
Research Tax Credits applied
Estimated Taxes Paid
Taxes Due (Refund)
|TJCA (As Originally Filed)||CARES ACT (If Amended)|
|Research Tax Credits Available
Research Tax Credits Utilized
Research Tax Credits Carryforward
The difference between the original refund and the new refund received by the company is $115,000. On top of that the company also now gets to carryforward $95,000 of research tax credits that would have been utilized otherwise. Further details about the changes to NOLs due to the CARES Act can be found below.
Another consideration is the impact on the taxpayer’s AMT liability, if any, in the carryback year. This can directly impact the taxes due section of the chart above. Consult with your CPA, CFO, or Accountant to see if this applies to your company.
Consolidated return groups need to consider a few things such as the availability and computation of the consolidated group’s NOLs, the allocation of the NOLs to a departing consolidated return member, and the group’s utilization of a member’s separate return loss year NOL. Taxpayers privy to an M&A transaction need to consider contractual limitations related to the carryback or carryforward of an NOL, if applicable. This would impact the NOL carryback section of the chart above, consult with your CPA, CFO, or Accountant to see if this applies to your company.
Business Interest Deductions limitations can also impact the utilization of the Research Tax Credit on an amended return. If a company was limited previously to only deducting business interest expense equal to 30% of the company’s Adjusted Taxable Income (ATI) then the increase to 50% of ATI will further reduce the company’s taxable income.
If the company has a lower taxable income it will be required to utilize less of its Research Tax Credit and will then be able to carryforward the difference – effectively “stretching” the value of Research Tax Credits. Further details about the changes to business interest deduction limitation due to the CARES Act can be found below.
NOLs and NOL Carrybacks
With the enactment of the Tax Cuts and Jobs Act of 2017 (TCJA), NOLs could not be carried back any longer, however they were allowed to be carried forward indefinitely. The TCJA also limited NOL utilization to 80% of taxable income. Under the new CARES Act, the following changes are now in place;
- NOLs arising in tax years beginning after December 31, 2017, and before January 1, 2020 may be carried back to each of the five tax years preceding the tax year of such loss.
- For example, if a loss occurs in tax year ending December 31, 2018, the taxpayer would be able to carry this loss back to tax year 2017, 2016, 2015, 2014, and 2013 until all of the loss has been utilized.
- Temporary removal of the 80% limitation until tax years beginning after 2020.
- There are special carryback rules provided for taxpayers such as real estate investment trusts (REITs) and life insurance company.
As a result, corporate taxpayers with eligible NOLs will now have the ability to claim a refund for tax returns from prior returns. Taxpayers still have the choice to waive the carryback and elect to carry NOLs forward to subsequent tax years if advantageous. With the temporary removal of the 80% taxable income limitation, taxpayers are able to fully utilize their NOLs in prior years applicable if they so choose.
Business Interest Deductions
The CARES Act modifies IRC Section 163(j), which affects many types of businesses, including corporations, and was substantially modified by the TCJA in 2017. IRC Section 163(j) limits the amount of business interest expense that may be deducted in a tax year to the sum of (1) the taxpayer’s business interest income for the year; (2) 30% of the taxpayer’s adjusted taxable income (ATI) for the year; and (3) the taxpayer’s floor plan financing interest expense for the year. The CARES Act increases the ATI limitation from 30% to 50%, but only for tax years that begin in 2019 or 2020. An election contemplated by the legislation would permit a taxpayer to opt-out of the 50% limitation. Another special election permits taxpayers to use their 2019 ATI in lieu of 2020 ATI, with a pro-ration mechanism for short tax years.
Therefore, corporations that would normally have disallowed business interest expense could be able to deduct more business interest expense in 2019 and 2020. Given the possibility of an economic downturn in 2020, several taxpayers could have greater ATI in 2019 than 2020. If that is the case, the election to use 2019 ATI in lieu of 2020 ATI would likely allow more interest expense to be deducted in 2020. As a word of caution, the additional interest expense deducted could give rise to, or increase, an NOL. Therefore, should be taken into consideration now that NOLS can be carried back to offset the taxable income of five prior tax years as previously discussed.
While this legislation is likely to improve the near-term cash flow of many corporate taxpayers and is clearly designed to be taxpayer-favorable, the choice to amend for a refund through an NOL carryback should be carefully considered, for reasons such as the effect on AMT liability in a carryback year (particularly when some or all of an associated AMT credit may have been recovered in subsequent years). Similarly, multinational groups with CFCs should be particularly mindful in considering the panoply of other Code provisions — many of which were enacted with the TCJA — that interact with an NOL deduction and could be affected by wholesale carryback decisions. Taxpayer profiles vary — for some, the modeling exercise and corresponding refund decision will be relatively straightforward, but many corporate taxpayers will benefit from more thorough, nuanced, quantitative decision-making.