There is no greater joy for a tax professional than delivering unexpected good news. Unfortunately, good news has been in short supply for all of us living through the COVID-19 pandemic, and it can be argued that business owners have been hit as hard as any other group. Luckily for those of us who advise business clients, the Coronavirus Aid, Relief, and Economic Security (CARES) Act gives us a chance to deliver a bit of positivity – and we don’t even have to moonlight as loan advisors or employment lawyers!
The tax provisions in the CARES Act haven’t gotten as much attention as stimulus checks, forgivable loans and payroll support, but by retroactively relaxing limitations of operating losses, interest expenses, asset depreciation, AMT credits and individual losses, Congress has afforded us the ability to go hunting for free money on our clients’ behalf. In no certain order, here are five highlights of the new law and how they might be used to benefit business owners.
#1: Net operating losses
With the passage of the Tax Cuts and Jobs Act (TCJA), taxpayers lost the ability to fully zero out their taxable income when carrying a loss from one tax year to another, having to instead limit the use of net operating losses to 80% of current year taxable income. In addition, losses could no longer be carried back to prior years, with some exceptions, including farm losses. Now, thanks to the CARES Act, losses incurred in 2018, 2019 and 2020 can be carried back up to five years, and loss carrybacks and carryovers can offset 100% of taxable income until 2021.
Any client that ran into the 80% income limit in 2018 or 2019 (assuming they already filed for 2019) may be due for a bit of their money back. Similarly, a client with losses in 2018 or 2019, but with taxable income in any of the five years previous to the loss year, can immediately seek a refund of tax paid on the portion of prior income that can now be offset. A client will probably be appreciative of a tax pro who tells them they are getting some of their 2013 tax back because of unused 2018 losses.
#2: Interest expense limitation
For some large businesses that had an annual gross of $26 million or more in 2019, with some exceptions, the TCJA limited the amount of interest that could be deducted to 30% of adjusted taxable income. While this was not a concern for most taxpayers, those affected were impacted drastically. Many had to change their capital structure and financing transactions, resulting in material impacts on their profitability. The CARES Act loosens these restrictions by increasing the limitation to 50% in 2019 and 2020, and by allowing taxpayers to calculate their 2020 interest limitation using their likely higher 2019 income.
#3: Qualified improvement property
Tax professionals should be familiar with the retail glitch in the TCJA in which Qualified Improvement Property (QIP) was intended to be given a 15-year useful life and accompanying qualification for 100% bonus depreciation and Sec. 179 expensing. Due to some poor wording, tenant improvements to commercial spaces were instead treated as only depreciable over 39 years. This mismatch between wording and intent comprised the glitch, which has now been fixed through the CARES Act.
Many businesses that lease their facilities likely have QIP placed into service in 2018 and 2019, and will be relieved to know that they may be entitled to a bit of their money back thanks to a change in the tax treatment of some of their property.
Note that many of us have long assumed that the retail glitch would be fixed at some point, and some of us rolled the dice beginning in 2018 by calculating QIP depreciation as though the glitch had already been fixed. If that’s the case, your clients may rest a bit easier not having to worry about their aggressive accounting catching up with them, but there won’t be any found money to report.
The IRS issued Rev. Proc. 2020-25 on April 17, 2020, providing requirements for amending returns for taxpayers who placed QIP into service in the taxpayers’ 2018, 2019, or 2020 taxable year. The IRS now permits certain taxpayers to file an amended return, administrative adjustment under Sec. 6227 (administrative adjustment request, or AAR), or Form 3115, Application for Change in Accounting Method, to change their depreciation of qualified improvement property. Because of the administrative burden of filing amended returns and AARs, the IRS now allows a late election under Sec. 168(g)(7), (k)(5), (k)(7), or (k)(10), or the revocation of the revocable election under Sec. 168(k)(5), (k)(7), or (k)(10), for property placed in service by taxpayers during their 2018, 2019, or 2020 taxable years, as a change in method of accounting for a limited period of time. Taxpayers now have until Oct. 15, 2021, to file an amended return, an AAR, or Form 3115.
#4: Corporate alternative minimum tax
One of the most welcome changes of the TCJA was the elimination of the corporate alternative minimum tax (AMT). While nobody mourned the loss, clients with AMT credits from prior years may have been disappointed that they were limited in the amount of credit they could use in 2018 through 2020, and that they wouldn’t be fully refunded until 2021.
With the CARES Act, corporate taxpayers can elect to receive a full refund of accumulated AMT credits in either 2018 or 2019. As a result, any corporate clients who are still running up against AMT credit limitations would do well to amend or request a refund of any outstanding credit amount. This may not be found money, but your client certainly wouldn’t mind finding out about future money they have right now.
#5: Individual loss limitation
Since the passage of the TCJA, some business owners with other sources of income may have been surprised to find that they were limited in the amount of business loss they could use to offset their non-business income. The TCJA put a $250,000 ($500,000 for married taxpayers filing jointly) limitation on the amount of business loss that could be used to offset income.
Under the CARES Act, the individual loss limitation is suspended for 2018, 2019 and 2020. If you have a client who was impacted by the limitation, they may be thrilled to find out that they can expect to receive a check from the IRS once their trusty tax advisor files the necessary paperwork.
What to do next
After combing through prior-year returns and identifying opportunities to get some cash back, a tax professional will need to determine the fastest and easiest way to get the client paid. While filing amended returns is always a possibility, it may be faster in the case of a refund resulting from a net operating loss carryback or 2018 AMT credit to request a tentative refund by filing Form 1139, Corporation Application for Tentative Refund, or Form 1045, Application for Tentative Refund, for individuals or pass-through owners. Forms 1139 and 1045 are normally limited in that they can only be filed within 12 months of the end of the tax year from which a net operating loss is being carried back, but under the CARES Act, the IRS has allowed an an additional six months for applications if only relating to the carryback of a net operating loss that arose in any taxable year that began during calendar year 2018 and that ended on or before June 30, 2019. The IRS is also temporarily allowing digital transmission. When these forms do apply, they often result in receipt of a refund faster than would be expected for an amended return. On the other hand, amended returns will be required when reaching back further than one year. They may not work as fast as a tentative refund request, but I’ve never known a client to complain about waiting for unexpected cash from the IRS.
Editor’s note: This article was originally published on April 16, 2020, and was later updated to reflect changes due to Rev. Proc. 2020-25.