Specific Tax Provisions to Leverage for Optimized Results
The March 27th, 2020 signing of the Coronavirus Aid, Relief, and Economic Support (CARES) Act created immediate economic support in the form of loans, subsidies, and much-needed tax relief, including several important tax provisions. The CARES Act increases interest expense limitations and changes Net Operating Losses (NOLs) as well as re-defining the Qualified Improvement Property (QIP) provision to allow for a 15-year life and bonus depreciation. Leveraged correctly, they can yield significant benefits for your organization.
Increase to Interest Expense Limitation Increases
The CARES Act makes a significant change to interest expense limits, increasing them from 30% to 50% for tax years beginning with 2019 for taxpayers subject to these limitations. The calculation is based on the Adjusted Taxable Income (ATI) – virtually, the tax version of Earnings before Interest, Taxes, Depreciation, and Amortization (EBITDA). Taxpayers may also elect for the 2020 tax year to use their 2019 ATI rather than 2020 if the 2019 ATI is higher.
It’s Different for Partnerships
Partnerships are treated differently under this provision. Instead of reaping benefits for the 2019 tax year, partners will receive a partial benefit in 2020 for the 2019 Excess Business Interest (EBI) – usually the amount of interest expense that exceeds the 30% limitation. In a partnership, the EBI passes out to each partner for each tax year.
The partner’s share of EBI becomes a carryover for the partner until that particular partnership passes out Excess Taxable Income (ETI), which is the amount that the ATI was above what was needed to deduct the interest for that year. The change the CARES Act makes to this provision is to provide a 2020 deduction of 50% of the 2019 EBI that passed out to them in 2019, while the remaining 50% continues to be a carryover until the partnership has ETI.
Additional Interest Expense Limitation Guidance
The Tax Cut and Jobs Act (TCJA) allows the option of electing to be a Real Property Trade or Business (RPTB) for businesses that qualify (e.g., real estate and construction). However, in exchange for not being subject to the interest limitations, the IRS requires RPTBs electing this option to slow depreciation through the use of the Alternative Depreciation System (ADS) method for real property such as buildings and QIPs.
The IRS also issued guidance that allows taxpayers to either revoke or to make a late election for 2018 or 2019 for treatment as an RPTB – a fantastic benefit for many. To leverage this guidance, you may have to file an amended return for the relevant tax year (2018 or 2019).
QIP Technical Correction
Now let’s take a look at the QIP technical correction. First, QIP includes any improvement to an interior portion of a building that is nonresidential real property as long as that improvement is placed in service after the building was first placed in service by any taxpayer (Section 168(k)(3)). There are some expressly excluded expenditures you must be aware of, including the enlargement of a building, elevators or escalators, or changes to the internal structural framework of a building.
Under the CARES Act, QIP is eligible for a 15-year life (20-year ADS) and is therefore suitable for bonus depreciation for entities that are not RPTBs. Since the rule is a technical correction of the TCJA, there are two options for taxpayers to take advantage of the additional expense for the 2018 year. Also, in this case, taxpayers may choose to file an amended 2018 return – or to push the 2018 adjustment through the 2019 tax return.
Net Operating Loss (NOL) Relief
NOL carrybacks were eliminated under the TCJA, as is putting an 80% limitation on the deductibility of the NOL. The CARES Act changes that: not only will individuals and businesses NOT be subject to the 80% TCJA limitation on the amount of loss that they can deduct, but they will also be able to carry the loss back up to five years – a considerable change. So, if any of these new provisions generate an NOL, you may be able to carry that back to a year where you may have been subject to a higher tax rate – one of the most important and impactful changes under the CARES Act, with great benefit for many.
Navigating the New Normal
Navigating the complexities of the CARES Act to ensure your organization is getting the maximum benefit may require professional expertise, and we’re here to help. If you have any questions about these provisions and their impact, please contact our Barnes Dennig COVID-19 Advisory Team.
Barnes Dennig COVID-19 Advisory Team Leaders: