On March 27, 2020, Congress adopted, and President Trump signed into law, the Coronavirus Aid, Relief, and Economic Security Act (the Act). While the Act includes economic relief through a variety of means, this alert focuses on the significant business tax provisions contained therein.
- Temporary relaxation of rules limiting the business interest expense deduction. Prior to adoption of the Act, the U.S. Internal Revenue Code (Code) limited a taxpayer’s deduction for business interest expense to its annual business interest income plus 30 percent of the taxpayer’s “adjusted taxable income” (ATI) for such year. The Act provides for a temporary relaxation of these rules by increasing the 30 percent threshold to 50 percent for taxable years 2019 and 2020. By including taxable year 2019, the Act reduces the amount of tax that taxpayers have to remit in 2020. In addition, the Act permits a taxpayer to elect to use its 2019 ATI rather than its 2020 ATI in calculating the limitation amount for 2020, potentially increasing the deductible amount for taxpayers that see a business contraction of ATI in 2020 due to the COVID-19 pandemic. The Act also allows taxpayers to elect out of these reduced limitation rules and provides special rules applicable to partnerships.
- Temporary relaxation of rules limiting net operating loss deductions. Prior to adoption of the Act, the deduction for net operating losses (NOLs) was generally limited to 80 percent of a taxpayer’s taxable income (computed without regard to NOLs), and taxpayers could not carry back NOLs to claim a refund for taxes paid in prior years. The Act generally (a) eliminates the 80 percent taxable income limitation for NOLs utilized in taxable years beginning in 2018, 2019, or 2020 and (b) provides a five-year carryback for NOLs arising in such years (unless waived by the taxpayer). Special rules apply to REITs and life insurance companies and to the interaction between NOL carrybacks and taxpayer liabilities under section 965 of the Code (relating to the 2017 transition tax on untaxed earnings of certain foreign corporations). For taxable years after 2020, the 80 percent taxable income limitation is reinstated with modifications that increase taxable income by the amount of any deductions under Code section 199A (relating to the 20 percent qualified business income deduction for non-corporate taxpayers) and Code section 250 (relating to the deduction with respect to foreign-derived intangible income and global intangible low-taxed income for domestic corporate taxpayers). The combined effect of these two temporary changes is that NOLs incurred in these years could fully offset current and prior year taxable income. Taxpayers with NOL carrybacks as a result of these new rules will be able to immediately file amended returns and seek a refund of taxes paid. In addition, the Act makes a retroactive technical correction to the Tax Cuts and Jobs Act of 2017 (TCJA) to allow NOLs arising in taxable years beginning in 2017 and ending in 2018 to be carried back two years.
- Observation – Most acquisition agreements include provisions relating to tax refund entitlements, often requiring the buyer to obtain and pay to the seller tax refunds for pre-closing tax periods (including as a result of a carryback of NOLs). Buyers and sellers should carefully review transaction agreements for acquisitions made during 2018 through 2020 to assess how this change in law may affect their rights and obligations with respect to tax refunds.
- Observation – Taxpayers looking to take advantage of the five-year carryback provision should consider accelerating deductible payments into 2020 (rather than deducting such payments in future taxable years) to create or increase 2020 NOLs that can be carried back to prior taxable years without limitation.