COVID-19 Relief Law - IRS Guidance NOLs (IRC Section 2303; 2304; 2306; & 2307)
The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act” or "Act") provides a number of tax provisions that should each be examined as a ready, if not immediate, source of cash to businesses or their owners, mostly through the filing of amended returns.
Section 2303 – Modifications for Net Operating Losses (“NOLs”)
The 2017 tax reform limited the deductibility of NOLs arising in taxable years beginning after 2017 to a maximum of 80 percent of a taxpayer’s taxable income and eliminated carry-backs. The Act has retroactively (i) repealed the 80 percent limitation for taxable years beginning prior to 2021, and (ii) reversed the limitation on carry-backs and actually expanded them.
Most critically, losses arising in taxable years beginning in 2018, 2019, or 2020 can now be carried back for up to five years, setting up an important potential current source of cash.
Keep in mind that the corporate tax rate prior to 2017 was 35 percent. So, a carry-back of a corporate loss from 2018, 2019, or 2020 to profitable pre-2017 Tax Act years could generate significant cash refunds.
Refunds: the Act, an application for a “tentative refund” (under Section 6411(a)) with respect to the carry-back of an NOL arising in a fiscal taxable year beginning before January 1, 2018, and ending after December 31, 2017, can be made within 120 days after the date of the enactment of the Act. Corporate taxpayers file Form 1139, which the IRS typically processes within 45 days after receipt.
Section 2304 – Modification of Section 461(l) Limitation on Losses for Non-Corporate Taxpayers
The 2017 Tax Act had disallowed the deduction of excess business losses of non-corporate taxpayers, i.e., the amount of business losses in excess of $250,000 ($500,000 for joint filers). The Act retroactively postpones the effective date to taxable years beginning after December 31, 2020.
Therefore, if a taxpayer had lost the benefit of an excess business loss on a filed 2018 or 2019 return, the taxpayer may either amend the return in question and claim a refund or, if the taxpayer wishes, simply use the carried over excess loss as an NOL, no longer subject to the 80 percent limitation.
Section 2306 – Modifications of Limitation on Business Interest
The 2017 Tax Act had amended IRC Section 163(j) to limit the deductibility of business interest (of corporations, partnerships, or individuals) to 30 percent of the business’ adjusted taxable income (ATI).
The CARES Act has retroactively amended Section 163(j) for taxable years beginning in 2019 and 2020 to increase the allowable amount of the interest deduction from 30 percent to 50 percent of ATI.
In addition, in an acknowledgement of the fact that many taxpayers will have an unusually low amount of ATI in 2020, for purposes of the 2020 computation of allowable interest expense, taxpayers may elect to use their 2019 ATI in applying Section 163(j). There are also special rules for partnerships.
Section 2307 – Technical Amendments Regarding Qualified Improvement Property ("QIP")
The 2017 Tax Act contained a major snag in that it had designated QIP in a manner such that it was depreciable over 39 years, and thus not eligible for immediate expensing under bonus depreciation.
The Act makes a technical correction to Section 168, assigning QIP a class life of 20 years, so that it is depreciable as 15-year property under Section 168(e)(3)(E), and most critically makes QIP placed into service after December 31, 2017 and before January 1, 2023 eligible for 100 percent bonus depreciation.
Because these changes are effective retroactively to QIP placed in service after December 31, 2017, taxpayers with such QIP can seek meaningful tax refunds. In fact, such taxpayers affected in 2018 have the option of either filing an amended 2018 tax return to claim 100 percent bonus depreciation for eligible QIP or filing an automatic accounting method change and receiving the corresponding Section 481(a) adjustment.
Evolving IRS Guidance on Refund Claims
The ability of the IRS to respond to refund claims is being affected by the COVID-19 crisis. On April 8, with respect to corporate and individual tax refund claims, the IRS stated that it “is currently exploring available options and expects to issue filing instructions in the coming days.” On April 9, the IRS admitted that it was “not currently able to process individual paper tax returns.” At this point, any taxpayer filing a refund claim should file it electronically. See IR 2020-68. In fact, certain IRS services such as live telephone assistance, processing paper tax returns, and responding to correspondence are extremely limited or suspended until further notice.
On April 8, the IRS issued Revenue Procedure 2020-23, which allows eligible partnerships to file amended partnership returns for taxable years beginning in 2018 and 2019, instead of filing administrative adjustment requests under the centralized partnership audit rules enacted in 2015. This change will better allow partners to obtain advantage of certain CARES Act benefits.
On April 9, the IRS issued guidance to taxpayers seeking to carry back NOLs:
Revenue Procedure 2020-24 provides guidance on how a taxpayer (i) can waive the carry-back period for NOLs arising in taxable years beginning in 2018, 2019, or 2020 or (ii) can make an election to exclude from the carry-back period certain taxable years in which the taxpayer has an IRC Section 956 inclusion.
Notice 2020-26 grants a six-month extension of time to file certain NOL carry-back forms for some NOLs that arose during 2018.
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