The CARES Act relaxes NOL and excess business loss rules, increases business interest deduction limit, and corrects asset life of Qualified Improvement Property.
Net Operating Losses
Prior to 2018 a taxpayer was able to carryback a net operating loss 2 years, apply it to income and amend the return to get a refund. If there was no income in the prior 2 years, a taxpayer could carryforward the net operating loss for 20 years and apply it against future income.
The 2017 Tax Cuts and Jobs Act altered the net operating loss rules by removing the ability to carry the loss back 2 years beginning in 2018. In addition, though the loss can be carried forward indefinitely, the taxpayer can only apply 80% of net operating losses occurring in 2018 in any one year.
The CARES Act has temporarily relaxed the net operating rules for tax years 2018, 2019 and 2020. Net operating losses in those years can be carried back 5 years (when tax rates were greater than the year they’re being carried back from) and a refund can be requested via an amended return.
A net operating loss carried to 2019 or 2020 will be allowed a 100% deduction. The net operating loss rules from the 2017 Tax Cuts and Jobs Act will revert beginning in 2021.
Excess Business Losses
Due to the passing of the 2017 Tax Cuts and Jobs Act taxpayers who had business losses exceeding $250,000 as an individual or $500,000 married filing jointly were not allowed to apply the excess against other income on the return beginning in 2018. The excess amount would be carried forward indefinitely as a net operating loss and applied to future years.
The CARES Act has temporarily relaxed the excess business loss rule for 2018, 2019 and 2020. A return with excess business losses in 2019 can be amended to allow the full amount of loss.
Business Interest Limitation
As part of the 2017 Tax Cuts and Jobs Act the ability to fully expense business interest expense was limited to some taxpayers.
Generally, taxpayers can deduct interest expense paid or accrued in the taxable year. However, if section 163(j) applies, the amount of deductible business interest expense in a taxable year cannot exceed the sum of:
- the taxpayer’s business interest income for the year;
- 30% of the taxpayer’s adjusted taxable income (ATI) for the year; and
- the taxpayer’s floor plan financing interest expense for the year.
For tax years beginning after 2017, the limitation applies to all taxpayers who have business interest expense, other than certain small businesses that meet the gross receipts test in section 448(c). The limitation does not apply to certain excepted trades or businesses.
The CARES Act temporarily increases the limitation to 50% of the taxpayer’s adjusted taxable income for 2019 and 2020. For those businesses who will not have taxable income in 2020 they can use their adjusted taxable income from 2019 to determine the total allowable interest expense deduction on their 2020 tax return.
A partnership follows a slightly different route to calculate the limitation. They will not be able to use the 50% limit of adjusted taxable income for 2019. Any interest disallowed at the partnership level is passed out to the partners and is suspended at the partner level under the normal rules. In 2020, however, 50% of the suspended interest “frees up”, and will be fully deductible, while the other 50% will remain suspended until the partnership allocates excess taxable income or excess interest income to the partner (or the partnership is no longer subject to Section (j).
Qualified Improvement Property
The 2017 Tax Cuts and Jobs Act attempted to simplify the capitalization of nonresidential improvements by creating one category called Qualified Improvement Property. It was intended this category would receive the same asset life as its predecessors, Qualified Leasehold Improvements, Qualified Restaurant Improvements and Qualified Retail Improvements. Unfortunately, the category was assigned a 39- year life and was not corrected prior to the passage of the legislation.
The CARES Act has corrected the asset life assigned to the QIP category and is now able to be depreciated over 15 years. This is important because an asset with a life of 20 years or less is eligible for bonus depreciation. Currently, bonus depreciation is 100%. In addition, the correction was retroactive to September 27, 2017. Taxpayers with significant QIP costs may consider amending their 2018 and 2019 returns to accelerate the QIP costs by taking bonus depreciation.
QIP costs include improvements made to an interior portion of a nonresidential building any time after the building is placed in service. It does not include an enlargement, elevator or escalator, or internal structural part of the building. Costs should be able to be identified separate on an invoice that may include other costs subject to a 39-year life.