The Coronavirus Aid, Relief and Economic Security Act (CARES Act) provides opportunities to U.S. businesses to increase cash flow and liquidity. Among many other items, the Act provides relief provisions allowing for a five-year net operating loss (NOL) carryback. Businesses incurring a tax loss in 2018, 2019 or 2020 are eligible to carry back these losses for up to five years, to otherwise closed tax years.
In our article, CARES Act and state tax NOLs: What business needs to know, we discussed a number of important considerations and ramifications of the federal five-year carryback for state tax purposes. State conformity was one of the primary concerns because most states do not allow for NOL carrybacks. Additionally, to the extent that states that do provide conformity to the federal NOL provisions re-evaluate looming budget deficient and shortfalls, some states may choose to decouple from the NOL carryback provisions as a way to increase (or not further reduce) state revenues. Our article also discussed additional filing requirements, statutes of limitations considerations and refund opportunities and assessment risks.
In addition to those items, taxpayers utilizing the five-year carryback should also be cognizant of the following impacts on state and local income taxes:
Domestic Productions Activities (Section 199) Deduction
Effective for tax years beginning before Jan. 1, 2018, a deduction was allowed for the lesser of 9% of Qualified Production Activities Income (QPAI), 9% of Taxable Income before the Domestic Productions Activities Deduction is taken into account, or 50% of wages allocable to qualified production activity. Taxpayers applying the NOL carryback for federal purposes, as provided by the CARES Act, may determine the deduction allowed on the originally filed return is either reduced or completely eliminated. The reduction in the expense may impact the state returns, specifically in the states that had historically conformed to the deduction. In states that historically conformed to the deduction, any change in the original expense could potentially increase the starting point of federal taxable income in states that start with line 28, federal taxable income before NOLs and deductions. As a result, the state liability may increase.
Section 951A and corresponding section 250 deduction
Effective for tax years beginning on or after Dec. 31, 2017, a corporation’s deductions under section 250, meant to reduce the effective tax rates on global intangible low-taxed income (GILTI) and foreign-derived intangible income (FDII), are limited to the extent of taxable income after the deduction for NOLs. The CARES Act did not amend or make any changes to the limitation of the deduction. It is possible that when taxpayers calculate their NOL carryback, the amounts of GILTI and FDII deductions could also be reduced or eliminated. Federally, this doesn’t have much of an impact because while the expense would be limited, taxpayers may be able to offset the reduction in the deduction with additional NOLs. If taxpayers file in states that: 1) tax GILTI and allow the section 250 deduction, and 2) do not allow for a 100% dividends received deduction, then the state tax liability may increase as a result of the federal NOL carryback.
The RSM state and local tax group can assist companies in assessing the potential state tax benefits and risks of pursuing a federal NOL carryback claim. Companies should understand the state filing impacts, the effect on conformity to various expenses and the refund opportunities and assessment risks. Importantly, one risk is that the filing of Form 1120X could extend, open, and reopen closed, state statutes of limitations. There is also uncertainty regarding whether the filing of Form 1139 would have the same impact on state statutes of limitations. Most importantly, companies should consult with their state tax advisors before filing the federal NOL claim. It remains to be seen whether states will issue guidance for taxpayers to address the state income tax issues addressed in this article.
Other state considerations for the COVID-19 pandemic can be found in RSM’s State tax planning in response to economic distress. For more information on the coronavirus, please see RSM’s Coronavirus Resource Center which includes related and frequently updated developments and a link to sign up for RSM’s weekly Coronavirus webcast series.