Liquidity remains a crucial issue for many middle market businesses. Yes, the real economy followed April’s plummet with some indications that a slow, elongated recovery is underway. But given the unpredictability of the public health and economic crises as states reopen, many businesses are prioritizing liquidity to minimize uncertainty, maintain operations and strengthen their positions as the recovery unfolds.
In addition to federal relief loan programs such as the Paycheck Protection Program and Main Street Lending Program, businesses can increase liquidity through federal, state and local tax pathways that were established either by coronavirus relief legislation or before the pandemic.
“These tax mechanisms can significantly improve cash flow and liquidity,” said Gretchen Valentine, RSM Enterprise Account Leader & Tax Partner. “Strategizing with a trusted advisor about how to maximize these benefits can help companies survive and thrive through the pandemic response and into the economic recovery.”
Here is a general overview of those tax pathways, supported by links to more technical details.
Maximize tax refunds with net operating loss carrybacks
Coronavirus relief legislation reintroduced net operating loss (NOL) carrybacks. By carrying back a NOL from one year to a previous profitable year, a corporation offsets taxable income for that prior year, reducing its tax liability and resulting in a tax refund. The legislation allows a corporation to carry back losses in tax years 2018, 2019 and 2020; such NOLs can be carried back up to five years. Because the federal corporate tax rate was 35% prior to 2018, when it dropped to 21%, lowering taxable income in years prior to 2018 results in a greater benefit than doing so in 2018 or after.
Consult an advisor about how NOL carrybacks could most benefit your business. “If you have a loss in 2018, 2019 or 2020, and you have income in a previous year to carry back to—taxes to go back and reduce—what can you do to make that loss as big as possible?” Valentine said. “Tax planning may enable the timing and/or size of a loss – what year provides the most benefit?”
Read more details about NOL carrybacks involving federal income tax and those involving state income tax.
Bonus depreciation of qualified improvement property
Relief legislation fixed the so-called retail glitch, a drafting error in the 2017 Tax Cuts and Jobs Act (TCJA). That oversight regarding qualified improvement property (QIP) created a disincentive for specific business investments, such as a restaurant reinvesting in capital improvements.
The recent correction, however, allows QIP to be depreciated over 15 years instead of 39, and it allows taxpayers to apply 100% bonus depreciation to QIP. Companies that made significant capital expenditures before the pandemic have an opportunity to enhance depreciation deductions for QIP in 2018 and 2019.
“If you had qualified improvement property, after TCJA you had to capitalize it as 39-year property,” Valentine said. “Now, it’s important you go back and identify QIP, carve it out, and either depreciate it over 15 years, or, apply the bonus depreciation provisions and pick it up as a deduction for 2018 or 2019.”
Read more about QIP here and here.
Increase deductions with the modified business interest limitation
When a company borrows to help pay for business operations, the interest paid on the loan is considered business interest expense. Relief legislation increased the limit on the amount of deductible business interest expense from 30% of adjusted taxable income (ATI) to 50% of ATI, for taxable years beginning in 2019 or 2020. This applies to federal taxes.
Read more about the eased limitation of deductible business interest expense.
Employment tax incentives
Two employment tax incentives stand out for how broadly they might apply to businesses: employee retention credits and deferral of payroll taxes.
Employee retention credits, which were established by relief legislation, are a credit for distressed businesses that keep employees on their payroll. It’s a refundable payroll tax credit of up to $5,000 per employee for the year. The credit is available to employers whose business either fully or partially suspends operations during 2020 due to government orders related to COVID-19, or experiences a significant decline in gross receipts. Note that federal law prohibits a business from borrowing a Paycheck Protection Program loan and taking an employee retention credit.
Relief legislation also allows all employers to defer for up to two years the deposit and payment of their share of the social security tax on employee wages. “You can’t defer what you withheld from your employees’ paycheck, but you can defer the employer portion,” Valentine said. “It’s essentially an interest-free loan for two years.”
Read more details about employee retention credits and deferral of payroll taxes.
Payroll deductions, partial furloughs, salary deferrals or noncash compensation alternatives
These common methods of improving cash flow and liquidity have proven to be effective. Although they aren’t tax pathways, there are tax considerations for salary deferrals and noncash compensation. When a company cuts compensation or defers regular bonus compensation, for example, proper structuring is essential to avoid strict provisions of deferred compensation rules. An advisor can help ensure you are not violating section 409A deferred compensation rules.
Here are more details about section 409A.
Assess tax incentives by key jurisdictions
The above incentives are federal items. Companies with significant operations in multiple states, international jurisdictions or both could benefit from COVID-19 and other incentives enacted by states and foreign jurisdictions. Many jurisdictions have allowed deferral on deposits of sales tax or VAT (value added tax). In some countries the VAT rates have been reduced. There may be opportunities to save on tariffs by evaluating the duty codes for significant categories of goods purchased. International companies impacted by COVID-19 may benefit from a review of the intercompany transfer pricing policies–to minimize losses in some countries and profits in others. A tax advisor can assist in reviewing key jurisdictions for opportunities or identifying unique industry related incentives.
Overall, these tax mechanisms should appeal to businesses seeking to increase liquidity as a way to strengthen their position during the pandemic response and economic recovery. A trusted tax advisor can help you take advantage of the relief legislation by identifying these opportunities and other tax mechanisms and establishing a plan to capture the maximum benefit.
