On March 27, 2020, the President signed the Coronavirus Aid, Relief, and Economic Security (CARES) Act into law. The Act includes several significant provisions for corporations including increasing the amount of deductible interest under section 163(j), allowing companies to carryback certain NOLs, and increasing the amount of NOL that corporations can use to offset income. For an overview of the provisions of the CARES Act, see RSM’s tax alert on the legislation. These changes may have significant effects on a company’s provision for income taxes, especially where companies have net operating losses or section 163(j) carryforwards and a valuation allowance against some of their deferred tax assets.
The sections below outline the potential implications of each of the changes in tax law. These changes include several retroactive provisions that may change the amount of income taxes payable or receivable or change a company’s assessment regarding the company’s ability to recognize deferred tax assets for financial statement periods ending prior to the effective date of the legislation. Under ASC 740-10-45-15, companies should include the effects of any tax law changes in the financial statement period including March 27, 2020, the date of enactment. Accordingly, the tax law changes outlined below should not be reflected in the income tax provision for periods ending prior to the date of enactment. Instead, for companies that are still in the process of preparing financial statements for such periods, the company should quantify the expected impact of the CARES Act and consider whether the effects are significant enough to warrant a disclosure describing the expected effect of the Act on their financials.
For interim provisions, ASC 740-270-25-5 indicates that the effect of tax law changes on the current payable/receivable should be reflected in the estimated annual effective tax rate no earlier than the period of enactment. Companies should record the effect on the deferred tax attributes as a discrete item in the period of enactment. Additionally, companies should account for the effect of retroactive tax law changes as a discrete item in accordance with ASC 740-270-25-6, in the period of enactment.
Net operating losses
The Act suspends the 80% limitation on the utilization of NOLs generated after Dec. 31, 2017 for taxable periods beginning before Jan. 1, 2021. For periods beginning after Dec. 31, 2020, the 80% limitation would be reinstated. Companies should ensure their current provision for periods that include the effective date reflects the effect of any increased amount of NOL allowed under the Act.
Additionally, the Act allows companies to carryback NOLs generated in taxable years beginning after Dec. 31, 2017, and before Jan. 1, 2021 to the five previous periods. If a company has taxable income in the carryback years, the reclassification between deferred tax assets and income tax receivable/payable would be recognized in the period of enactment. If the company intends to elect out of the carryback or there is no historical taxable income to offset, the company should continue to record any NOLs generated as a deferred tax asset.
The Act also provides clarity on certain NOL rules revised by the Tax Cuts and Jobs Act, including making a technical correction to the rules for certain fiscal year taxpayers and clarifying how the NOL deduction should be calculated in periods where both pre-2018 and post-2017 NOLs are being used. The TCJA resulted in an unusual application of the NOL carryforward and 80% limitation rules for fiscal filers due to a lack of conformity in the effective dates. The CARES Act corrects the statutory language to clarify that the 80% limitation for fiscal filers would apply to years beginning after Dec. 31, 2017. Further, the act clarifies that a net operating loss for a fiscal year ending in 2018 and beginning in 2017 may be carried back.
The CARES Act amends section 172 to define the 80% limitation on NOL utilization in future periods as 80% of the excess of taxable income, computed after the deduction for any NOL carry forward from years beginning prior to Jan.1, 2021. Companies should review these changes to ensure that their provision calculations conform to these rules, as they are retroactive to the effective date of the TCJA.
It should be noted that although NOLs for taxable years beginning after Dec. 31, 2017 and before Jan. 1, 2021 are now eligible to be carried back five years, such NOLs are also available for unlimited carryforward, but for taxable years beginning after Dec. 31, 2020, will be subject to the 80% limitation on NOL carryforwards.
As a result of these changes, companies should review the effects of these changes on the determination of any valuation allowances and the impact on scheduling of reversals of deferred tax assets and liabilities and utilization of tax attributes. Any changes in the valuation allowance as a result of the CARES Act would be reported as a discrete item in the period of enactment.
For more information about the NOL rules under the CARES Act, see the alert: CARES Act delivers five-year NOL carryback to aid corporations.
The Act makes several changes to the interest expense limitations under section 163(j). The Act increases 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. Under the Act, Companies may elect to calculate their 2020 interest expense limitation based on their 2019 ATI. This would be a benefit to companies expecting substantially lower ATI in 2020. Companies should determine whether they expect to make this election and reflect any benefit of the election and the increase in limitation in their current provision. Further, the change in the limitation related to 2019 may have an impact on a company’s 2019 tax position, deferred tax assets, and related valuation allowances.
Alternative minimum taxes and qualified improvement property
The Act accelerates the refund of the alternative minimum tax credits to allow a full refund of any remaining credit amount in taxable years beginning in 2019. The credits were originally fully refundable in taxable years beginning in 2021 under the TCJA. Accordingly, companies should present all remaining AMT credits as a current income tax receivable.
Additionally, the Act makes a technical correction to the qualified improvement property. This change is retroactive to the date of the enactment for the TCJA and allows companies to take favorable depreciation on qualified improvement property, generally resulting in a decrease to current taxes. Companies should assess whether they intend to take advantage of this benefit and if so, reflect the benefit of the additional deductions as a current tax benefit with an offset to deferred tax expense. Because this change is the result of a change in tax laws, a company may reflect the favorable treatment in their tax provision prior to the filing of any required Forms 3115. In accordance with the guidance above, the company should record the benefit related to prior periods as a discrete item in the quarter of enactment.
The temporary suspension of the limitation on NOL utilization, increased interest expensing limitation, and ability to carry back certain losses may change a company’s assessment of the ability to realize deferred tax assets. Companies should carefully consider how these tax law changes would affect the analysis of income generated by the reversal of deferred taxable temporary differences. Any resulting release of valuation allowance should be recorded as a discrete item in the period of enactment.
The CARES Act includes several significant changes for corporate taxpayers that should be reflected in the provision for income taxes in the period of enactment. For companies that anticipate benefits related to prior periods or a change in deferred taxes, these effects should be recorded as a discrete item in the quarter of enactment. Companies that are finalizing financial statements for periods ending prior to the enactment date should not reflect these changes in their income tax provision. To the extent that these provisions would result in a significant change in a Company’s 2019 financial statements, the impact of the changes should be disclosed.