Modifications for Net Operating Losses

The net operating loss (NOL) rules applicable to individuals and C Corporations recently changed and will now change again. To avoid confusion, let’s review:

Prior to 2018, NOLs could be carried back two years and carried forward 20 years, and there was no limit to the amount of income to which such losses could be applied.

When the Tax Cuts and Jobs Act (TCJA) was passed late in 2017, one of the revenue raising provisions was a change in the NOL rules. Such losses could no longer be carried back to years prior to 2018, they could now be carried forward indefinitely, and they were limited to 80% of taxable income in any given year.

Under the CARES Act, NOLs from 2018, 2019, and 2020 can now be carried back for up to five years. The election to forgo the carryback and carry losses forward instead has returned, and any losses carried to 2019 and 2020 may offset 100% of taxable income, rather than the 80% limit imposed by the TCJA.

We want to emphasize that this new provision allows taxpayers to take losses back to tax years when the tax brackets were higher. Given the right scenario, this could be an excellent tax saving opportunity. This new provision may provide opportunities to file amended returns and obtain refunds for taxes paid in prior years. Reach out to KHA to assess your specific tax situation if you think this might apply to you.

Modification of Limitation on Losses for Taxpayers other than Corporations

Ordinarily, taxpayers face several limitations on whether they are allowed to deduct losses from certain activities. These factors include a taxpayer’s basis in an investment, whether the taxpayer is at risk if an investment does not succeed, and whether the taxpayer is active or passive in the activity.

A second revenue raising provision of the Tax Cuts and Jobs Act (TCJA) of 2017 was a fourth limitation on using certain losses. A new subsection of the Internal Revenue Code, Section 461(l), limited an individual’s net business loss (which could be used to offset other income) in any given year to $250,000 (if single) or $500,000 (if married filing jointly). Any excess loss is now converted into a net operating loss (NOL) in the following year. See prior section for changes to the NOL rules.

The CARES Act temporarily suspends Section 461(l) for 2020 and retroactively to 2018. This may provide opportunities to file amended returns and obtain refunds if Section 461(l) limited deductions in 2018 and 2019.  Reach out to KHA to see if this change in the tax law applies to you.

Modifications of Limitation on Business Interest

A third revenue raising provision of the Tax Cuts and Jobs Act (TCJA) of 2017 was a new limitation on the deductibility of business interest expense. In very simple terms, the limited amount was 30% of “adjusted taxable income,” which in the TCJA’s initial years was an amount similar to EBITDA (earnings before interest, taxes, depreciation, and amortization). For tax years beginning after December 31, 2021, adjusted taxable income will approximate 30% of EBIT and will not be adjusted for depreciation and amortization.

The CARES Act expands the limitation for 2019 and 2020, from 30% of adjusted taxable income to 50% of adjusted taxable income. Since many businesses could experience losses and have no taxable income for 2020, the Act also allows businesses to use their 2019 adjusted taxable income when computing their 2020 limitations. Therefore, this provision will allow businesses to take on more debt during the crisis without being penalized as heavily by the tax code.

Any excess business interest expense is carried forward, at the business level for S corporations, and at the partner level for partnerships. Under the CARES Act, partnerships cannot use the 50% limit for 2019, but in 2020, 50% of any interest suspended at the partner level will be fully deductible, and 50% of the remaining amount will be suspended until the partner has accumulated enough excess taxable income or excess interest income to take the suspended deduction.

Technical Amendments Regarding Qualified Improvement Property

In the tax professional community this was a much-anticipated technical correction.  Sadly it took a pandemic to get the fix we have been awaiting since 2017.

Qualified Improvement Property (QIP) came into being in 2016 as a result of the PATH Act, passed late in 2015. QIP is “any improvement to an interior portion of a building which is nonresidential real property if such improvement is placed in service after the date such building was placed in service.” It does not include expenditures for the enlargement of a building, elevators or escalators, or the internal structural framework of a building. Unlike asset classes that preceded QIP, like qualified leasehold improvements, qualified restaurant property, and qualified retail improvement property, QIP does not need to be subject to a lease between unrelated parties, and there is no longer a three year waiting period for a property to be considered QIP.

When the Tax Cuts and Jobs Act (TCJA) was passed late in 2017, it was clear from the record that Congress intended to allow greatly accelerated depreciation on qualified improvement property (QIP). However, Congress infamously failed to give QIP a 15-year life instead of a 39-year life, which excluded QIP from those types of property that are eligible for bonus depreciation, which is 100% depreciable from September 27, 2017 through December 31, 2022. This oversight became known as “the retail glitch,” and Congressional Republicans sought to make a “technical correction” as part of various larger bills over the past couple of years, but were unable to negotiate enough support to repair the glitch.

The CARES Act includes the needed technical correction. QIP now has a 15-year life and is eligible for bonus depreciation. The change has been made retroactive to January 1, 2018.  This will provide opportunities for certain taxpayers to amend previously filed tax returns and obtain refunds.  Reach out to KHA if you think this might apply to you.

As your trusted advisors, we are committed to keeping you well-informed with any new legislation passed by Congress as well as any new pronouncements by the Department of Treasury that may affect you. Please do not hesitate to reach out to KHA with any additional questions you may have.  

These sources are simply included for informational purposes. KHA Accountants, PLLC, its partners and others do not provide any assurance as to the accuracy of these items or the information included therein. As such, KHA Accountants, PLLC cannot be held liable for any information derived from referenced sources. This is intended for illustrative and discussion purposes only.