Over the past two weeks, we tax people have had to wade into some uncomfortable waters, focusing our collective attention away from the Internal Revenue Code of 1986 and towards strange and intimidating bodies of law like the Small Business Act of 1953 and the Family and Medical Leave Act of 1993.
The crash course, of course, was completely necessary. We had to get our arms around the finer points of the new Paycheck Protection Program to help our clients stay afloat, and the new family and sick leave rules to keep our clients’ employees healthy and happy.
WASHINGTON, DC - MARCH 17 : President Donald J. Trump listens as Treasury Secretary Steven Mnuchin . [+] announced that the IRS would defer $300 billion worth of tax payments for Americans and businesses, with the coronavirus task force by his side, in response to the COVID-19 coronavirus pandemic during a briefing in the James S. Brady Press Briefing Room at the White House on Tuesday, March 17, 2020 in Washington, DC. (Photo by Jabin Botsford/The Washington Post via Getty Images)
The Washington Post via Getty Images
But if all the talk of PPPs, SBAs and EIDLs has left you longing for the tax law, be prepared to become very, very happy. In the past week, while you’ve been buried playing role of de facto loan officer, the IRS has issued a bevy of guidance governing how to implement the tax aspects of the CARES Act. From Section 163(j) to partnership amended returns to net operating loss carrybacks, new procedural guidance allows us to roll up our sleeves and start harvesting refunds for our clients. Let’s take a look at what we’ve learned in the past week:
Revenue Procedure 2020-22: Do-over of elections out of the interest expense limitation rules
The Facts:
As part of the Tax Cuts and Jobs Act (TCJA), Congress amended Section 163(j). The effect of the amendment was to limit the deduction for business interest expense to the sum of:
· Business interest income,
MORE FOR YOU· Floor-plan financing interest expense of an auto dealer, and
· 30% of a new term of art, “adjusted taxable income (ATI).”
There are a number of ways a business can avoid implication of the interest limitation rules; most notably, the rules don’t apply if a taxpayer has average gross receipts over the previous three years of less than $25 million (it’s now up to $26 million). This exception does not apply, however, if the business is a “tax shelter,” a nebulous term that the previous half century has done little to define.
There was also another way out, however. Under Section 163)(j)(7), a taxpayer with more than $25 million in average receipts or that met the definition of a tax shelter could make an irrevocable election out of Section 163(j) if the taxpayer was engaged in a “real property trade or business” under the meaning of Section 469(c)(7).
As with all things in the tax law, there was a cost to making the favorable election. In exchange for avoiding Section 163(j), the taxpayer was forced to depreciate its nonresidential rental property, residential rental property, and “qualified improvement property (QIP)” using the slower, straight-line alternative depreciation system (ADS). While ADS depreciation has little impact on the depreciation of the first two classes of property, it threatened to greatly slow down the recovery of the cost of QIP.
QIP – which is defined as any improvement made to the interior portion of a nonresidential building after the building has been placed into service – was supposed to find its 39-year life shortened to 15-years as part of the TCJA. This would then pull QIP into the realm of Section 168(k), which as amended by the TCJA, would allow for 100% bonus depreciation on all assets with a life of 20 years or less. Thus, any business electing out of Section 163(j) would have been required to depreciate QIP over the 20-year ADS life, while those businesses that did not elect out would be entitled to an immediate deduction for the full cost of any QIP.
Alas, the drafters of the TCJA failed to appropriately modify the Code so as to provide the desired 15-year life to QIP; as a result, the life stayed at 39 years (the ADS life stayed at 40), rendering QIP ineligible for bonus depreciation. As part of the recently enacted Coronavirus Aid, Relief and Economic Securities Act, however, Congress fixed the QIP problem, providing the asset class its intended 15-year life retroactive to 2018. In addition, for 2019 and 2020, all businesses other than partnerships are permitted to replace the “30% of ATI” limit with an increased 50% of ATI limit.
The Problem:
Put it all together, and in 2018 and 2019, many taxpayers engaged in real estate trades or businesses were faced with a decision: Do we subject our interest expense to limit of 30% of ATI – either because we had gross receipts over $25 million or met the definition of a tax shelter – or do we “elect out,” knowing that the only real cost of the election is to lose bonus depreciation on QIP, which isn’t really a loss since NO ONE can take bonus depreciation on QIP at the moment courtesy of the TCJA drafting error?
As a result, many businesses gambled and made the irrevocable election out of Section 163(j), trusting that it could be years before Congress fixed the QIP error. They were wrong. Now, not only is QIP fixed – and fixed retroactive to 2018 – but for the next two years, the ATI limit for interest deductibility is 50% for non-partnerships, making it more likely that those businesses that elected out of Section 163(j) would not have been subject to its limitations.
So what it is one of these businesses to do now?
The Fix:
Revenue Procedure 2020-22 gives businesses that elected out of Section 163(j) as a real property trade or business in 2018 or 2018 a “do over,” a rarity for any election deemed irrevocable by the IRS. Any taxpayer that wishes to withdraw a previously made election must file an amended return before October 15, 2021.
As we’ll discuss later, a partnership subject to the new centralized audit regime that is getting a one-time pass to amend 2018 or 2019 tax returns will be required to amend prior to September 30, 2020. A partnership that chooses not to file an amended return (we’ll get to this soon), may instead file an Administrative Adjustment Request (AAR) before October 15, 2021.
The amended federal income tax return, amended Form 1065, or AAR, as applicable, must include any adjustments to taxable income resulting from the withdrawn election, including changes to the deductible amount of interest expense and any additional depreciation expense attributable to QIP. Obviously, if a taxpayer files an amended return to withdraw an election for 2018, an amended return – reflecting any changes to taxable income resulting from the withdrawn election – must be filed for 2019 as well.
The election withdrawal statement should be titled, “Revenue Procedure 2020-22 Section 163(j)(7) Election Withdrawal.” The election withdrawal statement must contain the taxpayer’s name, address and SSN or EIN, and must state that, pursuant to Revenue Procedure 2020-22, the taxpayer is withdrawing its election under Section 163(j)(7).
Remaining Unanswered Questions:
What if a taxpayer elected out of bonus deprecation for the 15-year class of assets on a 2018 or 2019 return? Will a second relief procedure be provided to allow taxpayers to undo the previous election out of bonus depreciation now that QIP is bonus eligible?
Revenue Procedure 2020-23: BBA partnerships get a unique opportunity to file amended returns
The Facts:
Prior to 2018, audits of partnership returns were done pursuant to the Tax Equity and Fiscal Responsibility Act (TEFRA). Beginning January 1, 2018, however, TEFRA was replaced with a new centralized audit regime as part of the Bipartisan Budget Act (BBA).
The biggest change from TEFRA to the BBA is that for those partnerships subject to the new regime, audits are done – and tax is collected – at the partnership level rather than the partner level. Certain partnerships – namely, those with fewer than 100 partners that are all individuals, corporations, or estates – can elect out of the BBA regime.
For those who can’t elect out, however, the impact is felt in more ways than just a partnership-level assessment of tax upon audit. As part of the BBA, a partnership is generally not permitted to file an amended return; rather, if a partnership needs to change its income for a previous year, it must file an Administrative Adjustment Request (AAR) to report corrections to a prior year return.
The Problem:
The CARES Act made several changes that would cause a partnership to wish to amend a previously filed 2018 or 2019 tax returns. For example, as discussed above, a partnership that may have elected out of Section 163(j) may now want to undo that election. Or perhaps the partnership did not elect out, and would now like to amend the previous returns to claim bonus depreciation on QIP courtesy of the retroactive fix. If the partnership cannot elect out of the BBA regime, it is generally barred from amending; thus, for example, a partnership wishing to claim QIP depreciation for 2018 would have to file an AAR with its 2020 tax return, meaning any refund generated at the partner level would not be received until 2021.
The Fix:
The CARES Act was designed to get cash into the hands of struggling individuals and businesses NOW, and so forcing a partnership to wait until 2021 to file an AAR and receive a refund for its partners is not acceptable to the IRS. As a result, Revenue Procedure 2020-23 allows BBA partnerships the option to file an amended return for 2018 and 2019 rather than an AAR when filing their 2020 tax return. The ability to file an amended return for those years does not appear to be limited to claiming the benefits of the CARES Act; rather, a partnership can file 2018 or 2019 returns to make any adjustments that would ordinarily be reflected on an amended return.
The amended returns must be filed before September 30, 2020. As you will note, when we discussed Rev. Proc. 2020-22 above, the IRS stated that amended returns could be filed for 2018 or 2019 to withdraw a Section 163(j)(7) election until October 15, 2021. This date does NOT apply to BBA partnerships; those partnerships must file prior to September 30, 2020.
A BBA partnership must file a Form 1065 (with the “Amended Return” box checked) and furnish corresponding amended Schedules K-1 before the September 30, 2020, due date. The top of the return should indicate, “FILED PURSUANT TO REV PROC 2020-23,” and each K-1 should include a statement with the same notation.
Alternatively, a partnership that wishes to amend a 2018 or 2019 return may opt instead to do so with an AAR filed as part of its 2020 tax return. Any AAR that aims to withdraw a prior Section 163(j)(7) election for 2018 or 2019 must be filed prior to October 15, 2021.
Of course, a BBA partnership that files an amended return for 2018 or 2019 is still subject to the centralized audit regime.
Remaining Unanswered Questions:
Ha. In order to identify the remaining unanswered questions surrounding the BBA program, I’d have to first understand what is known about the BBA. Which I don’t. Moving on.
Revenue Procedure 2020-24
The Facts:
As part of the TCJA, significant changes were made to the treatment of net operating losses (NOLs). Prior to 2018, NOLs could be carried back two years and forward 20, and when carried forward, could offset 100% of taxable income. To carry a loss back, you had two choices: if you wanted your cash FAST, you would file a Form 1139 (for corporation) or Form 1045 (for all other businesses), and typically receive a refund within 90 days. The catch, however, was that the forms needed to be filed no earlier than the unextended due date of the return for the year that created the NOL, and no later than one year AFTER the end of the year that created the NOL. If you missed that deadline, you could instead file an amended return for the carryback year as late as three years after the due date of the tax year giving rise to the NOL. An amended return, however, could delay the refund related to the carryback claim significantly.
If you didn’t want to first carry losses back at all, but instead preferred to get straight to carrying the losses forward, Section 172 allowed you to “waive” the carryback period and do just that.
Courtesy of the TCJA, however, beginning in 2018, NOLS could no longer be carried back, but rather only carried forward. NOLS could now be carried forward indefinitely, but when carried forward, the NOLS could offset only 80% of taxable income.
These changes were intended by Congress to be effective for the first tax year BEGINNING after December 31, 2017. The legislative text of the TCJA, however, inappropriately applied the changes to the first tax year ENDING after December 31, 2017. Thus, for example, a corporation with an NOL for a fiscal year-end of June 30, 2018 would find itself subject to the new NOL regime; unable to carry back the loss and able to offset only 80% of income as the loss carries forward.
The CARES Act made several important changes to the treatment of NOLs. First, for tax years beginning after December 31, 2017 and before January 1, 2021, losses can again be carried back, but now for up to FIVE years. A taxpayer can elect to waive the carryback period, however, and instead carry the amounts forward. These losses, when carried forward to a year before 2021 – for example, a 2018 loss carried to 2019 – may offset 100% of taxable income.
In addition, the CARES Act made a technical correction to the fiscal-year 2018 problem, providing that the NOL changes did NOT apply to a business’s first tax year ENDING after December 31, 2017.
The Problem:
OK, great. Businesses can now carry back 2018 and 2019 losses to as far back as 2013 and 2014, respectively, to recoup prior taxes. Even better, the losses will offset income taxed at a 35% rate in those years, generating a larger tax benefit than if those losses were carried forward (the corporate rate was reduced by the TCJA from 35% to 21%). But how, and when, do we file the carryback claims? After all, the due date for a calendar year 2018 carryback claim on Form 1045 or Form 1139 was December 31, 2019, a date that has come and gone.
And what if we don’t want to carry back the 2018 loss; how can we elect to waive the carryback period and instead carry the loss forward immediately?
And lastly, what do we do about that technical correction? If we had a fiscal year business that generated an NOL in a tax year traversing December 31, 2017, how do we now carry back that NOL or elect to waive the carryback?
The Fix:
Revenue Procedure 2020-24 provides procedures intended to address the latter two items described immediately above: 1) waiving a carryback claim for a 2018 or 2019 NOL, or carrying back an NOL for a business’s first fiscal year ending after December 31, 2017.
To waive a carryback claim for a 2018 or 2019 NOL, a taxpayer must attach an election to forego the carryback to its federal income tax return filed for its first tax year ending after March 27, 2020. Thus, a calendar-year corporation would have until October 15, 2021 – the extended due date of the corporation’s 2020 tax return – to waive the carryback claim. So no rush, there.
For a taxpayer with an NOL for a fiscal year that traversed December 31, 2017, the NOL may be carried back on a Form 1045 or 1139 that is filed before July 27, 2020. Similarly, an election to waive the carryback period for that year must be filed before that same date; in this case, the taxpayer makes the election by attaching the wavier election to an amended return with “Filed pursuant to Rev. Proc. 2020-24” at the top. That date is only a few months away, so you’ll want to get cracking.
Finally, Notice 2020-26 provides perhaps the most important NOL guidance, addressing the timing of a carryback claim for the 2018 tax year. Absent relief, a taxpayer carrying back a 2018 loss to 2013 would be required to do so on an amended return; as a result, they would not be entitled to the expedited 90-day refund process that comes with filing a Form 1045 or 1139.
As a result, Notice 2020-26 grants taxpayers an additional 6-month extension of time to file a Form 1045 or 1139 for any tax year beginning in 2018 and ending before June 30, 2019. Thus, a calendar-year corporation has until June 30, 2020 to file a carryback claim.
To take advantage of Notice 2020-26, the taxpayer must do two things:
1. File the Form 1045 or 1139 no later than 18 months after the close of the year in which the NOL arose (i.e., June 30, 2020 for a 2018 tax year), and
2. Include on the top of the Form 1045 or 1139 “Notice 2020-26, Extension of Time to File Application for Tentative Carryback Adjustment.”
Remaining Unanswered Questions:
The corporate alternative minimum tax (AMT) was repealed as part of the TCJA at the end of 2017. Now, a taxpayer may be carrying back an NOL from a year with no AMT to a pre-TCJA year when the AMT was in effect. What is the amount of the AMT NOL being carried back? Is the taxpayer required to perform a computation of a quasi-AMT NOL for the NOL year? Or are we to treat the AMT NOL as equal to the regular NOL?
As you hopefully noticed, a number of these deadlines are in the not-too-distant future. June 30 is approaching rapidly, so get those Forms 1139 and 1045 for 2018 NOLs going posthaste. And while no one in the tax industry wants to be busy in May and June, managing Section 172 and 163(j) sure beats reading Section 7(m) of the Small Business Act.