Enacted in response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security (CARES) Act provides approximately $2 trillion in economic relief to eligible businesses and individuals affected by the novel coronavirus outbreak. This Tax Alert discusses temporary modifications the CARES Act makes to the limits on deductions for charitable contributions and excess business losses.

Modifications to charitable contribution limitation

Sections 2104 and 2105 of the CARES Act make temporary changes to the tax law to encourage the donation of charitable contributions. Specifically, during 2020, the limitations on deductions for charitable contributions increases for individuals who itemize, as well as for corporations. For individuals, the 50%-of-adjusted-gross-income (AGI) limitation is suspended for 2020. Additionally, individuals will be permitted an above-the-line deduction, up to $300, for cash contributions. For corporations, the 10% limitation increases to 25% of taxable income. The limitation on deductions for contributions of food inventory also increases from 15% to 25%. Tax-exempt organizations can use these provisions to encourage donors to provide additional support during tax year 2020.

Modification of the excess business loss rules

Section 2204 of the CARES Act temporarily suspends the IRC Section 461(l) limitation on excess business losses for pass-through businesses and sole proprietorships for the 2018, 2019 and 2020 tax years. Thus, net operating loss (NOL) relief is effectively extended to partnerships and sole proprietors by allowing excess business losses under IRC Section 461 for tax years before 2021. Further, the CARES Act makes certain technical corrections to IRC Section 461(l), including a change to IRC Section 461(l)(2), allowing carryover losses into subsequent tax years.

Implications

Charitable contribution deductions. A taxpayer still may choose to take advantage of normal charitable giving strategies, such as gifting (1) publicly traded securities to a private foundation (20%-of-AGI limitation) or to a public charity/donor-advised fund (DAF) (30%-of-AGI limitation), (2) cash to a private foundation (30% of AGI limitation) and (3) cash to a DAF or other public charity (60%-of-AGI limitation). Once you have stacked those contributions, you could utilize this provision to offset the remaining balance of AGI. Nonetheless, to the extent taxpayers are prioritizing tax benefits with philanthropic goals, a breakeven analysis should be done to determine whether a taxpayer over the pre-CARES AGI threshold has additional ordinary income that could be offset with further cash contributions.

Because this section is elective, taxpayers could make qualified contributions currently on the premise that they intend to take advantage of this section but then later decide, when filing their 2020 Form 1040 in 2021, to let the cash donations default to the standard 60%-of-AGI-limitation rule, which would then create a carryover going into 2021. A breakeven analysis would be prepared to determine whether the taxpayer has sufficient ordinary income to offset the larger charitable giving allowance or if that ordinary income will be offset by other provisions changed under the CARES Act, which would now release more losses than originally anticipated. An analysis and holistic review would bring to a taxpayer's attention how much ordinary income he or she has available to be offset by a charitable contribution deduction; it would also let taxpayers decide whether, due to other overarching goals, they wants to continue leveraging the 100%-of-contribution-base threshold even if further gifting was offsetting preferred-rate income, such as qualified dividends or long-term capital gains. At that point, a taxpayer might elect some but not all of those previously planned contributions to count toward the 100% limitation.

Taxpayers need to be careful about the interplay between itemized deductions and sections 2104 and 2105 of the CARES Act and review their tax position holistically, without focusing solely on the intended tax benefits of charitable giving. The reason for this is that the limitation on the charitable-giving deduction is based on AGI, whereas itemized deductions like investment interest expense reduce AGI to determine taxable income. Thus, if a taxpayer had a lot of ordinary investment income, such as interest, non-qualified dividends or short-term capital gains, the initial reaction might be to make a charitable gift to offset that income. But any investment interest expense that the taxpayer had might already be offsetting that income as an itemized deduction (as opposed to an adjustment to gross income) so the additional deductions wouldn't mechanically limit the charitable giving deduction. As a result, the taxpayer could end up with charitable contributions that would constitute allowable deductions but ultimately provide both no current tax benefit and generate no charitable contribution carryover.

Excess business loss deductions. These amendments to the NOL and excess business loss limitation rules affect tax years 2018 and 2019 in a unique way. Absent additional action by Congress or Treasury, the excess business loss repeal and five-year carryback period is mandatory for 2018 returns. As a result, all taxpayers that were limited by the excess business loss limitation and generated an NOL in 2018 will need to file an amended 2018 income tax return. Without the excess business loss limitation, that amended 2018 income tax return will allow 100% of the 2018 NOL to reduce taxable income.

Taxpayers with additional NOLs after amending the 2018 return will have a choice: carry back the NOL for the new five-year period to tax year 2013 and subsequent years or include an election to forego the carryback and carry the NOL to 2019. If the NOL is carried back, each return in the carryback period must be amended to use the NOL — there is no option to carry the NOL back to a specific year in the period. Either way, for 2019, those taxpayers have less NOL than they expected when making 2019 estimated tax payments and will need to recalculate 2019 tax for the extension payment now due on July 15, 2020.

When IRC Section 461(l) comes into effect in 2021, the rules will be different. In 2021 and after, wages will no longer be considered business income; business capital losses are not taken into account in the calculation, whereas net business capital gains are taken into account. For some taxpayers, these revised calculation rules will be beneficial; for others, they will not be. But these revisions to appear to track the original farm loss rules that IRC Section 461(l) was supposed to replicate when enacted in late 2017.

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