April 3, 2020 Examining key tax provisions in the CARES Act The Coronavirus Aid, Relief, and Economic Security Act, H.R. 748 (CARES Act), enacted on March 27, 2020, includes modifications to the Internal Revenue Code (IRC) intended to provide economic relief to those impacted by the COVID-19 pandemic. It also provides for loans and other benefits to businesses small and large, expanded unemployment insurance, direct payments to those with wages middle-income and below, and new appropriations funding for health care and other priorities. This Tax Alert discusses the following key provisions and considerations of the CARES Act:
Taxpayers will need to carefully consider the interaction of various amended IRC provisions and may need to engage in financial modelling to determine the best use of tax attributes, such as NOLs, during the limited periods in which these taxpayer-favorable changes are available. In addition, taxpayers should evaluate restructuring opportunities and accounting methods that may permit them greater utilization of certain tax attributes. 1. Employer and workforce relief Provisions of significance to employers and the workforce include:
Expanded unemployment benefits The CARES Act temporarily expands unemployment insurance (UI) benefits, significantly expanding the scope of the program to include self-employed workers and independent contractors as eligible claimants and increasing the cash benefit that is available to all claimants. Specific highlights include:
Implications Because COVID-19 benefits are not paid under the existing Disaster Unemployment Assistance program, states will not be able to begin making payments automatically. Instead, states must sign an agreement with the U.S. Department of Labor agreeing to provisions making them eligible to receive federal funds for the UI benefit payouts. To comply with the requirements for federal funding, states will have to make any needed administrative changes to their programs, systems, laws and policies to begin making the necessary payments. Accordingly, state requirements and procedures could vary, and states will not come online at the same time. This means that employers must track state developments as they occur. Social Security tax payment deferral CARES Act Section 2302 delays the timing of required federal tax deposits for certain employer payroll taxes and self-employment taxes incurred from March 27, 2020 (the date of enactment) through December 31, 2020. Amounts will be considered timely paid if 50% of the deferred amount is paid by December 31, 2021, and the remainder is paid by December 31, 2022. Applicable employment taxes include:
Deferral is available for employers remitting payroll taxes through an agent under IRC Section 3504 or a certified professional employer organization (CPEO). In these cases, the employer can direct the agent or CPEO to defer the applicable tax payments. Employers will be solely liable for making timely deposits under the deferred deadlines, including for worksite employees performing services for a CPEO customer. There is no dollar cap on the wages that are counted in calculating the taxes that may be deferred. The payroll tax deferral does not apply to federal income tax withholding, the Hospital Insurance (Medicare) tax, or the employee's portion of Social Security tax. In addition, the payroll tax deferral is not available to a taxpayer that obtains a Small Business Act loan under the Paycheck Protection Program established by the CARES Act if the loan is later forgiven. Implications All employers and self-employed individuals may avail themselves of the payroll tax deposit deferral. There is no need-based eligibility and this provision alone should provide positive cashflow to businesses on an interest-free basis, as there is no interest charge for the deferral. Employee retention tax credit CARES Act Section 2301 creates a new refundable employee retention credit (the Retention Credit) for wages paid from March 13, 2020 through December 31, 2020, by employers that are subject to closure or significant economic downturn due to COVID-19. The credit amount takes into account up to 50% of qualified wages, up to $10,000. Thus, the maximum Retention Credit amount is $5,000 per employee. The Retention Credit applies to:
To be eligible for the Retention Credit, an employer must carry on a trade or business in 2020 that experiences one of the two following COVID-19-related occurrences: (1) operations were fully or partially suspended on orders from a governmental authority due to COVID-19 (COVID-19 Shutdown), or (2) the business experienced a 50% reduction in gross receipts for a calendar quarter as compared to the same calendar quarter in the prior year (Gross Receipts Decline). For employers of more than 100 employees, qualified wages are wages (as defined under the Federal Insurance Contributions Act) paid for services an employee is not providing due to a COVID-19 shutdown or Gross Receipts Decline. The wages taken into account for those employers are limited to the amount the employee would have been paid for an equivalent amount of work in the 30 days immediately preceding the period for which the employee is paid. The Retention Credit is subject to numerous rules to prevent double-dipping. An employer's deduction for wages must be reduced by the amount of the Retention Credit. In addition, an employer may not take into account the following:
Implications The Retention Credit requires an analysis of how a business has been affected by COVID-19 and whether either the COVID-19 Shutdown or the Gross Receipts Decline tests have been met. The COVID-19 Shutdown test refers to a trade or business that has been fully or partially suspended due to government action. If the business does not meet the Gross Receipts Decline test, it may be unclear whether the business has been partially suspended. The Gross Receipts Decline test also presents unique challenges, as employers must analyze gross receipts across all aggregated entities rather than by location (a departure from rules associated with prior employee retention credits related to natural disasters). The combination of the retention credit with the payroll tax deferral will allow employers to reduce this year's Social Security tax and defer any remaining liability to 2021 and 2022. Employers will need to consider whether they intend to avail themselves of the Small Business Act loans made available through the Paycheck Protection Program under the CARES Act; these loan programs will affect the employer's ability to use the deferral and the retention credits. Amendments to mandated leave and credits under the Families First Act The Families First Act, enacted on March 18, 2020, imposed paid leave requirements and established corresponding payroll tax credits for employers of fewer than 500 employees. The CARES Act makes certain minor changes to these provisions:
The credit for this paid leave may be advanced to employers in accordance with forms and instructions provided by the Treasury Secretary, who has authority to prescribe the necessary rules. The Treasury Secretary shall waive penalties for failure to deposit if the failure was in anticipation of the payroll credits for paid leave. Expansion of employer-provided education assistance for student loans IRC Section 127 excludes up to $5,250 per year of employer-provided educational assistance from an employee's income. CARES Act Section 2206 amends IRC Section 127 to temporarily treat an employer's payment of principal or interest on an employee's student loan as excludable employer-provided educational assistance. To be excluded, the payments must be made after March 27, 2020 and before January 1, 2021. The income exclusion, including the loan payments, remains capped at $5,250 per year. Retirement plan distributions and funding The CARES Act provides for a one-year waiver of required minimum distributions (RMDs) from individual retirement accounts or individual retirement annuities (IRAs) and tax-qualified plans (including 403(b) plans and governmental 457(b) plans) for calendar year 2020. In addition, the CARES Act creates a new category of "coronavirus-related distributions" and loans from retirement plans of up to $100,000, which are not subject to early distribution taxes under IRC Section 72(t). For coronavirus-related distributions, the CARES Act allows income to be spread ratably over a three years and allows repayment to another eligible retirement plan within the same three-year period. If a loan, rather than a withdrawal, is taken, dollar limits under existing law are increased to $100,000 and repayments are not required to begin for one year. Implications The coronavirus-related distributions and loan provisions are voluntary, which means that employer-sponsored plans are not required to allow these new distributions or loans, although many will presumably do so to assist their employees. In addition, the CARES Act allows delayed plan amendments so that employers and IRA custodians and trustees may operationally allow coronavirus-related distributions (and loans in the case of employer plans) before amending the plan or contract terms. The IRS is expected to administer coronavirus-related distributions in a manner similar to other qualified disaster distributions. For example, the IRS created Form 8915 for individuals to report prior disaster-related distributions and repayments. Sponsors of single-employer defined benefit pension plans subject to minimum required contributions will benefit temporarily from the CARES Act's funding relief provision. Additional funding relief may be granted in future legislation, as this will be an important issue for some employers. Executive compensation limitations related to the CARE Act's business loans CARES Act Title IV provides for economic stabilization for distressed businesses and the passenger airline and air cargo industries. The Federal Reserve also may provide support to other eligible businesses. Businesses receiving such support must meet specific criteria, such as a prohibition on dividends, capital buy-backs, and employee reductions. Two specific provisions under CARES Act Sections 4004 and 4116 require limitations on employee compensation for businesses that avail themselves of loans or financial support. Under these limitations, no officer or employee whose total compensation exceeded $425,000 in 2019 may receive either:
Implications The compensation limitations are reminiscent of the limitations that were imposed on banks and other financial services organizations participating in the Troubled Assets Relief Program (TARP), which imposed certain tax deduction limits on compensation in excess of $500,000. In contrast, the CARES Act restricts the actual payment of compensation during the limitation period. Additional guidance is necessary to understand the definition of total compensation under the CARES Act, so employers can (1) identify the impacted officers and employees; (2) apply the limitations; and (3) determine how to take compensation that relates to multiple years into account. For example, it is unclear how to consider compensation that is awarded in one year, vests in a later year, and paid in a future year, in determining an officer or employee's total compensation for 12 months. Businesses may need to modify existing employment agreements, severance, and deferred compensation arrangements in order to participate in the CARES Act's loan and financial support provisions, which may raise other questions, including the operation of the IRC Section 409A deferred compensation rules. Extension of Department of Labor deadlines for employee benefit plans Under prescribed circumstances, the Employee Retirement Income Security Act of 1974 (ERISA) Section 518 authorizes the Labor Secretary to postpone deadlines under ERISA (such as deadlines affecting COBRA continuation coverage, special enrollment, claims for benefits, and appeals of denied claims) for up to one year. CARES Act Section 3607 expands the list of prescribed circumstances under ERISA Section 518 to include a public health emergency declared by the Secretary of Health and Human Services (HHS) under Section 319 of the Public Health Service Act. Because the HHS Secretary declared a public health emergency in response to COVID-19 on January 31, 2020, employers should expect guidance from the Department of Labor identifying postponed ERISA deadlines. (For more information, see Tax Alert 2020-0761.) 2. Net operating loss (NOL) deductions NOLs and NOL carrybacks Under the CARES Act, NOLs arising in tax years beginning after December 31, 2017, and before January 1, 2021 (e.g., NOLs incurred in 2018, 2019 or 2020 by a calendar-year taxpayer) may be carried back to each of the five tax years preceding the tax year of such loss. The CARES Act also temporarily removes the current 80% limitation on NOL absorption, reinstating it for tax years beginning after 2020. Special carryback rules are provided for taxpayers such as real estate investment trusts (REITs) and life insurance companies. The CARES Act also provides relief to fiscal-year 2017 corporate taxpayers (tax years beginning before January 1, 2018 and ending after December 31, 2017), to carry back NOLs for two years. This corrects the Tax Cuts and Jobs Act of 2017 (TCJA) provision that precluded fiscal-year 2017 taxpayers from carrying back NOLs. As a result of changes under the CARES Act, corporate taxpayers with eligible NOLs may now be able to claim a refund for tax returns from prior tax years. As the CARES Act did not modify IRC Section 172(b)(3), a taxpayer, where advantageous, can still waive the carryback and elect to carry NOLs forward to subsequent tax years. Further, in eligible tax years, corporate taxpayers may use NOLs to fully offset taxable income, rather than 80% of taxable income. Many taxpayers — particularly multinational corporate groups that own controlled foreign corporations (CFCs) — will need to carefully consider the interaction of an NOL carryback with other IRC provisions. For example, a taxpayer that elects to apply an NOL carryback to a tax year in which the IRC Section 965 transition tax was imposed will generally be precluded from taking its IRC Section 965 inclusion when determining the amount of taxable income that may be offset by NOL carrybacks. The CARES Act does not, however, generally prohibit taxpayers from using an NOL from a tax year with a lower corporate tax rate (e.g., 2020) to offset taxable income that was subject to a higher corporate tax rate in an earlier tax year (e.g., 2017). Before claiming an NOL carryback for a prior tax year, corporate taxpayers may also want to consider how other tax attributes (e.g., foreign tax credits) that were absorbed in a prior year may now be displaced as a result of the carryback. Other considerations include the impact on the taxpayer's AMT liability, if any, in the carryback year. Consolidated return groups will need to consider the computation and availability of consolidated NOLs, the allocation of that NOL to a departing consolidated return member and the group's utilization of a member's separate-return-loss-year NOL. Taxpayers that were party to an M&A transaction may also need to consider contractual limitations affecting their ability to carry back, or carry over, an NOL. Implications While this legislation is clearly designed to improve the near-term cash flow of many corporate taxpayers, the decision to pursue a refund through an NOL carryback should be carefully considered for all of its knock-on effects, such as the effect on AMT liability in a carryback year (particularly when some or all of an associated AMT credit may have been recovered in subsequent years). Similarly, multinational groups with CFCs should be particularly mindful in considering the panoply of other Code provisions — many of which were enacted with the TCJA — that interact with an NOL deduction and could be affected by wholesale carryback decisions, including:
There is a relatively limited window within which to act. The most significant IRC changes previously discussed are not permanent; e.g., the relaxed rules on NOL carrybacks and the elimination of the 80% taxable limitation for NOL absorption apply for only three tax years, two of which have already passed (for calendar-year taxpayers). Meanwhile certain elective mechanisms must be exercised within a relatively short window (e.g., July 25, 2010 - within 120 days of the CARE Act's March 27, 2020 enactment date). (For more information, see Tax Alerts 2020-9011 and 2020-9012.) 3. Expanded business interest expense deductions (IRC Section 163(j)) The CARES Act temporarily modifies IRC Section 163(j), which otherwise limits the amount of business interest expense that may be deducted in a tax year to the sum of (1) the taxpayer's business interest income for the year; (2) 30% of the taxpayer's adjusted taxable income (ATI) for the year; and (3) the taxpayer's floor plan financing interest expense for the year. For the years in question, ATI may be roughly analogized to the financial concept of earnings before interest, taxes, depreciation and amortization (EBITDA). The CARES Act changes the ATI limitation, increasing it from 30% to 50%, but only for tax years that begin in 2019 or 2020. An election contemplated by the legislation would permit a taxpayer to opt out of the 50% limitation. Moreover, another special election permits a taxpayer to use its 2019 ATI in lieu of 2020 ATI, with a pro-ration mechanism for short tax years. Thus, corporations that otherwise would have disallowed business interest expense (the amount in excess of 30% of ATI, up to 50%) may be able to deduct more business interest expense in 2019 and 2020. Also, many taxpayers could have greater ATI in 2019 than 2020; in that case, the election to use 2019 ATI in lieu of 2020 ATI generally allows more interest expense to be deducted in 2020 than otherwise would be permitted. For tax year 2019, partnerships must use the 30% of ATI limitation. The ATI limitation increases to 50% of ATI for partnerships in their 2020 tax years, unless the partnership elects not to apply the higher limitation. The partnership may elect to substitute tax year 2019 ATI for tax year 2020 ATI. Partners may treat 50% of any excess business interest expense (EBIE) allocated to them from a partnership in tax year 2019 as automatically paid or accrued to them in the partner's 2020 tax year, without further IRC Section 163(j) limitations at the partner level (i.e., the partner can deduct that 50% portion regardless of the partner's ATI). The remaining 50% of 2019 EBIE is subject to the "normal" testing rules for EBIE at the partner level (i.e., the partner needs to receive an allocation of excess taxable income (ETI) from that same partnership in future tax years to potentially free up those amounts). The partner may elect not to apply this special rule. Implications The additional interest expense that may be deducted may give rise to, or increase, an NOL, which, as previously discussed, may now be carried back to offset the taxable income of five prior tax years. If the additional deduction yields negative tax consequences for another tax provision, such as IRC Section 59A (BEAT), taxpayers may decide not to elect to apply the increased IRC Section 163(j) limitation. (For more information, see Tax Alerts 2020-9011 and 2020-9012.) 4. Alternative minimum tax (AMT) acceleration The TCJA repealed the corporate AMT and allowed corporations to fully offset regular tax liability with AMT credits. Any remaining AMT credit amount became refundable incrementally from 2018 through 2021. The CARES Act accelerates the refund schedule, permitting corporate taxpayers to claim the remaining credits as a refund in full in either 2018 or 2019. Taxpayers wishing to accelerate an AMT credit refund for 2018 may use a quick refund procedure (e.g., Form 1139) to claim these credits once further guidance is provided. Taxpayers with a short tax year in 2019 may experience a refund reduction and should consider electing the 2018 refund approach. (For more information, see Tax Alert 2020-9012.) 5. Qualified improvement property In general When the TCJA eliminated the separate definitions of qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property and provided for a single definition for QIP under IRC Section 168(e)(6), it was understood that Congress intended to provide a 15-year recovery period for QIP placed in service after December 31, 2017. Due to an apparent oversight, however, IRC Section 168(e)(3)(E), the provision generally describing the property to which a 15-year recovery period applies, was not amended to include QIP. As a result, QIP acquired after September 27, 2017, and placed in service after December 31, 2017 had to be recovered over 39 years and, accordingly, was not eligible for bonus depreciation. (However, QIP acquired after September 27, 2017, and placed in service on or before December 31, 2017, was eligible for bonus depreciation and, therefore, was not at issue in the CARES Act changes.) The TCJA also extended the bonus depreciation deduction through 2026. The TCJA allows taxpayers to claim 100% bonus depreciation for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023, phasing down bonus depreciation to 80% for qualified property placed in service before January 1, 2024; 60% for qualified property placed in service before January 1, 2025; 40% for qualified property placed in service before January 1, 2026; and 20% for qualified property placed in service before January 1, 2027. The TCJA specifies that qualified property includes tangible property with a recovery period of 20 years or less under MACRS, provided the remaining requirements of IRC Section 168(k)(2) are met. The TCJA, however, removed the specific reference to QIP as being qualified property and, as a result, QIP was not eligible for bonus depreciation. The CARES Act amends IRC Section 168(e)(3)(E) to retroactively include the QIP inadvertently classified as 39-year property under the TCJA as property to which a 15-year recovery period applies and for which bonus depreciation may be claimed. Under the TCJA, taxpayers may claim 100% bonus depreciation for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023. Because of the new technical amendments, taxpayers that make or have made improvements to their facilities may now take appropriate steps to claim the missed 2018 100% bonus depreciation. Pending additional anticipated Treasury Department guidance that potentially may provide more flexibility or change other analytical considerations, to claim bonus depreciation for QIP, a taxpayer may choose to amend prior-year tax returns before filing 2019 tax returns. Alternatively, a taxpayer may decide to file Form 3115, Application for Change in Accounting Method, under Section 6.01 of automatic Revenue Procedure 2019-43, to claim missed bonus depreciation, assuming all scope requirements of the existing procedure are met. Options for properly depreciating QIP over 15 years For taxpayers that have not yet filed a 2019 return. To correct the depreciation for QIP placed in service in 2018, a taxpayer generally can either amend the 2018 federal income tax return or file an automatic accounting method change for the 2019 tax year or a later tax year under current procedural guidance (i.e., Section 6.01(1)(a) and (b) of Revenue Procedure 2019-43). Section 6.01(1)(b) waives the application of the "two-year rule" for impermissible to permissible changes so taxpayers can depreciate property wrongly in one year and file a change in the following year. For taxpayers preparing to file a 2019 return. Treatment of QIP placed in service in 2019 will not directly impact depreciation issues for QIP placed in service in 2018. If the 2019 federal income tax return is filed in a manner that ignores the CARES Act QIP "fix" for QIP placed in service in 2018 (i.e., depreciation continues straight line over 39 years), however, then an accounting method will be established and the improper treatment can generally be corrected only through a method change (absent more generous procedural guidance that may be issued by the Treasury Department). If the 2019 return is filed in a manner that takes the correct depreciation for QIP placed in service in 2018 (i.e., 2019 federal income return reflects $0 depreciation for QIP placed in service in 2018), the taxpayer may still be able to amend the 2018 tax return to take the missed bonus depreciation in 2018 (assuming the tax year is still open from a statute of limitations standpoint). This would generally preclude a method change in a future tax year. For taxpayers that have already filed a 2019 federal income tax return using the "old", prior QIP method. If the 2019 tax return was filed in a manner that ignores the QIP fix for QIP placed in service in 2018 (i.e., depreciation continues straight-line over 39 years), then an accounting method will be established and the improper treatment can generally only be corrected through a method change (absent more generous procedural guidance issued by the Treasury Department). Implications Determining the best year to take the additional QIP deductions (e.g., 2018, 2019, 2020) depends on many factors, including actual and/or projected taxable income, any desire to apply carryback provisions, the need for cash (i.e., consider 4/15 prompt refund filing deadline in appropriate cases), other cash tax-planning, interaction with NOL rules, IRC Section 163(j) provisions, various international tax provisions (e.g., BEAT, GILTI, IRC Section 965, and FDII), and other provisions applicable to a taxpayer. Modeling of this and other CARES Act changes will be critical. The Treasury Department is expected to prioritize the issuance of guidance related to this provision (e.g., procedural guidance regarding how to implement the new QIP eligibility provisions, as well as guidance addressing the ability of taxpayers to formally elect out of bonus depreciation, if desired, in light of this recent statutory change). Treasury could allow for greater flexibility than the current rules provide or make other changes not reflected in the prior summary. More broadly, the ability to use optimal accounting methods in the current economic climate cannot be overemphasized in terms of potential immediate impact on cash flow. Taxpayers seeking to enhance cash flow in the short term should consider the availability of automatic accounting method changes for 2019 tax years, such as those related to wholly and partially worthless bad debts, depreciation, prepaid expenses and the recurring item exception, and the uniform capitalization rules. Taxpayers should also be aware of the effects of elections under IRC Sections 280C and 59(e) on 2019 R&D credits and expenses, and model how making those elections may affect tax liability for federal and state purposes. (For more information, see Tax Alert 2020-0806.) 6. IRS procedures to expedite refunds A corporation may expedite refunds of estimated taxes by filing either (1) Form 4466, Corporation Application for Quick Refund of Overpayment of Estimated Tax, or (2) a "First Return" followed by a "Superseding Return" to expedite the processing of their refunds. Individuals and estates and trusts can also take advantage of the First/Second return offering discussed next. Only corporations, however, may use Form 4466 to request a refund of estimated taxes. Form 4466/overpaid estimated tax In many cases, a loss corporation will have overpaid its estimated taxes when, for example, a significant part of the loss was incurred later in the year. A corporation can file Form 4466 after the end of its tax year, but no later than the due date for filing its tax return (not including extensions). Form 4466 must be filed before the corporation files its tax return. An extension of time to file the corporation's tax return will not extend the time for filing Form 4466. As such, calendar-year taxpayers must file their 2019 Form 4466 by April 15, 2020; the filing relief granted under Notice 2020-18 was not extended to Form 4466. A corporation should be cautious in estimating the amount of its liability, because overstating the amount of the overpayment reported on Form 4466 could result in interest and penalties, including a penalty under IRC Section 6655(h), when the final tax is later determined on the tax return for the year. Multiple Forms 4466 can be filed during the period previously described. Form 4466 has undergone an IRS processing change in recent years. The IRS conducts identity validation on all Forms 4466 by issuing a 1287C letter, usually about a month after the Form 4466 is filed. A unique code is imbedded in the letter and a Responsible Officer (who has authority to bind the company) must call the IRS to verify information on the Form 4466. Form 4466 cannot be validated by individuals authorized to represent a taxpayer before the IRS on a Form 2848 (POA). Form 8302 can also be filed with Form 4466 to request an electronic deposit of a refund of at least $1 million. First returns There are three steps in the traditional First Return process:
A corporation may desire to file its Form 1120, U.S. Corporation Income Tax Return (or other corporate return), as soon as possible after its year-end to obtain a refund, on an accelerated basis. As a result, questions may arise as to what constitutes a sufficient initial return (First Return), how complete a First Return must be, and which schedules must be included in the First Return filed by the taxpayer. Each return must meet minimum requirements as discussed in this Tax Alert and must (1) be filed on the proper form; (2) supply enough information to permit the IRS to calculate tax; (3) be properly signed under penalty of perjury; (4) represent an honest and reasonable attempt to satisfy the requirements of the tax law; and (5) be e-filed when required by the regulations unless a waiver to permit filing a paper return is obtained. If a First Return is deemed incomplete, the taxpayer's refund will be delayed, the statute of limitations for assessment will not start running, and the taxpayer could face penalties. There has been little explanation or discussion of what the IRS considers to be the minimum acceptable First Return. There is some support, however, for not including certain information reporting forms with an original loss return when a Superseding Return is expected to be filed. The First Return should include the taxpayer's best estimate of Subpart F income, U.S. shareholder calculation of GILTI, and IRC Section 250 deduction for FDII, in the computation of taxable income or loss reported on such return, based on the best available information at the time. At a minimum, the First Return should include at least one Form 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations, although it is recommended for the First Return to include completion of Form 5471 for each of the taxpayer's substantive foreign entities. Estimates included in the First Return should represent good-faith best estimates (e.g., not "book" numbers imported into the return) and should be reflected as such in the return. The supporting files should document the consideration of the basis of any estimates used. Further, a whitepaper disclosure should be attached to the return explaining the purpose of the filing to the IRS and the taxpayer's intent to perfect the First Return with a Superseding Return. A Superseding Return is a return that is filed before the due date (or extended due date when a corporation has requested an extension) and changes data reported on the prior-filed First Return. A Superseding Return becomes the original return for all purposes. As such, and in contrast to a corporate amended return, a return filed as a Superseding Return must include all final information, and not just information that changed from the prior filed return. A superseding return that must be e-filed must be a complete XML filing of the entire return, with all required forms, schedules, and attachments (XML or PDF, if applicable). A taxpayer filing a superseding return must indicate the return as such by selecting the Superseded Return checkbox (designation) in the software or the return will be rejected as a duplicate filing. Implications There are various filing dates and return-filing order that should be kept in mind to achieve the appropriate results. The Form 4466, Corporation Application for Quick Refund of Overpayment of Estimated Tax must be filed by the due date of the return without extensions. If filing a first return and a superseding return, the forms should be filed in the following order:
7. State income tax considerations The modifications to the IRC by the CARES Act will affect the corporate income taxes imposed by state governments. Generally, most state corporate income tax systems use some measure of income determined under the IRC, including federal taxable income (FTI) or adjusted gross income, as a starting point for state corporate income tax computations. The immediate impact of changes under the CARES Act to the FTI calculation will depend on how each state conforms and incorporates changes to the IRC. Some will instantly conform to these federal changes. Others will not be affected by the amendments until the state's legislature enacts new law to conform, such as by advancing the state's IRC conformity date to incorporate the changes made by the CARES Act (i.e., advancing the IRC conformity date to a date on or later than March 27, 2020). States generally conform to the IRC in one of several ways: (1) they automatically tie to the federal tax law as it changes (known as "rolling" conformity); (2) they tie to the federal tax law as of a specific date (known as "fixed" conformity); or (3) they pick and choose different federal tax law provisions and dates to which they will conform (known as "selective" conformity). Most states then generally define state taxable income as either FTI or adjusted gross income, as determined under the IRC, plus or minus certain additions or subtractions, such as adding back federal depreciation and substituting a state method of depreciation. A few states select sections of the IRC to which they will conform and then modify some of those provisions to meet their own tax policy objectives, meaning that the state's taxable income is computed independent of the FTI computations. State implications of changes to federal NOL rules Most states do not conform to federal changes to NOL rules because they either use FTI before the NOL deduction to determine state taxable income or require the addback of the federal NOL and substitute their own NOL provisions. Furthermore, most states have long disallowed carrybacks of NOLs — perhaps because allowing NOL carrybacks would upset state budgetary determinations in earlier years. For these reasons, the CARES Act amendments to the federal NOL deduction will likely not have a significant impact in most states because only a handful follow the federal NOL directly (e.g., Maryland2) or otherwise subject their own NOLs to utilization limitations derived from IRC Section 172 (e.g., Indiana3), unless those states enact amendments to their tax laws to decouple from the new federal rules. The more meaningful state impact emerges indirectly from the carryback of an NOL, which may affect other components of FTI to which states conform. The amount of an NOL deduction impacts a corporation's allowable IRC Section 250 deduction against FDII and GILTI. In states that conform to one or both components of the IRC Section 250 deduction, the carryback of a federal NOL may also change state taxable income. This scenario raises nuanced concerns about the impact of the CARES Act in states that conform to the IRC Section 250 deduction but decouple from IRC Section 172. For example, it is unclear whether a state might recompute the IRC Section 250 deduction for state corporate income tax purposes, excluding the effect of any federal NOL carryback deduction. Finally, and perhaps least intuitively, the carryback of an NOL may change state taxable income as a result of changes to total federal income tax. For example, corporations may, on an amended return, change their strategic decisions with respect to available BEAT elections to forgo deductions for all federal income tax purposes.4 Such elections can affect FTI and, therefore, state taxable income. Corporations should evaluate state tax consequences of these federal tax decisions in measuring the associated cost or benefit. State implications of changes to IRC Section 163(j) limitation on business interest expense States generally will conform to the CARES Act changes to IRC Section 163(j), absent state legislative decoupling, because the business interest expense deduction limitation is part of the computation of a deduction used to determine FTI. How the CARES Act changes affect a specific state income tax law will depend on how that state conforms to the IRC and, in particular, IRC Section 163(j). A "rolling" conformity state generally will automatically conform to the amendments to IRC Section 163(j) unless the state decouples from the provision. A "fixed" conformity state generally will not apply the CARES Act changes until the state updates its IRC conformity date to a date on or after the enactment date of the CARES Act (i.e., March 27, 2020), while a "selective" conformity state generally will also have to incorporate the CARES Act changes for them to apply. Since the TCJA's enactment, several states have enacted laws specifically decoupling their income tax law from IRC Section 163(j). For example, Connecticut decouples from IRC Section 163(j) for purposes of calculating Connecticut taxable income.5 State taxing authorities have also responded to the TCJA's business interest expense deduction limitation rules by publishing guidance regarding the application of IRC Section 163(j) in the context of their state's corporate tax scheme. For example, Virginia's Department of Taxation recently finalized such guidance.6 This guidance addresses several subtle federal-state conformity issues, including when corporate taxpayers will need to recompute ATI for Virginia purposes.7 These guidelines also note that Virginia law allows an additional deduction for 20% of the amount of business interest expense disallowed under IRC Section 163(j) for federal income tax purposes. Consequently, while taxpayers are allowed a larger deduction for Virginia income tax purposes in the year the interest expense was paid or accrued, they may need to reconcile in future tax years the accelerated Virginia business interest expense deductions with the federal deductions.8 Still, many states that generally conform to the TCJA's provisions have yet to address — either through taxpayer guidance or lawmaking — the application of IRC Section 163(j) under their state tax laws. Important questions persist in light of the proposed Treasury Regulations9 and now the significant changes made by the CARES Act. The CARES Act therefore means more favorable interest expense deductions in conforming states but at the cost of increased administrative complexity for both corporations and state taxing authorities. This is not a one-time reporting concern. Federal consolidated group members may be required to make stock basis and earnings and profits (E&P) adjustments to reflect the federal utilization of IRC Section 163(j) attributes among the members of that consolidated group. Taxpayers should recognize that most states, even some combined reporting states, do not permit these types of adjustments, which can result in significant differences in the federal and state tax treatment of future distributions and stock sales. State tax policy implications and other considerations As the CARES Act was enacted during the first quarter of the 2020 calendar year, state tax impacts of conformity, particularly in the rolling conformity states, may present time-sensitive compliance and reporting concerns. Most calendar year-end corporations will soon prepare estimated tax payments, and not all states currently provide an extension of time to file forms or pay tax due on April 15, 2020. For the latest in state responses to the COVID-19 pandemic as of the date of this Tax Alert, see Tax Alert 2020-0744 (EY endeavors to update this Tax Alert for state tax responses as they occur). In determining their response to the COVID-19 pandemic, state legislatures will have to address their own budgetary impact, including any impact of conformity to the CARES Act. States in which the legislature adjourned before enactment of the CARES Act will require a special or emergency session to respond to the new federal law. Taxpayers have significant opportunity to participate in this state tax policy process — for instance, through a board of trade or legislative committees of professional associations, such as a state CPA society. EY will follow state regular and special legislative sessions and will provide periodic updates on these developments as they occur. The CARES Act also arrives at a time when businesses may anticipate economic losses due to effects of the COVID-19 pandemic. Corporations should evaluate their state tax profile now to avoid situations in which any current year state NOLs could become "trapped" (e.g., assigned to states in which the taxpayer does not ordinarily have business activity because workers are telecommuting from states in which they do not ordinarily work) or interest expense deductions could become unusable in future tax years. Analysis of business organizational structure and other strategic evaluations, such as obligor (versus guarantor) debt terms, can illuminate risks and opportunities surrounding limitations on NOLs and business interest expense deductions. (For more information, see Tax Alert 2020-0784.) 8. Income tax accounting considerations The CARES Act can have an immediate impact on income tax accounts. ASC 740 requires the effect of changes in tax rates and laws on deferred tax balances to be recognized in the period in which new legislations is enacted. In the case of US federal income taxes, the enactment date is the date the bill becomes law, which generally is upon presidential signature. The effects of the legislation on current and deferred tax accounts should be considered in the interim or annual reporting period including March 27, 2020. Income tax accounting considerations for specific CARES Act provisions NOL carrybacks Companies with NOL carrybacks should consider the current and deferred tax effects of carrying back NOLs. A taxpayer may elect to not carryback an NOL and may also elect to skip a year that included the IRC Section 965 transition tax. If carrying back to years beginning before January 1, 2018, tax receivables may be recorded at the 35% federal tax rate rather than the 21% tax rate. As noted previously, the carryback of NOLs can impact other tax calculations, including foreign tax credits, FDII, GILTI, BEAT, the IRC Section 199 deduction and IRC Section 965 transition tax calculations. Companies should consider whether the carryback of NOLs impacts the utilization of foreign tax credits, for example, that need to be assessed for current and deferred tax recognition. In addition, any NOL, foreign tax credit or other carryforwards arising as a result of carrying back NOLs will need to be assessed for valuation allowance considerations. Temporary suspension of 80% limitation on NOL use Companies should consider the current and deferred tax effects of removing the 80% limitation on the use of NOLs in 2018, 2019 and 2020, including valuation allowance considerations. Immediate refund for AMT credit carryforwards Companies should consider reclassifying deferred tax assets or long-term receivables for AMT credit carryforwards to current receivables if a refund is expected within the next 12 months. Increased ATI limitation for business interest deductions under IRC Section 163(j) for 2019 and 2020 Companies should consider the current and deferred tax effects of increasing the ATI limitation from 30% to 50% for business interest deductions for 2019 and 2020, including valuation allowance considerations. Qualified improvement property (QIP) Companies should consider the current and deferred tax effects of being able to immediately write off QIP costs beginning in 2018, rather than depreciating those costs over the 39-year life of the building or other property. The change in deferred tax balances can also affect the analysis of the realizability of deferred tax assets and valuation allowance considerations. Increased deduction for 2020 charitable contribution Companies should consider the current tax effects of the increase in 2020 charitable contribution deductions. ASC 740 accounting reminders Changes in tax laws or rates For companies that have adopted ASU 2019-12, Simplifying the Accounting for Income Taxes, "[t]he tax effect of a change in tax laws or rates on taxes currently payable or refundable for the current year shall be reflected in the computation of the annual effective tax rate beginning no earlier than the first interim period that includes the enactment date of the new legislation." Prior to the adoption of ASU 2019-12, if the effective date of the provision is later than the enactment date, the impact of the change on the estimate of the payable or receivable for the current year would be included in the calculation of the estimated annual effective tax rate, beginning in the interim period including the effective date. The effect of a change in tax rates on deferred tax assets and liabilities is recognized as a component of income tax expense from continuing operations in the period in which the change is enacted. The impact of any retroactive changes in enacted tax laws and the effect on taxes current payable/receivable and deferred tax assets and liabilities is determined at the date of enactment using temporary differences and currently taxable income existing as of the date of enactment and the tax effect is included in income from continuing operations. Determining the estimated annual effective tax rate for an interim period Under ASC 740, each interim period is considered an integral part of the annual period, and tax expense is measured using an estimated annual effective rate. A company is required, at the end of each interim reporting period, to make its best estimate of the annual effective tax rate for the full fiscal year and use that rate to provide for income taxes on a current year-to-date basis. The estimated effective tax rate should reflect enacted federal, state and local income tax rates, foreign tax rates and credits, percentage depletion, capital gains rates, other taxes and credits, and available tax-planning alternatives. The rate should be revised, if necessary, as of the end of each successive interim period during the fiscal year to the entity's best current estimate of its annual effective tax rate. (For more information, see Tax Alert 2020-0696.) ———————————————
——————————————— 1 A Superseding Return becomes THE return for purposes of applying the Code to the taxpayer's filing for the tax year; the First Return becomes irrelevant once the Superseding Return is timely filed. Thus, a Superseding Return becomes the taxpayer's original return for the tax year. 2 Md. Code Ann., Tax-Gen. §§ 10-301, 10-304; Md. Code Regs. 03.04.03.07 (additional state rules apply and may modify federal NOLs). Maryland is a generally a "rolling" conformity state. An amendment of the IRC, however, does not affect the determination of Maryland taxable income for any tax year beginning in the calendar year in which the amendment is enacted, unless the Comptroller determines that the amendment's impact on state income tax revenues will be less than $5 million for the state's fiscal year that begins in the calendar year in which the amendment is enacted. Md. Code Ann., Tax-Gen. §§ 10-108, 10-304(1); Md. Code Regs. 03.04.03.05(B); Md. Admin. Release No. 38 (Sept. 1, 2010). 3 See Ind. Code § 6-3-2-2.6(c)(1) ("An Indiana [NOL] equals: … (1) the taxpayer's federal [NOL] for a [tax] year as calculated under Section 172 of the Internal Revenue Code, derived from sources within Indiana and adjusted for certain modifications required by [Ind. Code § 6-3-1-3.5] as set forth in subsection (d)(1)"). 4 Prop. Reg. Section 1.59A-3(c)(6), 84 Fed. Reg. 67056 (Dec. 6, 2018). 5 Conn. Gen. Stat. § 12-217(a)(6) [beginning with the 2018 tax year]. 6 Va. Dep't of Tax., Guidelines Regarding the Business Interest Limitation (effective Dec. 26, 2019). See here. 7 If a Virginia affiliated group files its federal and Virginia returns on a different basis, or to the extent that any corporation is subject to Virginia's fixed date conformity modifications, it must recompute its FTI and [therefore] ATI for Virginia purposes before determining its business interest expense deduction limitation for Virginia purposes. 8 Virginia is a "fixed" IRC conformity date state, so the CARES Act changes to IRC Section 163(j) will not be incorporated into Virginia's tax law unless and until the state's legislature updates its IRC conformity date. 9Prop. Reg. Section 1.163(j)-0 et seq., 83 Fed. Reg. 67490 (Dec. 28, 2018). | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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