The Coronavirus Aid, Relief, and Economic Security (CARES) Act may be best known for its provisions designed to shore up the economy as the nation copes with the COVID-19 pandemic. These include distributing Economic Impact Payments to individuals and offering Paycheck Protection Program (PPP) loans to businesses.
But the act also includes several provisions that can help construction companies (and other businesses) reduce their tax bills and, thereby, boost their cash flows. In many cases, this tax relief is retroactive, which may allow your company to either 1) amend its prior-year tax returns and collect refunds of taxes paid in those years, or 2) file Form 3115 (“Application for Change in Accounting Method”) and claim “catch-up” deductions on this year’s return. Here are a couple of such tax-reduction opportunities offered under the CARES Act.
Excess business losses
The Tax Cuts and Jobs Act of 2017 (TCJA) set a cap on business loss deductions by noncorporate taxpayers. For 2018 through 2025, the TCJA limited deductions for net business losses from sole proprietorships, partnerships and S corporations to $250,000 for individuals and $500,000 for joint filers. Losses in excess of these thresholds (which are annually indexed for inflation) may be carried forward to future tax years under the net operating loss (NOL) rules. The CARES Act suspended the limits on business loss deductions for the 2018, 2019 and 2020 tax years. So, if this provision reduced deductions on your 2018 or 2019 (if already filed) tax returns, you may be entitled to amend those returns to claim your full losses and obtain a refund of some or all of the taxes you paid in those years.
What’s more, if these newly allowed losses create NOLs for 2018 or 2019, the CARES Act allows you to carry those NOLs back up to five years and secure additional refunds. (The act also suspended the TCJA’s prohibition of carrybacks for NOLs arising in 2018, 2019 and 2020, permitting those NOLs to be carried back up to five years.)
Business interest expense
The CARES Act also provides some relief from the limit on deductions of business interest expense. Under the TCJA, for larger construction businesses — that is, those whose average annual gross receipts for the preceding three years exceed $26 million (based on inflation indexing for 2019 tax returns) — these deductions are generally limited to 30% of adjusted taxable income (ATI). The CARES Act increases the limit to 50% for the 2019 and 2020 tax years (with special rules for partnerships).
The act also allows companies to calculate the 2020 limit based on their 2019 ATI. This may result in higher deductions for businesses whose income declines this year.
Construction companies and other “real property trades or businesses” may elect to opt out of the business interest limit provided they forgo certain accelerated depreciation benefits — including bonus depreciation. Once made, this election is irrevocable, which presents a problem for companies that previously opted out but now wish to claim bonus depreciation on newly eligible qualified improvement property (QIP).
Because of a technical error in the TCJA, QIP had been ineligible for bonus depreciation. The CARES Act corrected the error, retroactive to January 1, 2018.
Businesses that invested in QIP that was placed in service on or after that date have an opportunity to claim missed bonus depreciation deductions by amending their returns for 2018 or 2019 (if already filed) and obtaining a refund. Alternatively, they can file Form 3115 and claim a catch-up deduction on their 2020 returns.
Unfortunately, companies that opted out of the business interest deduction limit can’t take bonus depreciation on QIP. To solve this problem, the IRS recently issued Revenue Procedure 2020-22. It permits companies that elected to opt out of the business interest limit in 2018 or 2019 to withdraw the election and take advantage of the CARES Act’s changes. This may be an attractive option if the benefits of bonus depreciation on QIP outweigh any lost business interest deductions.
Keep those dollars available
To enhance cash flow, contractors should take advantage of these and other CARES Act provisions. They can help reduce this year’s tax bill and claim tax refunds for previous years. If you believe your construction company may be eligible for relief, work with your CPA to follow the proper procedures.