Renner Business News; January 18, 2021–Joan M. Renner, CPA, CGMA
To address devastating losses from the COVID-19 pandemic, new laws will bring businesses some relief on their 2020 federal tax returns. The CARES Act has loosened limits on deducting 2020 business interest and net operating losses, and the Consolidated Appropriations Act of 2021 (CAA) has clarified favorable tax treatment for PPP forgiveness.
Here’s a rundown of five high points you may see on your 2020 tax return.
- Your PPP will not be taxed. The CARES Act created forgivable loans to small employers under the Paycheck Protection Program (PPP) to pay payroll and other specific costs. Section 1106(i) of the CARES Act provides that any PPP loan forgiveness shall be excluded from gross income.
- Expenses paid by PPP will be deductible. Initially, the IRS announced that no deduction would be allowed for otherwise deductible expenses to the extent they were used to obtain PPP forgiveness. Disallowing these deductions could leave a business owing a boatload of tax with no cash left to pay it.
Fortunately, the CAA clarified Congress’ intent that expenses qualifying for PPP forgiveness are deductible. The CAA says “no deduction shall be denied or reduced, no tax attribute shall be reduced, and no basis increase shall be denied by reason of the exclusion from gross income” of a PPP loan effective for taxable years ending after March 27, 2020.
- NOLs can be carried back for a refund. A Net Operating Loss (NOL) arises when business deductions for the year are more than business income for the year. NOLs arising in 2020 can be carried back five years and used to offset prior year income to get a refund of taxes previously paid. Previously, NOLs arising after 2017 could only be carried forward. The CARES Act opens up not only 2020 losses, but also 2019 and 2018 losses, for this five-year carryback, providing much-needed cash to businesses that paid taxes in previous years.
The CARES Act also allows more loss to be applied to each year. Previously, not only were NOLs arising in 2018, 2019 and 2020 limited to being carried forward, when you did get to apply them in a future year, you could only offset up to 80% of taxable income. The CARES Act removed the 80% limit on the amount of income that can be offset by an NOL for 2018, 2019 and 2020. Now, the NOL deduction for 2018, 2019 and 2020 can offset up to 100% of income. The 80% limit comes back in 2021.
- NOLs created in 2020 can be carried forward. Previously, unused Net Operating Losses expired if not used to offset future income within 20 years. The CARES Act eliminated the 20-year expiration for NOL carryovers. Now, unused losses can be carried forward indefinitely, until they can be used to offset future income.
- More business interest can be deducted. Previously, a business’ deduction for business interest was generally limited to 30% of adjusted taxable income plus business interest income plus floor plan interest. Any business interest expense above that was not deductible on the current year return, but could be carried forward to future years without any expiration. The CARES Act temporarily raises the limit on how much business interest can be deducted in one year, allowing businesses to deduct business interest up to 50% of adjusted taxable income for 2019 and 2020.
Note: Your state may not conform to these tax benefits.
You may not see the above federal tax benefits on your state tax return if you operate in Virginia, Florida, California and other states that only adopt federal changes as of a specific date, or not at all. You will only see these tax benefits on your state tax return to the extent your state adopts the federal tax law changes. The effect on your tax return in these states may be significant.
If you operate in the District of Columbia, Maryland, New York, Pennsylvania and other states that adopt federal tax law changes as they occur, your state will probably adopt the tax benefits discussed above. No guarantees. The Comptroller of Maryland is allowed to decide not to conform to new tax law changes if the effect on the state budget would be more than $5 million.
To determine whether your state will adopt the above federal tax benefits, it’s vital that you consult your tax advisor about the rules in your state. Official guidance may take some time.
There are many more details related to the high points discussed in this article.
There are also many more details contained in the new legislation. New federal tax guidance will be provided by the Secretary of the Treasury. This information is intended to be a summary of the basics and is not a substitute for individual advice. For specific information about how these provisions apply to you, contact your financial professional.
More about COVID-19-related relief for small employers:
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