In the midst of the COVID-19 pandemic and the tax law changes within the CARES Act, companies are starting to consider the impact to their financial statements. Within this article, we will outline some of the tax accounting considerations that companies should review prior to the issuance of their financial statements.
The CARES Act was enacted on March 27, 2020 and it includes many measures to assist companies, including the temporary reversal or adjustment of many of the revenue raisers within the Tax Cuts and Jobs Act of 2017. The following outlines some of the key income based tax law changes within the CARES Act:
Eliminating the 80% of taxable income limitation by allowing corporate entities to fully utilize net operating loss (NOL) carryforwards to offset taxable income in 2018, 2019 or 2020. The 80% limitation is reinstated for tax years after 2020
Allowing NOLs originating in 2018, 2019, or 2020 to be carried back five years
Increasing the net interest expense deduction limit to 50% of adjusted taxable income from 30% for the tax years beginning January 1, 2019 and 2020
Allowing taxpayers to elect to use 2019’s adjusted taxable income for their 2020 interest expense limitation calculation
Allowing taxpayers with alternative minimum tax credits (“AMT credits”) to claim a refund in 2020 for the entire amount of the credit rather than over a period of time
Allowing companies to deduct more of their cash charitable contributions paid during the calendar year 2020 by increasing the taxable income limitation from 10% to 25%
Under ASC 740 tax law changes are to be recognized in the period in which new legislation is enacted. This means that any impact of the CARES Act would be reflected in the first interim period that includes the enactment date. For calendar year companies, this would be their first quarter financial statements.
Net operating losses (“NOL”)
Companies need to consider whether the elimination of the 80% of taxable income limitation impacts their ability to use additional NOLs in 2018 and 2019. In addition, companies need to consider whether they have NOLs that can be carried back to a previous taxable income year (5 year carryback). If it is expected that an NOL (measured at 21% enacted tax rate) will be carried back to a year in which the enacted tax rate was 35%, companies should reclassify the amount of tax affected NOLs they expect to carryback to a current income tax receivable or payable (if a refund is expected within 12 months). Companies may also need to reevaluate valuation allowance conclusions that were made prior to the CARES Act. With the changes to the carryback rules, elimination of the 80% of taxable income limitation, and the increase to the interest expense deduction; valuation allowance conclusions made pre-enactment date may have a different outcome.
Additionally taxpayers will need to consider the interplay of any NOL carrybacks with the disallowance of tax deductions (such as GILTI or FDII) and tax credits. A deferred tax asset should be recorded for any credit carried forward as a result of NOL carrybacks.
Increase to interest expense deduction
Companies with deferred tax assets for interest deduction limitations in 2019 will need to consider the impact of the increase from the 30% to 50% limitation. In addition, the impact of the potential NOL generated or utilized in that tax year should be considered as well as the ability to carryback.
Due to timing change of when companies will be able to claim a refund for any carried over AMT credits, companies should reclassify the amount of the AMT credit from a long-term deferred tax asset to a short-term prepaid tax (or offset to current taxes payable) account.
With all of the business related uncertainties during the coronavirus pandemic, companies are working with their advisors to determine the need (if any) for asset impairments. The tax teams should be working closely with financial management to understand the potential for impairments to ensure that the proper tax impact of those impairments are properly considered under ASC 740.
If you have any questions regarding the COVID-19 legislative changes and the impact on your company’s tax provisions, do not hesitate to contact Matthew Werner, James Sayre, or any other member of Schneider Downs & Co., Inc.
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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.