How Certain CARES Act Provisions Will Affect State Taxes

The Coronavirus Aid, Relief, and Economic Security (CARES) Act modified several sections of the Internal Revenue Code of 1986, including changes enacted as part of the Tax Cuts and Jobs Act (TCJA) of 2017.

The CARES Act applies to states with statutory federal conformity provisions and those that rely on the Internal Revenue Code (IRC) to determine their corporate and personal income tax base. 

States choose to conform to provisions of the IRC in one of three ways. Either

  • The state has rolling conformity and adopts the IRC in its current form;
  • The state has fixed date conformity and conforms to the IRC as of a specific date in time; or
  • The state will choose to conform to select provisions of the IRC at different points in time. 

About half of states with a corporate or personal income tax have rolling conformity. Without specific decoupling, they will conform to the changes made by the CARES Act. But states do have the ability to decouple from CARES Act changes to the IRC if state legislatures or revenue departments decide the changes are not in the state’s best interest. 

Since the CARES Act was enacted during the first quarter of the 2020 calendar year, taxpayers need to consider the impact on state tax provisions. Legislatures in states with rolling conformity must be monitored as they may choose to retroactively decouple from all or part of changes to the IRC included in the CARES Act.

Following are some key areas in which provisions of the CARES Act may or may not affect state taxes. 

1. Net Operating Loss rules

The CARES Act temporarily repeals the 80% taxable income limitation on the use of a Net Operating Loss (NOL) deduction that was added to IRC Sec. 172(a) by the TCJA. The updated NOL section applies to tax years beginning after December 31, 2017, and before January 1, 2021.

The CARES Act also gives taxpayers the ability to elect to carry back NOLs generated in a tax year beginning after December 31, 2017, and before January 1, 2021 for a period of five years. For any NOLs generated in a tax year beginning after December 31, 2020, taxpayers may not use the NOL carryback to directly reduce the amount of IRC Section 965 transition tax incurred in a transition year. Taxpayers would still have the ability to carry NOLs forward if they decide against making an election to carry the NOLs back. 

The carryback or carryforward of an NOL may affect a taxpayer's (1) allowable IRC Section 250 deduction (both against foreign-derived intangible income (FDII) and global intangible low-taxed income (GILTI)); (2) allowable foreign tax credits (FTCs); (3) base erosion anti-abuse tax (BEAT) liability, and (4) in some cases, the taxpayer's IRC Section 965 transition tax liability.

Most states have long disallowed carrybacks of NOLs and have already decoupled or modified their NOL provisions under Section 172. As a result, these CARES Act changes are unlikely to apply to taxes at the state level.

Four states (Alaska, Delaware, Maryland and Oklahoma) currently follow the elimination of the 80 percent taxable income limitation and provide a five-year carryback for NOLs arising in a taxable year beginning after December 31, 2017 and before December 31, 2021.

2. Limitations on business expenses  

The CARES Act allows taxpayers to increase the 30% of adjusted taxable income (ATI) limitation on the business interest expense deduction to 50% of ATI for tax years beginning after December 31, 2018, and before January 1, 2021. Taxpayers have the ability to elect to not apply the higher 50% limitation. Taxpayers also have the ability to elect to use their 2019 ATI as the ATI for the 2020 tax year.

Because most states have rolling conformity, this provision is likely to be adopted at the state level. It remains to be seen how many states will enact legislation to specifically decouple from the 50 percent limitation. New York, for example, has already voted to do so as part of the adoption of its state budget for the upcoming year.

It also will be interesting to see how states react to the federal elections under the CARES Act that allow taxpayers to use their 2019 ATI to calculate their 2020 IRC Section 163(j) limitation. This will only impact states with rolling conformity or states that adopt static conformity after March 27, 2020. 

3. Depreciation of Qualified Improvement Property

The TCJA originally provided for 100% expensing, or bonus depreciation, of qualified assets placed in service after Sept. 27, 2017 and before Jan. 1, 2023. An error in the legislative language omitted qualified improvement property (QIP) from the list of properties that qualify for bonus depreciation. As a result, the TCJA required entities to depreciate QIP over 39 years.

The CARES Act makes a technical correction to make QIP eligible for bonus depreciation retroactively. This correction allows taxpayers to claim 100% bonus depreciation for QIP placed in service during 2018 and 2019. The technical correction also provides for a 15-year MACRS recovery period and a 20-year ADS recovery period. Because the CARES Act correction is retroactive, entities will have the option of either amending prior tax returns to claim the additional depreciation deduction or filing an Application for Change in Accounting Method with their 2019 return and taking the benefit on their next tax return.

However, since most states have already decoupled from the bonus depreciation provisions of Section 168(k), this technical correction will affect taxpayers in a small number of states.

Those who file amended federal returns to take the 100% federal bonus depreciation should be aware of the need to potentially file amended state income tax returns that would be triggered by filing amended federal returns. 

If you have any questions regarding the state income tax impact in response to COVID-19, contact a Weaver professional today. We're here to help.

© 2020

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