What is the Impact of the CARES Act on ASC 740?

The CARES Act includes a combination of tax provisions and other stimulus measures to help companies and individuals during the COVID-19 pandemic. The Act includes a number of business tax provisions that could produce tax refunds for companies and affect their income tax accounting.

Along with analyzing the tax provisions in the Act, companies should consider the impact on ASC 740, which requires taxpayers to recognize the impact of changes in tax rates and laws on deferred tax balances in the period in which new legislation is enacted. For federal tax purposes, the enactment date is the date a bill becomes law. For the CARES Act, the enactment date is March 27, 2020, and companies need to take a closer look at the effects on current and deferred tax accounts in the interim or annual reporting period that includes that date.

Some key business tax measures in the Act include a temporary reinstatement of the carryback period for net operating losses (NOLs), an increase in the business interest expense deduction limitation, and an acceleration of refunds for corporate alternative minimum tax (AMT) credit carryforwards. Businesses must also consider the impact of these changes on state and local income taxes, as well as financial reporting.

Temporary reinstatement of NOL carryback

The CARES Act amended IRC Section 172(a) to allow businesses to carryback NOLs incurred in 2018, 2019 and 2020 for up to five years. The NOLs are also not subject to the 80 percent of taxable income limitation, meaning they could fully offset 2020 or prior-year taxable income.

Companies carrying back losses from the 2018 to 2020 tax years need to weigh the impact of tax rates in the carryback year to which the losses are applied. NOLs arising in 2018, 2019 or 2020 would have previously created a deferred tax asset measured at 21 percent. If these NOLs are carried back to years before 2018, the resulting refund would be during a tax year when the tax rate was 35 percent, resulting in potential cash tax savings. Increasing NOLs in tax years 2018 through 2020 would help companies maximize this potential cash refund.

Companies also need to evaluate the impact of this benefit on their current-period provision for any carryback claims, as other tax positions may be affected. For interim reporting purposes, any current tax benefit for 2020 losses that a company carries back to prior years would be part of its annual effective tax rate (AETR) calculation. Any current tax benefit from the carryback of 2019 and 2018 losses would generally be recorded as discrete items in the quarter for which a reasonable estimate of the NOL carryback refund can be made.

Companies may need to update their analysis of whether, and how much of, the deferred tax assets are realizable, including the scheduling of temporary difference reversals, as carrying back NOLs may have reduced deferred tax assets related to NOLs. At the same time, carrying back losses may free up credits that were otherwise used to reduce taxes in the carryback years. Negative economic conditions may also have significant effects on an entity’s assessment of whether its deferred tax assets are realizable, including whether reliance may be placed on estimates of future taxable income.

Increased business interest deduction limit

The CARES Act also increased the limit on the business interest deduction under IRC Section 163(j) by increasing the adjusted taxable income portion of the limit from 30 percent to 50 percent for tax years 2019 and 2020. The Act also allows businesses to use their taxable income from 2019 (rather than 2020) in tax year 2020 for the purposes of applying the 50 percent limitation.

Companies need to consider any changes affecting the ability to realize Section 163(j) deferred tax assets. Some profitable companies have recorded valuation allowances against their Section 163(j) carryforwards on the basis that their future taxable income will not be of the appropriate character to offset the interest limitation. For companies in this position, the Section 163(j) provisions of the CARES Act may result in a discrete favorable adjustment in the quarter that includes March 27, 2020, as some portion of the valuation allowance on existing Section 163(j) carryforwards could be released.

Accelerated AMT credit refunds

The CARES Act allows corporations to accelerate to 2019 claims for fully refundable corporate AMT credits. Corporations also have the option to claim the fully refundable AMT credits in 2018. The Tax Cuts and Jobs Act (TCJA) repealed the corporate AMT for taxable years after 2017 and allowed corporations to claim any unused AMT credits against regular tax for tax years beginning in 2018 through 2021 with credits fully refundable in 2021. As a result, companies that have remaining refundable AMT credits would classify these amounts as a current receivable.

State and local income tax considerations

Many of the CARES Act’s provisions could also have state and local income tax implications, and companies should carefully monitor state responses to the Act. Most state income tax laws use federal taxable income as a starting point for determining state income tax. While some states automatically adopt federal tax law changes, others conform their laws with federal laws on specific dates or decouple from the new federal tax provisions and continue to apply current law. Due to this possible inconsistency, companies may need to follow one set of rules when determining federal taxable income and multiple sets of rules when determining state and local taxable income.

Financial reporting

The changes in the CARES Act do not affect financial statements for the periods ending before its March 27, 2020 enactment date with the exception of subsequent event disclosures. For private companies, changes from the Act will be reflected as return-to-provision adjustments in the following period’s financial statements. For publicly traded companies, the impact of the Act will be included in the quarter that includes March 27, 2020.

Authored by Jon Pezzi, Tax Partner.

For more information on the impact of the CARES Act on accounting for income taxes, please contact us. We’re happy to help.

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