Tax Strategy: Business interest deduction limits under the CARES Act
The Tax Cuts and Jobs Act imposed a 30 percent of adjusted taxable income limit on business interest deductions as part of a package that expanded bonus depreciation. In order to help assist businesses during the coronavirus pandemic, the CARES Act increased the limits on business interest deductions. The IRS in Rev. Proc. 2020-22 has provided guidance on implementation of the CARES Act changes and provided several elections for taxpayers to consider in determining what approach might be best for a particular business.
The Tax Cuts and Jobs Act amended Code Sec. 163(j) to impose a 30-percent-of-ATI limit on business interest deductions for taxpayers with annual gross receipts of $25 million or more. Certain electing real property businesses and farming businesses could elect out of the interest deduction limit. The IRS guidance on that election requires that a business making the election could not utilize bonus depreciation, must use the alternative depreciation system, and that the election be irrevocable.
Through a drafting error, the TCJA also prevented qualified improvement property — i.e., leasehold improvements, retail improvements, and restaurant property — from utilizing bonus depreciation and required 39-year depreciation, while prior law had allowed 15-year depreciation.
The CARES Act
The CARES Act increases the 30-percent-of-ATI limit under the TCJA to a 50 percent limit for 2019 and 2020. It also provides an election for a taxpayer to not utilize the 50 percent limit for either 2019 or 2020 and retain the 30 percent limit. The CARES Act also permits a taxpayer to utilize the taxpayer’s 2019 ATI in determining the limit for 2020, anticipating that the coronavirus epidemic might result in a much lower 2020 ATI.
For partnerships, the CARES Act provides that the partnership may claim an interest deduction at the 50-percent-of-ATI limit for 2020; however, for a tax year beginning in 2019, the excess business interest expense is allocated to the partners, who can claim 50 percent of that interest in the partner’s 2020 tax year.
The CARES Act brought back net operating loss carrybacks, which had been eliminated by the Tax Cuts and Jobs Act, for up to five years. The CARES Act also corrected the error in the TCJA to permit qualified improvement property to utilize bonus depreciation for tax years going back to 2018.
Rev. Proc. 2020-22
Revenue Procedure 2020-22 provides guidance on several elections available to taxpayers with respect to the business interest limit changes of the CARES Act.
With respect to real property businesses and farmers, it provides that those taxpayers who had never made the election to be excluded from the business interest limitation now have an extended time until Oct. 21, 2021, to make that election for the 2018, 2019 or 2020 tax year, but in no event later than the applicable period of limitations on assessment for the tax year for which the amended tax return is being filed. The election may be made by filing an amended tax return, an amended Form 1065, or an administrative adjustment request.
Partnerships subject to the new centralized partnership audit regime are given special guidance for filing amended tax returns for the 2018 and 2019 tax year under Rev. Proc. 2020-23.
The election requires an election statement titled “Revenue Procedure 2020-22 Late Section 163(j)(7) Election” that includes the taxpayer’s name, address and Social Security number or Employer Identification Number; a description of the taxpayer’s trade or business and principal business activity code; and a statement that the taxpayer is making an election under Code Sec. 163(j)(7(B) or (C).
A real property business or farming business that has made an election out of the business interest deduction limitation may now revoke that election with an AAR or with an amended tax return or amended Form 1065, filed by Oct. 15, 2021, but again in no event later than the applicable period of limitations on assessment for the tax years for which the amended return is being filed.
The revoked election is treated as though it had never been filed, giving such taxpayers the opportunity to refile the election under the guidance above for a taxpayer who had never made the election. This election also requires an election withdrawal statement titled “Revenue Procedure 2020-22 Section 163(j) Election Withdrawal,” and includes information similar to that required for the election statement.
Rev. Proc. 2020-22 also sets forth three elections with respect to the 50 percent limitation in the CARES Act. First, a taxpayer may elect out of the 50 percent limitation and apply the 30 percent limitation for the 2019 or 2020 tax year. For partnerships, the election may be made by the partnership only for the 2020 tax year. The election again can be made on a timely filed income tax return, Form 1065 or AAR, but no formal statement is required.
Second, taxpayers may also make an election to use the ATI for the last tax year beginning in 2019 as the ATI for any tax year beginning in 2020. A taxpayer may make the election on a timely filed tax return, Form 1065 or AAR. A taxpayer may also revoke the election on a timely filed amended tax return, amended Form 1965 or AAR. Again here, no formal statement is required.
The third election available with respect to the 50 percent limitation is for a partner for the 2020 tax year to elect out of deducting 50 percent of EBIE for tax years beginning in 2020. This election may also be made by a timely filed tax return, Form 1065 or AAR, or amendments to these.
This election may also be revoked by a timely filed amended tax return, amended Form 1065 or AAR.
Factors in election decisions
The CARES Act changed a number of key tax provisions from the Tax Cuts and Jobs Act. An ability to increase the business interest deduction could negatively impact other deductions by reducing taxable income. The business interest deduction may be available in future years, while other deductions may not.
The new availability of net operating loss carrybacks and the availability of bonus depreciation for qualified improvement property, as well as the increase in the ATI threshold, could cause real property businesses and farming businesses to have a change of heart with respect to their election out of the Code Sec. 163(j) limits.
Taxpayers and their advisors have a number of elections to consider and some time to think them through. Some of the elections also permit the taxpayers to change their minds and revoke an election recently made or reinstate an election recently revoked.