CARES Act business tax provisions with significant multistate tax considerations

Multistate tax considerations under the CARES Act

Conformity to the CARES Act

Many state corporate income tax regimes are affected by federal tax law and regulatory changes because they conform to the IRC for purposes of administrative ease by either incorporating the IRC in whole or in part, or by using federal taxable income as the starting point. When considering the state tax impact of a federal tax law or regulatory change, taxpayers should be mindful of the particular state’s level of conformity.

Approximately half the states, so-called rolling conformity states, have provisions that tie to the federal system in such a way that they automatically pick up certain changes as they occur. Other states that tie to the federal system as of a specified date, so-called static conformity states, may pick up CARES Act changes when those states' legislatures update their conformity provisions. However, even in states that follow the version of the· IRC that includes the CARES Act provisions, federal and state differences may remain as states may decouple from or modify the federal treatment for state income tax purposes.

To determine how the amendments to the CARES Act apply for state income tax purposes, taxpayers should consider the varying levels of conformity, along with any specific decoupling provisions, in their relevant states as these provisions may lead to significant differences between the federal and state income tax treatment.

Section 163(j) Interest Expense Limits

For federal income tax purposes, the CARES Act temporarily loosens the business interest limitation under section 163(j) increasing it from 30 percent to SO percent of ATI for taxable years beginning in 2019 and 2020.

As explained above, many states conform to the federal system on a rolling basis. Absent a specific decoupling provision, these states automatically pick up the CARES Act changes easing limits on the deductibility of interest expense by increasing the section 163(j) 30 percent limit to SO percent. Since the enactment of the TCJA in 2017, which imposed the 30 percent limitation under section 163(j), states have been slow to decouple from the business interest limitation provisions. As a result, almost half the states now follow the new SO limitation business interest limitation. These states include: Alabama, Alaska, Colorado, Delaware, the District of Columbia, Illinois, Iowa (for tax years beginning on or after January 1, 2020), Kansas, Louisiana, Maryland, Michigan (at the taxpayer's option), Montana, Nebraska, New Jersey, New Mexico, North Dakota, Oklahoma, Oregon, Pennsylvania, Rhode Island, Tennessee (for tax years beginning prior to January 1, 2020), and Utah. Of the remaining states, many states will continue to follow the 30 percent limitation enacted as part of the TCJA, absent any specific decoupling or modification provisions. A few states, such as California and Texas, do not follow section 163(j) due to a lagging conformity date that pre-dates the TCJA and the CARES Act.

While it is too soon to determine how states may react to the increased section 163(j) limitation, the recent passage of the New York FY 2020-2021 Budget Act (New York Budget Act) may provide a preview of what is on the horizon. In the New York Budget Act, New York specifically decoupled from the CARES Act amendment that increased the section 163(j) limitation to SO percent and requires taxpayers to add back the difference.

In addition to increasing the section 163(j) limit to SO percent, the CARES Act provides taxpayers with the ability to elect to use their 2019 ATI as their ATI in 2020. When businesses are considering whether to respond to the CARES Act election to use 2019 ATI to calculate a 2020 section 163(j) limit, they should consider the impact of the election on their state income taxes. Like the CARES Act increase to the section 163(j) limit, the CARES Act election to use 2019 ATI will only be available in rolling conformity states that tie automatically to the change or in static conformity states that update their conformity statute.

The chart below identifies which states are tied to the CARES Act's increase in the ATI threshold to SO percent, which states are still tied to the ATI threshold of 30 percent, and which states decouple from the interest expense deduction limitation.⁶

 
Net operating losses

On the federal front, the CARES Act also amended the NOL provisions under section 172. The amendments, among other things, eliminated the 80 percent taxable income limitation and provided a five-year carry-back for NOLs arising in taxable years beginning after December 31, 2017, and before January 1, 2021.

While states have been slow to decouple from the business interest limitation provisions under section 163(j), states commonly decouple from or specifically modify the NOL provisions under section 172, leading to differences in federal and state NOL balances. Some states are tied to the federal NOL provisions and will continue to follow the 80 percent taxable income limitation enacted as part of the TCJA, absent state legislation that updates the fixed conformity date to a version of IRC on or after the enactment of the CARES Act. A few states, such as Connecticut, provide their own state-specific taxable income limitation.

Significant differences also arise between federal and state carry-back provisions. Most states tend to decouple from the federal NOL carry-back provisions, and even in conforming states, the states may limit the annual amount of NOLs eligible to be carried back. Other states may have state-specific carry-back provisions which are subject to several nuances, including the amount of the carry-back and the timing of when it may be claimed. Therefore, only a small number of states allow for NOL carry-backs such that they will pick up the CARES Act carry-back reinstatement. The chart below identifies the states tied to the CARES Act NOL changes and describes other state-specific treatments.⁹

 
Based on a review of the relevant state NOL provisions, only Alaska, Delaware ($30,000 limit), Maryland, and Oklahoma now follow the elimination the 80 percent taxable income limitation and provide a five-year carry-back for NOLs arising in a taxable year beginning after December 31, 2017, and before January 1, 2021, as provided under the CARES Act.

Qualified improvement property

The headline CARES Act QIP change is to permit 100 percent bonus depreciation for eligible QIP placed in service by the taxpayer after December 31, 2017 and before January 1, 2023. This change may be significant for certain businesses and will flow through to a small group of states that are automatically tied to the federal bonus depreciation provisions.

However, most states have enacted legislation to fully decouple from the bonus depreciation provisions of section 168(k). Of the minority of states that do conform to section 168(k), some require the bonus depreciation to be deferred and recovered over a period of years set by statute, while others conform to section 168(k) with no modification.

Accordingly, taxpayers should be aware that when filing the corresponding 2018 amended state tax returns (as applicable) or reporting the accounting method change to the states for the above-mentioned retroactive application of bonus depreciation to QIP, the tax impact of this deduction must be analyzed and adjusted to conform with applicable state tax requirements.

Certain taxpayers may consider amending their 2018 federal return to claim 100 percent bonus depreciation. The amended federal return will trigger a requirement to file amended returns in most states, even in those which have decoupled from the bonus depreciation provisions of section 168(k).

CARES Act QIP changes go beyond the provisions of section 168(k). The CARES Act makes changes to the MACRS and ADS class life of QIP, retroactively amending sections 168(e)(3)(E) and 168(g)(3) to reduce the recovery period of QIP for MACRS and ADS to 15 and 20 years, respectively. As mentioned above, most states have decoupled from the section 168(k) bonus deprecation provisions. However, very few states have decoupled from the MACRS and ADS class life recovery periods in section 168. Accordingly, the CARES Act changes to substantially shorten recovery periods for QIP will likely be reflected in the state depreciation computations without regard to the state’s conformity to bonus depreciation. As with the other CARES Act provisions, some states will pick up these QIP class life changes automatically while many other states will only pick up the changes when they update their conformity statutes.

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References

¹ Coronavirus Aid, Relief, and Economic Security Act, H.R. 748, 116th Cong. (2020). A copy of the CARES Act is available here.

² Id. at Sec. 2303.

³ Id.

⁴ Id. at Sec. 2306.

⁵ Id. at Sec. 2307.

⁶ The chart reflects state laws in effect as of April 3, 2020.

⁷ Nevada, Ohio, South Dakota, Washington, and Wyoming are not included within this table as these states do not impose a corporate income or franchise tax.

⁸ Reflects treatment for Business Corporation Tax, General Corporation Tax, and Unincorporated Business Tax purposes.

⁹ The chart reflects state laws in effect as of April 3, 2020.

¹⁰ Nevada, Ohio, South Dakota, Washington, and Wyoming are not included within this table as these states do not impose a corporate income or franchise tax.

¹¹ Prior to carrying back any NOL, the 10-year carryforward period must first be exhausted. If any NOL remains after the expiration of the 10-year carryforward period, the taxpayer may then carryback the NOL up to three years immediately prior to the year of the loss. Kan. Stat. Ann. §§ 79-32,143(a), (d).