How Your Struggling Business Clients May See Some Relief

The Coronavirus Aid, Relief and Economic Security (CARES) Act provides various forms of tax relief to struggling businesses coping with the fall-out from the COVID-19 pandemic.

May 8th 2020
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One provision for businesses in the CARES Act that has mostly flown under the radar liberalizes the tax rules for business interest deductions imposed by the Tax Cuts and Jobs Act (TCJA). Best of all, these latest changes are retroactive to 2019, so a business can now recoup extra tax paid on a previous return.

Prior to the TCJA, businesses could generally deduct business interest expenses, subject to certain restrictions like passive activity rules and at-risk limitations. But there was no deduction limit based on the percentage of business interest.

The TCJA imposes new limits, beginning in 2018. Under the TCJA, the annual deduction is limited to:

  • Business interest income
  • 30 percent of adjusted taxable income (ATI)
  • Floor plan financing interest expense paid by certain vehicle dealers

Any excess could be carried forward to offset taxable income in a future year, but the annual limit remains in effect. Note that special rules may apply to real estate and farm operations. 

Key point: The TCJA also included an exemption from these rules for “qualified small businesses.” Specifically, there is no limit on the business interest deduction for businesses with average gross receipts of $25 or million or less (subject to inflation indexing) for the three-year period ending with the previous tax year. The inflation-indexed amount for the 2019 tax year is $26 million.

Now the CARES Act provides more flexibility under these rules. For starters, it raises the applicable ATI limit to 50 percent for the 2019 and 2020 tax years.  As a result, a business client might benefit by amending its 2019 return. Furthermore, a business can elect to use the 50 percent limit for 2020 based on its ATI in 2019. This may provide a bigger deduction than what would have been allowed for a business that will have a reduced ATI in 2020—a common fate.

Finally, be aware of a unique wrinkle in the CARES Act rules affecting partnerships. Although the new 50 percent-of-ATI limit extends to partnerships in 2020, and thus amounts passed onto partners, it isn’t available for 2019. Any disallowed business interest expense is suspended at the partner level.

In other words, 50 percent of the amount carried over from 2019 is deductible by the partner in 2020 without regard to the business interest deduction cap. The remaining 50 percent is then subject to the normal limit calculated at the partner level. As with other business entities, partnerships can elect to use 2019 ATI in order to calculate their 2020 ATI limit.

As you can see, these rules are extremely complex. Discuss the changes with your business clients to determine how to maximize their tax benefits.

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