What Do Business-Owning Clients Need to Know About the Impact of the CARES Act?

CARES Act changes involving tax aspects for businesses—including provisions affecting business interest deductions, net operating losses (NOLs), payroll tax deferrals and employee retention credits—could significantly affect business valuations in the future.

Jul 9th 2020
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The Coronavirus Aid, Relief and Economic Security (CARES) Act, signed into law back on March 27, was intended to provide stopgap relief to beleaguered businesses. But the impact will be long lasting.

For instance, the CARES Act temporarily repeals the 80 percent income limit for NOLs, retroactive to 2018. This change could result in tax refunds and boost cash flow.

To help CPAs and other valuation experts meet the challenges ahead, the American Institute of CPAs (AICPA) has issued answers to a set of frequently asked questions (FAQs) about adjusting business valuations in the wake of the CARES Act. Following is a sampling of the FAQs relating to the key tax provisions.

Q. When should a valuation analyst consider the impact of the business tax provisions?

A. Generally, an analyst should factor this into the valuation if the business tax provisions were known, or should have been known, on the valuation date. If uncertainty exists as of the valuation date, the valuation analyst may want to consider scenario analysis.

Q. How do the business tax provisions affect the analysis of the entity?

A. The business tax provisions may create immediate or future increases to the entity’s cash flows. Besides weighing this aspect, the analyst should determine the impact, if any, to the balance sheet in the form of deferred tax assets and/or deferred tax liabilities.

Q. What adjustments might be considered for the asset approach?

A. For a valuation prepared under the asset approach, the valuation analyst should consider if the business tax provisions applicable to the entity generate any assets or liabilities which aren’t already reflected on its financial statements as of the valuation date.

Q. How might the business tax provisions affect the entity’s cost of capital?

A. If a valuation analyst is using a weighted average cost of capital (WACC) in determining value under an income approach method, he or she should consider if the interest rate deductibility in the CARES Act impacts the entity’s long-term cost of debt at the valuation date. The analyst may need to adjust the cost of debt in the WACC to reflect the deductible amount.

Q. What adjustments might be considered for the market approach?

A. The valuation analyst should understand the provisions applicable to both the  company and publicly traded guideline companies or guideline company transactions. Also, he or she must consider the impact on financial metrics and valuation multiples an exclude any nonrecurring income or expenses from the earnings stream of the company.

Q. How might the business tax provisions affect pass-through entity tax benefits?

A. The temporary repeal of the excess loss limitations in the CARES Act may create an increased tax benefit to non-corporate taxpayers owning pass-through entities.

Q. What interview questions should the valuation analyst ask clients or prospects?

A. The list of questions may include the following:

  • Do they anticipate using any of the business tax provisions in the CARES Act?
  • Will you qualify for any employee retention credits?
  • Will you qualify for payroll tax deferral?
  • Do you have any NOLs subject to the carryback rules?
  • Do you have any losses in excess limits for non-corporate taxpayers which were repealed?
  • Does your business interest expense exceed 30 percent of taxable income?
  • Do you have any qualified improvement property (QIP) as defined by the CARES Act?

Note that this brief discussion has been limited to business tax implications in the CARES Act. The AICPA has also created FAQs regarding the following:

  • Whether Paycheck Protection Program (PPP)  loans will be forgiven, and treated as a grant, or whether the PPP loans are low-interest loans, and treated as debt, and how that determination alters projected net income or cost of capital.
  • How the SBA covering six-months of Small Business Debt Relief Program payments alters cash flow, increases net income or changes cost of capital.
  • If conducting a market approach, whether comparable companies benefitted from the CARES Act provisions and how that alters their multiples.
  • If acceptance of CARES Act funds indicates a business is under duress and as a result, past financial results are not indicative of future operations.

The FAQs are intended to provide clarity and consistency among valuation professionals, Practitioners should continue to rely on their experience and professional judgment when performing valuations.

Finally, be aware that the AICPA Coronavirus (COVID-19) Resource Center provides additional information and resources relating to the CARES Act. For a broader discussion on the impacts of COVID-19 on valuation, visit the Valuation Services COVID-19 Resource Page.

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