Category Archives: Blog

Relaxed Limit on Business Interest Deductions

December 1, 2020

To provide tax relief to businesses suffering during the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security (CARES) Act temporarily relaxes the limitation on deductions for business interest expense. Here’s the story.

TCJA Created New Limitation

Before the Tax Cuts and Jobs Act (TCJA), some corporations were subject to the so-called “earnings stripping” rules. Those rules attempted to limit deductions by U.S. corporations for interest paid to related foreign entities that weren’t subject to U.S. income tax. Other taxpayers could generally fully deduct business interest expense (subject to other tax-law restrictions, such as the passive loss rules and the at-risk rules).

The TCJA shifted the business interest deduction playing field. For tax years beginning in 2018 and beyond, it limited a taxpayer’s deduction for business interest expense for the year to the sum of:

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

Business interest expense is defined as interest on debt that’s properly allocable to a trade or business. However, the term trade or business doesn’t include the following excepted activities:

• Performing services as an employee,
• Electing real property businesses,
• Electing farming businesses, and
• Selling electrical energy, water, sewage disposal services, gas or steam through a local distribution system, or transportation of gas or steam by pipeline, if the rates are established by a specified governing body.

Interest expense that’s disallowed under the limitation rules is carried forward to future tax years indefinitely and treated as business interest expense incurred in the carry-forward year.

Small Business Exception

Many businesses are exempt from the interest expense limitation rules under what we’ll call the small business exception. Under this exception, a taxpayer (other than a tax shelter) is exempt from the limitation if the taxpayer’s average annual gross receipts are $25 million or less for the three-tax-year period ending with the preceding tax year. Businesses that have fluctuating annual gross receipts may qualify for the small business exception for some years but not for others — depending on the average annual receipts amount for the preceding three-tax-year period.

For example, if your business has three good years, it may be subject to the interest expense limitation rules for the following year. But if your business has a bad year, it may qualify for the small business exception for the following year. If average annual receipts are typically over the $25 million threshold, but not by much, judicious planning may allow you to qualify for the small business exception for at least some years.

Special Rules for Partnerships and S Corporations

The interest expense deduction limitation rules get more complicated for businesses operating as partnerships, limited liability companies (LLCs) treated as partnerships for tax purposes and S corporations.

Basically, the limitation is calculated at both the entity level and at the owner level. Special rules prevent double counting of income when calculating an owner’s ATI for purposes of applying the limitation rules at the owner level.

IRS proposed regs set forth the special rules for applying the business interest expense limitation to partnerships and S corporations and their owners. The rules are complex and present significant compliance challenges.

Favorable CARES Act Changes

The CARES Act generally allows businesses, unless they elect otherwise, to increase the interest expense deduction limitation to 50% of ATI for tax years beginning in 2019 or 2020. Businesses can also elect to use 2019 ATI to calculate the 2020 ATI limitation, which can allow for a larger deduction if 2020 ATI is less, which may be the case for many businesses.

For partnerships (including LLCs treated as partnerships for tax purposes), the 30% of ATI limitation remains in place for tax years beginning in 2019 but is 50% for 2020. Disallowed partnership business interest expense from a partnership’s 2019 tax year is allocated to partners and carried over to their 2020 tax years.

Unless a partner elects otherwise, 50% of carried-over partnership business interest expense from 2019 is deductible in the partner’s 2020 tax year without regard to the business interest expense limitation rules. The remaining 50% is subject to the normal limitation rules, calculated at the partner level, for carried-over partnership business interest expense. Like other businesses, partnerships can elect to use 2019 ATI to calculate the 2020 ATI limitation.

Help is Available

As you can see, the business interest expense limitation rules are complicated. The temporarily relaxed limitations can allow affected businesses to reduce their federal tax liabilities for 2019 and 2020. However, for partnerships and partners, limitation rules are relaxed only for 2020. Your tax advisor can help your business take advantage of the relaxed rules for business interest expense deductions and benefit from other tax relief measures made available by the CARES Act.

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2020-2021 Tax Planning Guide

September 22, 2020

Do your tax strategies need a refresh? With individuals and businesses coping with the impact of the COVID-19 pandemic and some new tax laws going into effect, you probably have questions about tax planning this year. To save the most on your 2020 taxes, you need to plan carefully and take advantage of all deductions, credits and other breaks that current tax law allows. This is exactly what our online tax planning guide can help you do. So, look through the guide then contact us to talk about ways to lighten your tax burden and better achieve your financial objectives.

2020-2021 Tax Planning Guide

 

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The Ins and Outs of the Easing of Loss Limitation Rules

September 22, 2020

To provide businesses and their owners with some relief from the financial effects of the COVID-19 crisis, the Coronavirus Aid, Relief, and Economic Security (CARES) Act eases the rules for claiming certain tax losses. Here’s a look at the — mostly temporary — modifications.

Liberalized Rules for NOL Carryforwards

The CARES Act includes favorable changes to the rules for deducting net operating losses (NOLs). First, it eases the taxable income limitation on deducting NOLs.

Under an unfavorable provision included in the 2017 Tax Cuts and Jobs Act (TCJA), an NOL arising in a tax year beginning in 2018 or beyond and carried forward to a later tax year couldn’t offset more than 80% of the taxable income for the carryforward year (the later tax year), calculated before the NOL deduction.

For tax years beginning before 2021, the CARES Act removes the TCJA taxable income limitation on deductions for prior-year NOLs carried forward into those years. So NOL carryforwards to tax years beginning before 2021 can be used to fully offset taxable income for those years.

For tax years beginning after 2020, the CARES Act allows NOL deductions equal to the sum of:

• 100% of NOL carryforwards from pre-2018 tax years, plus
• The lesser of 1) 100% of NOL carryforwards from post-2017 tax years, or 2) 80% of remaining taxable income (if any) after deducting NOL carryforwards from pre-2018 tax years.

As you can see, this is a complicated rule. But it’s more taxpayer-friendly than what the TCJA allowed. This favorable change is permanent.

Carrybacks Allowed for Certain NOLs

Under another unfavorable TCJA provision, NOLs arising in tax years ending after 2017 generally couldn’t be carried back to earlier tax years and used to offset taxable income in those earlier years. Instead, NOLs arising in tax years ending after 2017 could only be carried forward to later years. But they could be carried forward for an unlimited number of years.

Under the CARES Act, NOLs that arise in tax years beginning in 2018 through 2020 can be carried back for five years. For example, a taxpayer could carry back an NOL arising in 2020 to 2015 and recover federal income tax paid for that year. That could be very beneficial, because the federal income tax rates for both individuals and corporations were higher before the TCJA rate cuts took effect in 2018.

When advantageous, taxpayers can elect to waive the carryback privilege for an NOL and, instead, carry the NOL forward to future tax years. In addition, barring a further tax-law change, the no-carryback rule will come back into play for NOLs that arise in tax years beginning after 2020.

Excess Business Loss Rules Postponed

Another unfavorable TCJA provision disallowed current deductions for so-called “excess business losses” incurred by individuals and other noncorporate taxpayers in tax years beginning in 2018 through 2025.

An excess business loss is one that exceeds $250,000 ($500,000 for a married joint-filing couple). These limits are adjusted annually for inflation.

The CARES Act removes the excess business loss disallowance rule for losses arising in tax years beginning in 2018 through 2020.

Barring a further tax-law change, the excess business loss disallowance rule will come back into play for losses that arise in tax years beginning in 2021 through 2025. Any disallowed excess business loss for one of those years will be carried forward to the following year and can be deducted under the rules for NOL carryforwards.

Amended Return Opportunities

These taxpayer-friendly CARES Act changes can affect prior tax years for which you’ve already filed returns. Amended returns may be needed to benefit from the changes. Please contact our office if you would like more information.

 

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