State tax implications of phase three relief

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April 2020

Overview

The Coronavirus Aid, Relief, and Economic Security Act (the CARES Act), enacted March 27, includes business tax provisions with potential state tax implications. These include modifications to the following provisions that were enacted as part of the 2017 federal tax reform legislation (TCJA):

  • A temporary relaxation of the Section 163(j) interest expense deduction limitation by allowing businesses to elect to increase the limitation from 30% of adjusted taxable income (ATI) to 50% of ATI for 2019 and 2020 and allowing a business to elect to use 2019 ATI in calculating its 2020 limitation. For 2019, this provision does not apply to partnerships; instead, partners may deduct 50% of their distributive share of the partnership’s excess business interest in 2020 without regard to Section 163(j). 
  • Allows a net operating loss (NOL) from tax years beginning in 2018, 2019, or 2020 to be carried back for five years. The provision temporarily removes the current-law taxable income limitation to allow an NOL deduction to fully offset income in tax years beginning in 2018, 2019, and 2020. The provision also makes a retroactive technical correction to the 2017 tax reform act to allow NOLs arising in a tax year beginning in 2017 and ending in 2018 to be carried back two years.
  • A technical correction to the TCJA to provide a 15-year recovery period for qualified improvement property (QIP). This technical correction makes QIP eligible for bonus depreciation and is effective as if enacted as part of the 2017 tax reform act.

The potential state tax implications of these changes depend on the manner in which a state conforms to the Internal Revenue Code (IRC) and then whether the state has decoupled or has a modification that impacts the specific federal provision affected by the CARES Act. For those states that conform on a rolling basis, these changes are automatically operative, but, as discussed in more detail below, could lead to state income tax results that differ from federal tax treatment as a consequence of other differences in federal and state tax law. For those states that conform on a fixed-date basis, state legislatures will need to proactively conform to these changes; with the current uncertainty of when state legislative sessions may resume, it is not clear if or when such states will extend similar state tax relief provided by the CARES Act.

The takeaway

The CARES Act may have significant state and local income tax effects. Entities will need to evaluate how the CARES Act impacts not only their current tax expense, but also their previous valuation allowance assessments on state deferred tax assets.

Areas of particular significance for states may include the provisions related to changes in the interest expense limitations, changes in the 2018 through 2020 NOL provisions, and retroactive full-expensing for QIP. The threshold state income tax questions are whether and how a state adopts the IRC. As noted above, states generally adopt the IRC in one of three ways:

  • Rolling date conformity: State adoption of the IRC conforms to federal amendments automatically;
  • Fixed date conformity: Conformity with the IRC remains fixed as of a specific date until the state legislature adopts a new date; or
  • Adoption of select sections of the IRC.

Based on these conformity rules, each state will need to assess the impact of the change in tax law as of March 27, 2020. Companies will need to evaluate how each state adopts the IRC and record their state tax provisions based on the enacted state law.

Contact us

Peter Michalowski

State and Local Tax Leader, PwC US

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