During these uncertain times of the COVID-19 pandemic, many companies face closures, decreased sales, and a surplus of inventory, among other challenges. Under these circumstances, maintaining your company’s operations and staff are top of mind.
Most of the following strategies available to companies offer a number of opportunities to increase current year losses and the recovery of taxes paid in prior years.
Here’s a list of tax tools that can be used to generate a one-time or recurring cash flow for your operation:
More details are provided for each of the strategies in the individual sections below.
Quick Refunds Available for C Corporations
During times of business disruption, C corporations could be looking to quickly generate increased cash flow.
For a C corporation whose estimated tax deposits significantly exceed its anticipated tax liability, one option is to file a quick refund claim before its original tax return filing date.
This opportunity is only available for C corporations if their anticipated overpayment is at least:
- 10% of its expected tax liability
To apply for the quick refund claim, calendar-year corporations must file Form 4466 no later than July 15, 2020.
The IRS will act on the form within 45 days from the filing date. Some states could also allow a quick refund of income taxes.
If the refund requested by the corporation is greater than the refund due when the return is filed, the corporation will be liable to pay the additional tax and interest when returns are filed.
Net Operating Loss Carrybacks and Carryforwards
The Coronavirus Aid, Relief, and Economic Security (CARES) Act allows a taxpayer to decide whether to carry net operating losses (NOLs) back or carry them forward; an election can be made for each separate tax year in 2018, 2019, and 2020.
Most companies will benefit by choosing to carry the loss back because tax reform in 2018—also known as the Tax Cuts and Jobs Act (TCJA)—lowered the corporate tax rate from 35% to 21% at the start of that year. Instead of receiving $21 of benefit for every $100 of loss carried forward, a corporation could receive $35 with a carryback—a permanent difference.
Prior to the TCJA, NOL carrybacks for corporations often resulted in alternative minimum tax credits as opposed to a full refund on prior taxes paid. The CARES Act now allows taxpayers to accelerate refunds of these credits to one year from the prior four years under the TCJA.
If the taxpayer has an opportunity to carry back a 2018, 2019, or 2020 loss, it could be beneficial to maximize the loss to the extent there’s income and associated taxes to recover during the five-year carryback. A downturn in the economy offers a number of unique opportunities to enhance such losses.
For more details, please watch the webcast Net Operating Losses Carryback Opportunities.
Electing to Treat Certain 2020 Losses as 2019 Deductions
Taxpayers could make an election to treat certain losses arising from a presidentially-declared disaster as having occurred in the prior tax year. This election results in all eligible losses directly linked to the disaster being deductible on the prior year’s return.
Such losses must be evidenced by a closed and completed transaction that is not reimbursed by insurance, but can include the following:
- Losses from inventory sold below cost
- Inventory donations to non-charities
- Costs associated with closures such as lease origination or lease improvements
- Previously capitalized costs on abandoned expansion plans
The election and corresponding deduction will require the following documentation:
- Identification and calculation of the disaster losses after giving consideration to insurance or other financial indemnities
- Factual analysis establishing the cause and effect of the disaster to the losses
It’s important to note this provision is typically available in the context of a natural disaster, such as a wildfire or hurricane, and limited to geographic area. Guidance is needed to understand its implications in a pandemic.
The choice to make the election should be part of an overall cash flow strategy that considers the enhanced carryback and quick refund opportunities.
Below is a list of inventory strategies where tax deductions can be accelerated.
Deduction for Subnormal Goods
A tax deduction for the write-down of subnormal finished goods could be allowed if careful steps are followed. While many companies record inventory obsolescence reserve on their generally accepted accounting principles (GAAP) financial statements, these reserves aren’t typically deductible for tax until realized.
If steps are taken near to and following year-end, a deduction for subnormal goods is permitted for income tax purposes. The lower inventory valuation must be substantiated by providing evidence of the following:
- Actual offerings
- Actual sales
- Actual contract cancellations
Subnormal raw materials and subnormal work in process are governed by different rules than finished goods, but also offer opportunities to accelerate tax deductions.
The net realizable value of subnormal raw materials or work-in-process must be established on a reasonable basis taking into consideration the usability and condition of the goods, but not below scrap value. When writing down subnormal raw or work-in-process materials, the taxpayer must satisfy the burden of proof in the US Department of the Treasury (the Treasury) Regulations.
The IRS guidance has clarified that taxpayers may not deduct the same inventory basis twice and need to choose between the above strategies–inventory losses from the disaster loss election and the accounting provisions for impaired inventory–when seeking accelerated deductions.
Corporate Charitable Giving of Inventory
The CARES Act increased the limitation on charitable contributions from 10% to 25% of taxable income for corporations for donations made in 2020.
Companies with taxable income in 2019 and 2020 should consider taking advantage of donations for specific use to qualified charities where they may be able enhance the allowable deduction up to two-fold. This deduction is especially applicable to companies in the food, beverage, and restaurant industries.
Proper documentation needs to be in place by the corporate filing date to receive the enhanced deduction.
However, companies expecting taxable losses in 2019 or 2020 that have prior year income eligible for the carryback could consider a different strategy. If they are able to characterize qualifying donations as advertising expenses, the donations aren’t subject to limits based on current year income.
The company must establish that the donation was publicized in a manner sufficient to enhance the brand. Such an approach could increase the loss carry back refund assuming the company paid sufficient taxes during the prior five years.
Accelerating Deductions for Partially Worthless Bad Debt
There’s a significant opportunity for taxpayers to accelerate bad debt deductions of trade receivables by electing to write-down partially worthless debt.
Many companies add back the book bad debt reserve and don’t deduct bad debt for income tax purposes until the asset is actually written off. However, there are a number of situations in which partial worthlessness of a debt can be identified and partially charged-off prior to a balance sheet write-off.
With proper analysis and documentation, the taxpayer could, in effect, recognize a portion of the bad debt reserve as an expense for tax purposes at a significantly earlier point.
Accelerating Deductions for Returns and Allowances
There are also significant opportunities for taxpayers to accelerate reserves for returns and allowances by determining where the return or allowance is fixed and not an estimate.
Many companies add back the return and allowance reserve and don’t deduct until such time as the inventory is returned or the allowance refunded. However, the following are a number of situations where a portion of the reserve can be identified as deductible:
- Contractual terms such as markdowns and advertising
- Lags in record keeping during the return process
- Identification of disputed receivables
The deduction of such reserves requires analysis to determine the amount eligible for acceleration and documentation to support it.
Cost Segregation Studies and Qualified Improvements
Cost segregation is a tax deferral strategy that frontloads depreciation deductions into the early years of ownership. It does so by segregating cost components of a building into the proper asset classifications and recovery periods for federal and state income tax purposes.
The end result is significantly shorter tax lives—five-year, seven-year, and 15-year depreciation periods—that can lead to bonus depreciation eligibility rather than the standard 39-year depreciation periods.
In addition, the CARES Act included the long-awaited technical correction to qualified improvement property (QIP).
Any improvement made by the taxpayer to the interior portion of nonresidential real property after the building was first placed in service—excluding improvements to enlarge the building, any elevator or escalator, or the internal structural framework of the building—could be considered a QIP.
The fix is retroactive so taxpayers that placed QIP in service in 2018 are able to treat such property as 15-year property eligible for bonus deprecation. Depending on when QIP was placed in service, the taxpayer may need to file for an accounting method change.
Tax Accounting Method Changes
Accelerating deductions and deferring revenue in stable tax environments is always good tax planning. These timing differences can create significant cash flow benefits for taxpayers. However, when combined with the recent opportunity to carryback net operating losses, these planning strategies can also create significant permanent differences for such taxpayers.
The following are typical opportunities where a taxpayer can change their method of accounting to accelerate deductions or defer revenue through an accounting method change:
- Accrual to cash for taxpayer with $26 million or less of revenue over a 3-year period
- Accelerate the deduction of certain prepayments including services, advertising, catalogue costs, insurance, and property taxes
- Deferral of revenue for cash received from gift cards
- Accelerating the deduction for website development costs
- Changes to accounting for cash discounts from gross to net invoice method
Accounting method changes also offer the opportunity for taxpayers using an impermissible method of accounting to correct the method and defer cost of the correction over four years while protecting against prior year audit adjustments.
Increase of Section 163(j) Limit
The CARES Act increases the Section 163(j) interest deduction limitation from 30% to 50% of adjusted taxable income (ATI) for tax years beginning in 2019 or 2020. Partnerships, however, remain subject to the 30% limitation for tax years beginning in 2019.
Taxpayers eligible for the 50% limitation could elect to use the 30% limitation instead. In addition, all taxpayers, including partnerships, may elect to use their ATI for the tax year beginning in 2019 to compute their Section 163(j) interest deduction limitation for the tax year beginning in 2020. This favorable election should be beneficial for many businesses dealing with a downturn from the pandemic.
Partners that are allocated excess business interest expense (EBIE) for tax years beginning in 2019 are able to deduct 50% of that EBIE in tax years beginning in 2020 while the remaining 50% of the 2019 EBIE is subject to the normal Section 163(j) rules. The expense is carried forward to tax years for which the partner is allocated sufficient excess taxable income (ETI) from the partnership.
Suspension of Excess Business Loss Rule Through 2020
The CARES Act modifies excess business loss (EBL) rules for noncorporate taxpayers by postponing the effective date of the provision to tax years beginning after 2020. EBL rules previously limited the amount of business losses against other income.
Those taxpayers that filed 2018 tax returns reflecting an EBL are presumably eligible to file an amended tax return to remove any imposed EBL limitation and receive a refund.
2020 Payroll Planning Opportunities
The CARES Act provided several opportunities to defer or receive a permanent credit against payroll. The opportunities are listed below.
Payment of Employer Payroll Taxes Deferred
Employers can defer payment for the employer portion of payroll taxes incurred on March 27, 2020, through December 31, 2020.
If deferred, the employer would instead pay 50% of this amount by December 31, 2021, and the remaining 50% by December 31, 2022. The eligible payroll taxes are the employer’s portion of Social Security taxes—6.2% of an employee’s wages.
Employers that have loans forgiven under the Payroll Protection Program (PPP) loan—Section 1102 of the CARES Act—aren’t eligible. However, qualifying payroll amounts may be deferred up until the date the loans are actually forgiven.
Employee Retention Credit for Employers
Eligible employers may claim a credit against Social Security taxes for each qualifying calendar quarter, equal to 50% of qualified wages, and up to $10,000 for all quarters per employee. The maximum credit could be worth up to $5,000 per eligible employee.
Eligible employers operating a business during 2020 must have experienced either:
- A partial or full suspension of the operation of their trade or business during the calendar quarter due to governmental orders that limited commerce, travel, or group meetings due to COVID-19.
- A significant decline in gross receipts from 2019.
Employers who take advantage of the PPP loan aren’t eligible. Also, qualified wages don’t include amounts paid for the sick leave credit or family leave credit enacted by the Families First Coronavirus Response Act (FFCRA) described below.
The Families First Coronavirus Response Act
The FFCRA, enacted on March 18, 2020, requires certain employers to provide employees with paid sick leave or expanded family and medical leave for specific reasons related to COVID-19.
Additionally, the FFCRA provides temporary tax credits for impacted employers and self-employed individuals for emergency paid leave. These provisions will apply from April 1, 2020, to December 31, 2020.
Under the FFCRA, covered employers required to provide paid sick leave—or expanded family and medical leave for specific reasons related to COVID-19—will qualify for an immediate dollar-for-dollar tax offset against the payroll taxes they paid each quarter.
For more details, please read our Alert.
Taxpayers with ownership of real estate, inventories, equipment, facilities, offices, storefronts, or other property will generally be assessed property tax on a specified taxable value.
In many jurisdictions, this taxable value can be reviewed for potential opportunities in order to assess proper liability.
A review of valuation, asset life classification, inventory exemptions, intangible property, and other cost savings opportunities could provide opportunity to:
- Reduce current year expenses
- Recoup overpaid tax
- Reduce future expenditures
Here’s a list of considerations if you’re thinking about reviewing your property tax liability:
- Review your property tax values and consider a real estate valuation study to substantiate any reduction in value.
- Examine asset listings with jurisdictions by completing an asset review that will assess taxability of intangible property, reporting of out-of-service assets, and proper trending factors.
- Review filings for Freeport Exemptions that can reduce property tax on inventory holdings.
R&D Tax Credit
The R&D tax credit is a dollar-for-dollar tax savings that directly reduces a company’s tax liability. The R&D tax credit is available to companies developing new or improved products or processes, including software, that result in increased performance, functionality, efficiency, reliability, or quality.
There is no limitation to the amount of expenses and credit that can be claimed each year, and any unused credit can be carried forward for up to 20 years. Previously filed tax returns can typically be amended for up to three years in order to claim the R&D credit retrospectively providing an avenue to recoup previously paid taxes.
For more details, please see our Guide to Claiming the Federal R&D Tax Credit.
Tax Credit for Alternative Fuels
President Trump signed the Further Consolidated Appropriations Act into law on December 17, 2019, which retroactively restored the refundable federal tax credit for the sale or use of alternative fuels including propane.
The credit—which originally expired on December 31, 2017—is now extended for fuel sold or used through December 31, 2020.
IRS Notice 2020-8 provides procedural guidance for 2018 and 2019 refund claims. Taxpayers may claim a one-time credit for fuels sold or used during 2018 and 2019 without having to file amended returns. This may provide substantial benefit to many businesses.
Claims must be filed by August 11, 2020.
Taxpayers must be registered with the IRS, make detailed calculations, and ensure they have documentation for claims.
For more details, please see our Alert.
The strategies below apply only to the state of California.
Sales and Use Tax
Effective March 30, 2020, all taxpayers who file a return with a liability of less than $1 million will receive an automatic extension to July 31, 2020 to file and pay the collected sales tax reimbursements from their customers. This means returns for the first quarter of 2020 and March 2020 filings originally due April 30, 2020, are extended automatically for an additional 90 days. 2019 annual use tax returns, originally due April 15, 2020, received an automatic extension to July 31, 2020 as well.
If your company’s liability is $1 million or more, you can still request an extension and relief from penalties and interest that would have applied due to the late filing or late payment of the tax. However, these requests will be approved on a case-by-case basis. Instructions can be located on the CDTFA website.
Finally, for business with less than $5 million in taxable sales, interest-free payment plans are available. Check the CDTFA website for more details.
Businesses should be aware that:
- The applicable tax return and payment of the sales and use tax in full needs to be completed by July 31, 2020.
- Failure to file the return or make the payment of sales and use tax in full at that time will subject the business to interest and penalties after July 31, 2020.
- As of May 11, 2020, second quarter and April monthly filing and payment dates have not been extended.
Businesses should be mindful of using tax collected from their customers for interim operating cash flow needs. The CDTFA isn’t waiving payment of tax.
Businesses still have an obligation to remit tax collected from their customers.
Not all other states have provided relief for either late filing or late payment. You can check the status of your state by visiting its tax collecting agency’s website. Check the date any information was posted to ensure it’s current.
Executive Order on CA Property Tax
Governor Gavin Newsom issued an executive order on May 6, 2020, suspending the California property tax late filing penalty provisions if property tax returns are filed by May 31, 2020. Since May 31, 2020, falls on a Sunday, any property tax statement mailed and postmarked on or before the next business day, June 1, 2020, will be deemed timely filed.
The executive order also extends the property tax payment date for:
- All owner-occupied residential real property
- Real property owned and operated by a qualified small business
The small business definition isn’t the same as the definition used for PPP loan eligibility, therefore it may not apply to larger organizations that were considered small businesses due to special carve outs in the CARES Act.
Governor Newsom’s order covers all tax jurisdictions within the state.
If you’re considering an opportunity to lower property taxes as a result of the market impact of COVID-19, it’s important to understand the lien date, and the time period for which substantial evidence is allowed to support such valuations.
In California, March 31 has historically been the latest date that market data is permissible to support valuations for the earlier January 1 lien date. Exceptions exist for certain disasters, but it remains to be seen whether the pandemic will qualify for such an exception. The appeals process in California has historically started on July 2.
Businesses should be aware that if paying real estate taxes are a condition of an existing lease obligation, they should consult their attorneys regarding available options for deferring payment.
We’re Here to Help
If you have any questions about how to increase cash flow for your business, please contact your Moss Adams professional.