Karen M. Jurichko-Lowell is an associate and Pat Derdenger is a partner at Lewis Roca Rothgerber Christie LLP in Phoenix.
In this article, the authors discuss key provisions of the Coronavirus Aid, Relief, and Economic Security Act and summarize state conformity status for corporate and personal income taxes.
In March Congress enacted the Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136), a $2 trillion package offering relief to individuals and businesses suffering from the impact of the COVID-19 pandemic. In addition to stimulus payments and expanded unemployment benefits available to individuals, the CARES Act made numerous changes to federal income tax laws.
Forty-six states1 plus the District of Columbia impose a state income tax that is based at least in part of the federal income tax provisions of the Internal Revenue Code. In some states the income tax law is written to continuously update based on the version of the IRC then in effect. In other states, however, the income tax law conforms to the version of the IRC on a specific date as defined by that state’s law, and further conformity requires legislative action. Finally, many states have adopted legislation or issued guidance conforming (or decoupling) from some or all of the CARES Act provisions.
This article reviews the key provisions of the CARES Act, and summarizes current state conformity status for both corporate and personal income taxes.
I. CARES Act Provisions
The following are some key tax provisions of the CARES Act that are generally applicable to individuals and businesses.
1. Net Operating Losses
The 2017 Tax Cuts and Jobs Act enacted restrictions on net operating loss carrybacks and carryforwards. The CARES Act relaxes these restrictions by allowing NOLs generated in 2018, 2019, or 2020 to be carried back five years before the year of the loss and permitting the NOL carryback to offset 100 percent of taxable income in the carryback years, without regard to the 80 percent limitation in the TCJA. However, taxpayers cannot file a carryback refund claim based on a 2020 NOL until the tax year has closed.
2. Excess Business Losses
For noncorporate taxpayers, the TCJA disallowed the deduction for excess business losses for tax years beginning after 2017 and ending before 2026. Excess business losses are the amount by which the total deductions attributable to all trades or businesses exceed the total gross income and gains attributable to those trades or businesses plus $250,000 (or $500,000 for a joint return).
The CARES Act eliminated the excess business loss deduction limitation for losses arising in 2018, 2019, and 2020. This change means that net business losses in any of those tax years can be used to offset the taxpayer’s other sources of income, and any excess may also give rise to an NOL that may be carried back under the rule described above.
3. Business Interest Expense Limitation
The business interest expense deduction was generally limited to 30 percent of adjusted taxable income by the TCJA. The CARES Act temporarily increases the limitation to 50 percent of ATI for tax years beginning in 2019 and 2020. For the 2020 tax year, taxpayers can elect to use their 2019 ATI as the basis for determining the interest expense limitation, which may permit taxpayers to increase the allowable deduction if 2019 income is higher than 2020 income. Partnerships, however, are subject to more complex rules.
4. Qualified Improvement Property
The CARES Act corrects a significant drafting error in the TCJA that made some improvements to the interior portion of a nonresidential building (including leasehold improvements, restaurant property, and retail improvement property) ineligible for bonus depreciation. With the enactment of the CARES Act, this property is now eligible for bonus depreciation. This fix may be particularly beneficial to retail and hospitality businesses, which have been among the most significantly affected by the pandemic. The amendment applies retroactively to January 1, 2018 (the original effective date of the TCJA), creating a significant refund opportunity for taxpayers who choose to amend their returns.
5. Charitable Contributions Deductions
Before the CARES Act, corporations were able to claim a deduction of up to 10 percent of taxable income for cash donations to qualifying charitable organizations. The CARES Act increases this limitation for the 2020 tax year from 10 percent to 25 percent on an elective basis.
1. Economic Impact Payments
Some taxpayers were eligible to receive a one-time economic impact payment under the CARES Act of $1,200 ($2,400 for joint taxpayers) and $500 for each child under 17.
A number of states, including California, Connecticut, Hawaii,2 Iowa,3 Mississippi,4 and Pennsylvania,5 have issued guidance or adopted legislation exempting the CARES Act economic impact payments from state income tax.
2. Charitable Contribution Deductions
The CARES Act amended the rules for deductions for charitable contributions to encourage taxpayers to donate to qualifying charitable organizations. Taxpayers who do not itemize their deductions are allowed to deduct up to $300 of cash donations for the 2020 tax year (usually, a deduction is available only if the taxpayer itemizes).
Under the TCJA, many taxpayers were unable to claim deductions for charitable contributions because of the increased standard deduction. Also, before the CARES Act individuals were entitled to deduct only up to 50 percent of adjusted gross income for cash donations. The CARES Act suspends this limitation for individuals for the 2020 tax year.
3. Retirement Accounts
The CARES Act waives the 10 percent penalty on an early distribution from a retirement plan (including IRAs, 401(k) plans, and other defined contribution retirement plans) when the distribution is taken for coronavirus-related reasons. Ordinarily, a penalty is imposed when a retirement plan participant takes a distribution before age 59-1/2 and no exceptions apply. The CARES Act extends the eligible exceptions to include distributions related to the pandemic. Also, while distributions must still be included in the taxpayer’s gross income, the CARES Act allows taxpayers to spread the distribution over three years. Normally, the entire distribution must be included in income for the year of the distribution. Finally, the CARES Act temporarily increases the amount a taxpayer can borrow from a retirement plan from the greater of $50,000 or 50 percent of the taxpayer’s vested balance to $100,000 or 100 percent of the vested balance. Taxpayers can borrow the increased amount through September 25 (180 days from March 29), and repayment generally begins on January 1, 2021.
II. State Reactions
This section summarizes state action in response to the amendments in the CARES Act. The section has been divided by states with rolling conformity, states with static or no IRC conformity, and states that have taken specific action in response to the CARES Act.
A. Rolling Conformity
Many states with an income tax use what is known as rolling conformity, meaning that the state’s income tax code automatically incorporates changes made to the IRC without any action required by the legislature. Furthermore, decoupling from federal law would require legislative action. The following states have adopted the provisions of the CARES Act based on rolling conformity:
B. Legislation and Guidance Regarding CARES Act Provisions
The following states have adopted legislation or issued other guidance regarding the application of the CARES Act. Also, some of these states have different conformity rules for corporate and personal income tax.
California: The state generally has static conformity to the IRC and requires legislative action to adopt amendments to the IRC. According to guidance issued by the Franchise Tax Board, California does not conform to the modifications for NOLs adopted in the CARES Act for franchise or income tax purposes. However, California does conform for purposes of the waiver of penalties on early withdrawals from qualifying retirement accounts.
Colorado: On July 11 Gov. Jared Polis (D) signed H.B. 1420, the Tax Fairness Act. The bill makes the following modifications to the income tax law:
For tax years either beginning or ending between March 27, 2020 (the enactment date of the CARES Act), and January 1, 2021, taxpayers must add the following amounts to their federal taxable income when determining Colorado income:
the difference between the taxpayer’s NOL deduction as determined under federal law before the amendments made by section 2303 of the CARES Act and the taxpayer’s NOL deduction as determined under federal law after the amendments;
an amount equal to the taxpayer’s excess business loss as determined under federal law without regard to the amendments made by section 2304 of the CARES Act, but with regard to the technical amendment made in the same section; and
an amount equal to the amount in excess of the limitation on business interest under federal law without regard to the amendments made by section 2306 of the CARES Act.
For tax years commencing on or after January 1, 2021, taxpayers must add to their federal taxable income an amount equal to the deduction for qualified business income for an individual taxpayer whose adjusted gross income is greater than $75,000 ($150,000 for joint filers) when determining Colorado income.
The amount of NOL that a corporation may carry forward is limited to $400,000. A corporation may add the amount of all NOLs that the corporation cannot subtract, with interest, to the allowable NOL that is carried forward.
The state income tax modification for qualifying net capital gains is eliminated for tax years starting on or after January 1, 2021.
H.B. 1420 also makes a number of changes to Colorado sales tax laws. Guidance prepared by the Department of Revenue is available on the state website.7
NOLs: For corporate business tax purposes, Connecticut has its own rules regarding NOLs that are not affected by federal carryforward and carryback rules. Also, for individual income tax purposes, the carryback of federal NOLs that affect an individual’s Connecticut income tax liability are applied according to the Connecticut Tax Court’s decision in Adams v. Sullivan, No. CV 11 6011324 (Conn. Sup. Ct. July 24, 2014), and Conn. Gen. Stat section 12-727(b). Taxpayers should be aware that the NOL provisions in the CARES Act do not affect an individual’s Connecticut-source loss if there is no corresponding federal loss; rather, the rules in Conn. Agencies Regs. section 12-711(b)-6 apply.
Excess business loss limitation: Connecticut does not statutorily modify the excess business loss limitation in IRC section 461(l) for determining Connecticut AGI.
Distributions from qualified retirement accounts: There are no Connecticut statutory modifications specific to coronavirus-related distributions for calculating Connecticut AGI. Therefore, to the extent that these distributions are included or excluded from federal AGI in a particular year will dictate the Connecticut tax treatment of the distributions.
Qualified improvement property: For corporate tax purposes, Connecticut conforms to the calculation of depreciation under the IRC except for section 168(k). Thus, Connecticut conforms to the changes made to the depreciable life of qualified improvement property by the CARES Act, but does not conform to the ability to claim bonus depreciation on such assets.
Bonus depreciation: When determining Connecticut AGI for individuals and Connecticut taxable income for passthrough entities for tax years beginning on or after January 1, 2017, taxpayers are required to add back any amount of bonus depreciation allowed under IRC section 168(k) for property placed in service after September 27, 2017. Also, if the taxpayer files federal Form 3115, the amount of the adjustment under IRC section 481(a) regarding bonus depreciation must be added back to Connecticut income. Finally, if the taxpayer files a federal amended return to reflect the change in the depreciation of qualified improvement property, the taxpayer must also file a Connecticut amended return and add back the amount of any depreciation allowed under section 168(k). Taxpayers are allowed to deduct 25 percent of the amount of each of these addbacks in each of the four succeeding tax years.
Georgia: On June 30 Gov. Brian Kemp (R) signed H.B. 846. The bill updated Georgia’s IRC conformity date for tax years beginning on or after January 1, 2019, to generally conform to the IRC in effect March 27, 2020. However, Georgia did decouple from some of the provisions adopted in the CARES Act, including the revised NOL provisions. Additional guidance from the DOR is available on its website.10
Iowa: On June 29 Gov. Kim Reynolds (R) signed H.F. 2641, adopting rolling conformity to the IRC for tax years beginning on or January 1, 2020. Iowa did not, however, adopt the provisions of the CARES Act as they apply to earlier tax years. Guidance issued by the DOR addresses Iowa’s nonconformity.11
Maryland: Maryland generally conforms to the IRC on a rolling basis and requires legislation to decouple from any new amendments. However, if the comptroller determines that federal amendments will affect state revenue by $5 million or more, Maryland automatically and temporarily decouples for the tax year in which the amendments are passed. The comptroller determined that the impact of the amendments in the CARES Act will exceed that threshold and issued a letter dated June 12. The effect is that Maryland will conform with the CARES Act for tax years before 2020, but decouples for the 2020 tax year.
Massachusetts: The DOR issued Taxpayer Information Release (TIR) 20-9 July 13 with information regarding CARES Act conformity for personal and corporate income taxes. For the individual income tax, Massachusetts conforms to the IRC as it existed January 1, 2005, but automatically conforms to the current code for specific provisions, including sections 72, 401-20, and 457 (federal retirement plans) and section 163 (business interest deduction). TIR 20-9 explains that Massachusetts does not conform to the CARES Act regarding the limitation on deductions for charitable contributions, exclusion for some student loan payments, and the limitation on business losses.
For the corporate income tax, Massachusetts conforms to the IRC in effect for a given tax year. As such, Massachusetts conforms to the CARES Act provisions except that it has specifically decoupled from the changes to section 172 (NOLs) and section 168(k) (bonus depreciation rules).
Michigan: Taxpayers may elect to conform to the IRC on a rolling basis, or conform to the version of the IRC that existed January 1, 2018.12 Also, on June 8 the state Department of the Treasury issued guidance13 on how the business interest expense limitation under section 163(j) affects Michigan taxpayers, particularly unitary business groups.
New Mexico: The state automatically conforms to the IRC; however, on June 29 Gov. Michelle Lujan Grisham (D) signed H.B. 6, which decouples New Mexico from the NOL provisions of the CARES Act. The bill also provides state tax relief14 in the form of waiving interest and penalties on late tax payments for specific taxpayers, doubling distributions of revenue from gross receipts tax on online sales to cities and counties, and exempting federal CARES Act payments to some New Mexico healthcare providers from gross receipts taxes. H.B. 6 was passed in the Legislature’s 2020 special session.
New York: New York generally adopts the IRC on a rolling basis. However, the Department of Taxation and Finance issued Notice N-20-7 June 10, informing taxpayers that the CARES Act amendments do not apply to individual income tax returns.
North Carolina: On June 30 Gov. Roy Cooper (D) signed H.B. 1080. The bill updates the state’s IRC conformity date to May 1, 2020, but decouples from the NOL and interest expense provisions of the CARES Act. On July 20 the DOR issued guidance15 on the effects of H.B. 1080.
Oregon: Oregon has a static conformity date of December 31, 2018, unless the provision in question relates to the definition of taxable income, in which case Oregon prospectively adopts the version of the IRC in effect for that tax year. Adopting other amendments to the IRC requires action by the legislature.
Pennsylvania: For corporate income tax purposes, Pennsylvania has rolling conformity and requires legislation to decouple from new amendments. Pennsylvania follows the current version of the IRC. However, for personal income tax purposes Pennsylvania adopts only specific IRC sections but not the code as a whole, although the provisions conform on a rolling basis. Also, Philadelphia issued guidance16 on the effect of the CARES Act on the city business income and receipts tax.
Wisconsin: The state has static conformity; however, on April 15, A.B. 1038 was enacted, adopting the provisions of the CARES Act.
C. No Conformity
The following states have static conformity to the IRC, meaning that state law specifies that the tax law conforms to the IRC in effect as of a particular date designated by statute. Changing the date of conformity requires an act of the legislature. The following states have not updated their conformity dates to adopt the provisions of the CARES Act:
CARES Act conformity varies widely from state to state. The information in this article is current as of August 10. Taxpayers should be aware that the states where they file income tax returns may issue additional guidance or adopt legislative changes before the filing deadlines for the 2020 tax year.
1 Four states impose no corporate or personal income tax: Nevada, South Dakota, Washington, and Wyoming. Also, Alaska, Florida, and Texas do not have a personal income tax. Finally, New Hampshire and Tennessee do not tax wages, but do impose an income tax on some investment income and interest.
3 Iowa Department of Revenue, “Iowa Nonconformity: Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020.”
6 Corporate income tax only; Tennessee imposes an individual state income tax only on interest from bonds and stock dividends.
11 Iowa DOR, supra note 3.
12 See Mich. Comp. Laws sections 206.607(6) (corporate taxpayers) and 206.12(3) (individual taxpayers).
13 Michigan Department of Treasury, “Notice: Corporate Income Tax Treatment of the IRC 163(j) Business Interest Limitation” (June 8, 2020).
15 North Carolina DOR, “Important Notice: North Carolina’s Reference to the Internal Revenue Code Updated — Impact on North Carolina Corporate and Individual Income Tax Returns” (July 20, 2020).
16 Philadelphia DOR, “Federal Coronavirus Aid, Relief, and Economic Security (CARES) Act — Net Operating Losses (NOLs) Guidance” (June 26, 2020).
17 Florida has static conformity for the purposes of the corporate income tax. Florida does not impose an individual income tax.
18 Corporate franchise tax only; Texas does not impose an individual income tax.