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CARES Act Interest Limitation Relief Could Have State Tax Effects

Posted on Apr. 2, 2020

There could be interesting state tax consequences stemming from the modification of the net business interest deduction limitation in the recent federal coronavirus economic relief package, KPMG LLP advisers said April 1.

The Tax Cuts and Jobs Act limited the section 163(j) deduction to 30 percent of a taxpayer’s adjusted taxable income, but businesses now have the option to deduct interest expense up to 50 percent of ATI for the 2019 and 2020 tax years under the Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136). Also, for tax years beginning in 2020, the CARES Act allows businesses to elect to use 2019 ATI for purposes of computing the 2020 limitation.

Almost half the states will automatically conform to the new increased business interest deduction limitation because they conform to the IRC on a rolling basis, Justin Hill of KPMG said during a webcast hosted by the firm. But legislative action is needed in fixed-date conformity or selective-conformity states, and many of them have either already updated their conformity to the IRC this year or have suspended their legislative sessions because of the pandemic, he said. 

There are noteworthy considerations aside from the conformity issue, Hill said. Michigan, for example, has a fixed-date conformity to the IRC as it was before enactment of the CARES Act but also gives taxpayers the option to use the IRC in effect for the tax year. “This may be an opportunity to apply the CARES Act changes in 2020, and potentially 2019, in Michigan as a result of the election,” he said.

“There are many other nuances with respect to conformity and different election opportunities and the dates in which 163(j) applies to particular states,” Hill said, adding that federal elections are important to note.

There may be situations, for example, when for federal consolidated purposes a taxpayer with a higher ATI in 2019 elects to use the 2019 figure for purposes of calculating the 2020 limitation. “That may or may not be beneficial from a state perspective, especially in separate-reporting jurisdictions,” Hill said. “So I think it’s important to think holistically when making an election and consider whether the federal election will apply, and the impact in the state context.” 

“From a big-picture perspective the changes to section 163(j) are very positive for taxpayers,” Hill said. But these changes will likely result in increased complexity in complying with already burdensome federal-state disconnects in calculating the business interest limitation, accounting for related-party addback rules, and tracking state carryforwards separately, he said.

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