SC&H’s Key Takeaways
- Under Maryland tax law, all changes to the Internal Revenue Code that would reduce Maryland tax revenues by $5 million or more are subject to decoupling, as well as certain provisions that are hard-wired into Maryland’s tax code
- The CARES Act included several taxpayer friendly provisions that trigger this analysis by the Comptroller’s office and they just issued public guidance
- Several key changes in the CARES Act will require separate and independent treatment when preparing Maryland tax returns:
- Net operating loss treatment for 2020
- Business interest deductions for tax year 2020
- Business loss deductions in 2020
- Qualified improvement property
The CARES Act became law on March 27, 2020. This legislation, which created PPP loans and other forms of economic relief for businesses and individuals, also contained several income tax provisions that were intended to increase deductions, and therefore cash flow, for taxpayers. The Comptroller of Maryland is just issuing guidance on how the decoupling modifications will be administered related to these provisions.
Maryland is a tax law conformity state, which essentially means Maryland tax law follows federal tax law, except when decoupling provisions are triggered. Some of those are already in place – bonus depreciation decoupling being the most common provision – along with others such as NOL modifications, estate tax thresholds, etc. Maryland does not allow bonus depreciation, so two sets of books for tax depreciation must be kept. When new tax legislation is enacted by the US Congress, Maryland tax authorities review each provision to determine its projected impact on Maryland tax revenues. Any provision which would reduce Maryland tax revenue by $5 million or more in the year of enactment is automatically decoupled from for Maryland purposes, absent legislative action to the contrary.
Four such instances exist from the CARES Act, which we will discuss below.
Net Operating Loss (NOL) Provisions
The CARES Act allowed 2018 and 2019 NOLs to be carried back up to 5 years, then carried forward if any loss remained. This was a change from the new rules that came with the Tax Cuts and Jobs Acts of 2017 (TCJA), which disallowed carrybacks. In addition, the TCJA only allowed 80% of a NOL carryforward to offset future income on an annual basis. The CARES Act allows 100% of a NOL carryforward to be utilized on 2018-2020 returns. (See our blog on this issue here)
Maryland law will allow carryback of 2018 and 2019 NOLs to prior years, as that change does not affect 2020 returns. This is good news and getting this guidance from the Comptroller now removes any doubt that prior year Maryland NOLs can be carried back to generate tax refunds. However, NOLs incurred in 2020 may not be carried back for Maryland purposes. Further, only 80% of a NOLs carried into 2020 from prior years may reduce 2020 income. This will mean that NOL carryover amounts for federal and Maryland purposes will be different and need to be separately tracked over time with annual differences reported on Form 500DM.
Business Interest Deductions
The TCJA introduced a new limit on business interest expense deductions starting with tax year 2018. Interest expense, for companies of a certain size, became limited to 30% of adjusted taxable income for each table year. Exceptions were provided and complexity ran deep in the changes to IRC 163(j). The CARES Act rolled these limitations back to 50% of adjusted taxable income for all business types except for partnerships, effective for tax years 2019 and 2020. In addition, when computing adjusted taxable income in 2020, one can elect to use the 2019 amount if that allowed more interest to be deducted. Partners would see more interest deductions being available to them in 2019 and 2020, under somewhat complex rules. (See our blog on this issue here)
Maryland will decouple from these favorable changes for tax year 2020. So, many taxpayers will have a different allowable interest deduction for federal purposes than they do for Maryland purposes in 2020. Further, if the additional deduction at the federal level affects a NOL, the NOL amount will be different in Maryland as well.
Business Loss Deductions Under IRC 461(l)
The TCJA limited the ability of business losses incurred by trusts and individuals to offset nonbusiness income to $500,000 per year. Excess losses would be carried over and wage income was considered business income, which helped to lessen the impact of this law change in 2017.
The CARES Act eliminates the limitation for tax years 2018 through 2020. This created an opportunity for amended returns and tax refunds for 2018 and tax reduction in 2019 and 2020 for affected taxpayers. (See our blog on this issue here)
Maryland will conform to the CARES Act changes for 2018 and 2019 only. For 2020, the limitations in place from the TCJA will once again apply. Note that Maryland will automatically follow the new provision from the CARES Act in 2021 that stipulates that wage income is not business income for purposes of these loss limitation rules.
Qualified Improvement Property (QIP)
The CARES Act corrected a drafting error in the TCJA that allows QIP to be classified as 15-year property for depreciation purposes. Most importantly, this meant that QIP was also eligible for 100% bonus depreciation for the year qualifying property is placed in service. QIP is generally improvements made to the interior of nonresidential real property. (See our blog on this issue here) The CARES Act change was retroactive to 2018 tax years.
Maryland is already decoupled from bonus deprecation and enhanced Section 179 deductions, so there was no uncertainty there. However, the Comptroller’s office has determined that QIP can depreciated over 15 years, as opposed to 39 years without the changes from the CARES Act. This will mean, that while bonus depreciation will need to be added back to Maryland income, taxpayers will not be depreciating property over different tax lives, which is welcome news. Further, if depreciation from QIP creates a Maryland NOL in 2018 or 2019, that loss can be carried back, since it does not affect the 2020 tax year directly.
Finally, a reminder to manufacturing businesses – you are allowed bonus depreciation in Maryland as well as enhanced Section 179 deductions. This provision was created legislatively by Maryland and is effective for tax year 2019 and forward.
Given that many of the decoupling provisions above relate to only one tax year—2020—and that all of the provisions are timing differences, we would like to see the Maryland legislature choose not to decouple from any of the provisions above to decrease the compliance burden on taxpayers and their advisors.
However, given the current economic environment and past behavior exhibited by the Maryland legislature when the TCJA created a substantial windfall for Maryland tax revenue, we believe that we will all be forced to follow the guidance outlined above in Maryland for tax year 2020.
Please contact SC&H or your tax team for more information on the above.