State Income Tax Implications of Coronavirus Legislation
By Adam Johnson, Director, Tax & Business Services
Congress passed two significant pieces of tax legislation in response to the coronavirus pandemic. The Families First Coronavirus Response Act (FFCRA) was signed into law on March 18, 2020, and the Coronavirus Aid, Relief, and Economic Security (CARES) Act followed soon after on March 27.
The two laws provide significant benefits to individuals and businesses, largely through changes to the tax code. Some of the new tax provisions are effective retroactively to January 1, 2018. As we have previously written, this may present an opportunity for taxpayers to file amended federal income tax returns for 2018 and/or 2019 to take advantage of the new rules and potentially obtain tax refunds.
State Tax Implications: New York and Maine
It is important to note that the FFCRA and the CARES Act directly affect only federal taxes. The interaction between federal and state tax law varies from state to state. Some states tie their tax law to the Internal Revenue Code (IRC) as of a specific date. In these states, the law remains static unless and until new legislation is passed. Other states operate under a system known as rolling conformity, whereby changes in federal tax law automatically apply at the state level. However, many rolling conformity states have enacted laws which decouple them from certain specific provisions of federal tax law.
The discussion below focuses on two northeastern states — New York and Maine — which have already passed new legislation or issued tax guidance in response to the federal coronavirus legislation. Many more states will surely come up with their own approaches in the months ahead. Some states may effectively implement certain rules by default, based on their current status as either a fixed-date conformity or rolling conformity state.
New York has historically been a rolling conformity state, although it had decoupled from specific federal tax provisions such as 100% first year bonus depreciation. The first state legislation in response to the CARES Act came on April 3, 2020, as part of New York’s fiscal year 2020-21 budget. For corporate taxpayers, the law decouples New York from CARES Act provisions related to the business interest deduction. For individual taxpayers, the law decouples New York from all amendments to the IRC enacted after March 1, 2020, for tax years beginning before January 1, 2022. This effectively transforms New York into a fixed-date conformity state as relates to individual taxpayers.
Income tax law in the state of Maine is currently in conformity with the IRC as amended through December 31, 2019, prior to passage of the FFCRA and CARES Act. Maine Revenue Services recently issued guidance and new forms to calculate and report the adjustments to state taxable income required due to the recent changes in federal tax law.
Federal Provisions Affecting State Returns
Several significant benefits provided by the FFCRA and CARES Act may need to be adjusted on the relevant state income tax return(s) if claimed on the federal tax return.
- Business interest deduction exceeding 30% of federal adjusted taxable income. The CARES Act increased the limit to 50%, thereby enabling businesses to take larger interest expense deductions. For both New York and Maine, any interest deduction beyond the prior 30% limit must be added back in calculating state-level taxable income.
- Increased charitable contributions deduction for corporations. The CARES Act increased the limit on cash donations to 25% of taxable income for donations made during calendar year 2020. Deductions claimed on the federal tax return for cash donations exceeding the prior limit of 10% must be added back in calculating Maine taxable income. As stated earlier, New York automatically accepts the IRC as enacted, for corporate tax purposes. As of this writing, New York has not decoupled from this corporate tax provision.
- Forgiveness of Payroll Protection Program (PPP) Loans. To the extent that forgiveness of PPP loans is excluded from federal taxable income, it must be added back in calculating Maine taxable income. New York has not specifically addressed PPP loan forgiveness, such that, absent future legislation to the contrary, C corporations may not be required to make an adjustment. Because New York decoupled from all IRC changes enacted after March 1, 2020, as relates to individual taxpayers, businesses operated as sole proprietorships or pass-through entities (partnerships and S corporations) which are taxed as part of the business owners’ individual income tax return would be required to add back the PPP loan forgiveness to the extent it is excluded from federal taxable income.
- Paid sick leave and family leave credits under the FFCRA and Employee Retention Credit under the CARES Act. These credits reduce the amount of a business’s deduction for payroll expenses on the federal tax return. For both New York and Maine, the reduction in payroll expense due to these credits must be reversed on the state income tax return. This effectively restores the state-level deduction to the full amount of the expense.
- Limitation on net business losses for taxpayers other than C corporations. Prior legislation limited the amount of business losses which could be deducted against non-business income to $250,000 (or $500,000 on a married joint return), effective for the 2018 tax year. The CARES Act deferred implementation of this limitation until 2021. To the extent business losses exceeding these levels reduce federal taxable income in 2018, 2019, or 2020, they must be added back in calculating state-level taxable income for both New York and Maine.
- Accelerated depreciation on qualified improvement property (QIP). The CARES Act reduced the depreciation period for QIP from 39 years to 15 years, and also made QIP eligible for 100% first year bonus depreciation. These changes are retroactively effective January 1, 2018.
Even prior to the CARES Act, New York had decoupled from federal bonus depreciation. The federal tax provisions related to bonus depreciation and to the depreciable lives of property are contained in different subsections of the IRC. Due to rolling conformity for New York corporate taxpayers, they may be able to use a 15-year life for QIP. Further guidance from the state is needed in this area. For taxpayers in Maine, QIP has a 39-year recovery period and is not eligible for bonus depreciation.
For both states, income modifications are required in order to account for the difference in the depreciation deduction on the federal return and the deduction allowed by the state. For the year in which QIP is placed in service, state taxable income must be increased by the difference between the depreciation deduction for QIP on the federal return and the allowable depreciation under the state’s rules. Further adjustments to state taxable income will be necessary in each year of the asset’s recovery period. After the first year, the adjustments may reduce state-level taxable income, particularly if the federal deduction is $0 due to the application of 100% bonus depreciation in the first year.
With many provisions of the CARES Act retroactively effective January 1, 2018, taxpayers may have an opportunity to amend federal tax returns for 2018 and/or 2019 to claim these tax benefits. At the same time, the related impact on the state income tax returns should also be addressed.
In other cases, taxpayers who filed their 2019 original income tax returns after passage of the CARES Act may have already taken advantage of some of its favorable provisions, such as the 15-year recovery period and 100% bonus depreciation of QIP. In light of new state legislation and guidance limiting or denying such benefits at the state level, it may now be necessary to amend state tax returns.
At this time, only a few states have enacted legislation or issued formal guidance with respect to how they will treat various aspects of the CARES Act. It is expected that many more will do so as the year unfolds. If you would like assistance in determining how your state’s response to the federal coronavirus legislation impacts your tax situation, please contact your Marcum tax advisor.
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