CARES Act Changes in Tax Law: Navigating the Filing of Individual and Partnership Amended Tax Returns

The recently passed CARES act made several taxpayer-friendly changes to the tax code. Changes include the carrying back of net operating losses, shortening the depreciable life and bonus eligibility of qualified improvement property, eliminating individual excess business loss limitation rules, and modifying the business interest expense limitations, to name a few. These provisions, except for the modified business interest expense limitation rules, were made retroactive to 2018. Individuals, corporations, and partnerships can amend their 2018 tax filings to take advantage of these tax law changes and can obtain significant tax refunds.

Bipartisan Budget Act (BBA) Partnerships:

Filing an amended return in order to adjust for retroactive tax law changes is a straightforward process for corporations and non-BBA partnerships. The business entity would file a 2018 amended return, supply a Schedule K-1 to the shareholder or partner, who in turn would then amend their personal individual return, and presumably receive their refund in short order.

However, the process could become more complicated for BBA partnerships. Beginning in 2018, all partnerships were considered to be BBA partnerships, unless they elected out of the BBA audit regime on their 2018 tax return. There were specific criteria that had to be met in order to elect out of the BBA audit regime. For example, partnerships with more than 100 partners, or partnerships with a Trust or another partnership as a partner could not make this election. To adjust a previously filed return under the BBA audit regime, partnerships must file an “Administrative Adjustment Request (AAR),” and are not allowed to merely file an amended return. Depending on whether the adjusted taxable income is increasing, decreasing, or even staying the same, there are different filing requirements.

The income adjustments resulting from the tax law changes provided in the CARES act will most likely result in a reduction of taxable income. Under the BBA audit regime, these adjustments, termed “non-positive adjustments” do not get reported by the BBA partner in the year the adjustment relates, rather they are reported in the year in which the adjustment is reported. For example, assume that a partnership under a BBA audit regime could benefit from being able to identify qualified improvement property as 15-year property and take 100% bonus depreciation for the property in the 2018 taxable year. Under the BBA audit regime rules, the partnership would have to file an AAR in 2020 for the bonus depreciation adjustment related to the 2018 taxable year, but the partner in the partnership would not receive notification and be able to include the beneficial adjustment until the 2020 taxable year. Even more discouraging is that the actual cash benefit would not be received by the partner until 2021, at the time their 2020 tax return is filed.

Administrative Adjustment Requests (AAR):

The Internal Revenue Service was quick to identify the BBA Partnership AAR issue, and recognize that delaying benefit recognition until the 2021 taxable year was in contradiction with the intent of the CARES act which overwhelmingly focused on getting cash in the hands of taxpayers quickly during the COVID outbreak. The IRS issued Revenue Procedure 2020-23 on April 8, 2020 which allows BBA partnerships to file amended returns for the 2018 and 2019 tax years and avoid having to follow the BBA audit regime rules, including filing an AAR. In order to receive this benefit, the partnership amended returns must be filed by September 30, 2020, and must include “FILED PURSUANT TO REV PROC 2020-23” on the top of the return and on each of the Schedule K-1’s. Once the partnership return is amended, and the partners receive amended K-1 information, each partner can then file their own amended individual tax return and receive the benefit immediately. This allows partners to receive the beneficial cash impact related to the favorable CARES Act tax law adjustments as early as the 2020 taxable year, and not force partners to have to wait until 2021.

For an individual partner to amend their 2018 or 2019 tax return, an individual would file Form 1040-X – Amended U.S. Individual Income Tax Return. If the amendment results in a lower taxable income, then a cash refund would start to be processed by the IRS. However, if the amendment results in an individual net operating loss, additional steps need to be taken in order to carryback that net operating loss to previous tax years.

Under the CARES Act, losses arising in taxable years ending after December 31, 2017, and before January 1, 2021 are allowed to be carried back for 5 years. This means that a net operating loss generated on an individual’s amended 2018 tax return, could be carried back to their 2013 taxable year to offset taxable income and taxes paid.

In order to claim a net operating loss carryback, individuals can either file a Form 1045, Application for Tentative Refund, or Form 1040-X for the year in which they are carrying back the net operating loss. The significant difference between the two filing options is the timing of when the cash refund will be received. The IRS is required to process a Form 1045 within 90 days of filing. However, the IRS states that a Form 1040-X can take up to 12 weeks to process and may take longer during busy times, which the IRS most likely will have over the next 6 months. Therefore, many taxpayers who create a net operating loss in 2018 or 2019 will most likely want to File Form 1045 to expedite the refund process.

The Internal Revenue Service recently issued Notice 2020-26, which extends the deadline to June 30, 2020 for taxpayers who need to file Form 1045 in relation to a 2018 net operating loss carryback claim. The normal deadline was December 31, 2019, which already passed. While this extension to June 30, 2020, is a relief to individual taxpayers, this does mean that any 2018 partnership returns that need to be amended will have to be completed well advance of the June 30, 2020 deadline, allowing individual partners time to properly file their 2018 1040-X amended tax return, and submit their Form 1045, Application for Tentative Refund.

Currently the IRS is not capable of processing Form 1045 electronically, nor is the IRS processing returns that are submitted on paper. Where does this leave a taxpayer seeking a refund? Hopefully you have not discarded your old fax machine! Beginning April 17, 2020, the IRS will accept Form 1045 and Form 1139 (for C Corporations) via fax. The number to call is 844-249-6237 (for Form 1045) or 844-249-6236 (for Form 1139). The size of the fax is limited to 100 pages.

If your head is not spinning yet, it should be! While the CARES Act has provided a variety of taxpayer-friendly initiatives, the timing and how filings will be submitted is important when evaluating how quickly the cash refund will be received. Please do not hesitate to reach out to your Bonadio professional team members to talk about any of the CARES Act tax law changes.

Contact your Bonadio team for more information.

The information and advice we are providing for this matter relates to COVID-19 legislative relief measures. Because legislative efforts are still ongoing, we expect that there may be additional guidance and clarification from regulators that could modify some of the advice and information provided to you, after the conclusion of our engagement. We therefore make no warranties, expressed or implied, on the services provided hereunder.