CARES Act Triggers Maryland’s Automatic Decoupling

On June 12, 2020, the Maryland Comptroller issued its report to the Governor and General Assembly regarding the impact of certain tax provisions included in the Coronavirus Aid, Relief, and Economic Security (CARES) Act on Maryland Tax Revenues.  The report outlines Maryland’s required decoupling from the following three provisions of the CARES Act:

• IRC section 163(j) – the CARES Act decreased the limitation on business interest expenses deduction from the 30% of adjusted taxable income limitation implemented through the Tax Cuts and Jobs Act of 2017 (TCJA) to 50% for tax years 2019 and 2020;
• IRC section 172 – the CARES Act amended the NOL provisions enacted under the TCJA to allow a five-year carry back of NOLs and suspend the 80% carry forward limitation for tax years beginning after December 31, 2017 and before January 1, 2021 (i.e., tax years 2018, 2019, and 2020).
• IRC section 461(l) – the CARES Act eliminated the loss limitations imposed on non-corporate taxpayers by the TCJA for tax years 2018, 2019, and 2020.

Maryland generally conforms to the Internal Revenue Code (“IRC”) on a “rolling conformity” basis.  In other words, Maryland conforms to amendments to the IRC as they occur. However, Maryland law does require the state’s income tax statute to automatically decouple from the IRC under certain circumstances. The automatic decoupling occurs when an amendment to the IRC effects a tax year that begins in the calendar year that the amendment is enacted by Congress if the amendment is determined by the Maryland Comptroller to impact state income tax revenue for the upcoming fiscal year by $5,000,000 or more. This automatic decoupling does not occur very often because Congress typically makes changes to the IRC effective as of the tax year after the year law is enacted. The CARES Act, however, was enacted in 2020 and has amendments to the IRC that impact tax year 2020. Therefore, the Comptroller was required by law to prepare a report to the Governor and General Assembly addressing whether any of the amendments to the IRC in the CARES Act will have an impact fiscal year 2021 income tax revenue by $5,000,000 or more.

The report issued by the Comptroller concluded that each of the provisions listed above would have an impact greater than $5,000,000 for each tax year impacted by the amendments. Therefore, the report concluded that Maryland automatically decouples from the provisions above. However, due to the language of Maryland’s automatic decoupling statute, Maryland has only decoupled from the CARES Act provisions listed above for tax year 2020. The statute does not allow for an automatic decoupling for tax years 2018 and 2019 statute because the statute states that the decoupling applies to “a taxable year that begins in the calendar year in which the amendment is enacted.”

In addressing the limitation of the automatic decoupling rule, the report issued by the Comptroller states “the intent of the decoupling language . . . is to prevent a change to the federal tax code from significantly impacting State revenues until the legislature has had the opportunity to either accept . . . or to deny the change . . . .  However, it appears that the current statute did not contemplate the passage of federal legislation that in its year of enactment, would alter the computation of taxable income for tax periods beginning in prior calendar years.”  Thus, Maryland has automatically decoupled from the provisions discussed above for tax year 2020, but has not decoupled from any of these provisions for tax years prior to 2020.

Of course, the General Assembly could still hold a special session to enact legislation that would have Maryland decouple from the above provisions for prior years as well. This would likely be somewhat of an administrative nightmare, as taxpayers have already filed (or will soon file) their 2019 Maryland income returns reflecting conformity to the CARES Act.  Further, many taxpayers will be amending, or already have amended, their 2018 returns to claim additional losses due to the amendments to IRC sections 172 and 461(I). The Comptroller’s report recognizes this potential issue, and even mentions the possibility of “not process any of the related amended filings . . . or even just delaying the processing until a policy framework is determined.”

Below is a brief summary of the impact of Maryland’s automatic decoupling from the CARES Act.

• Business Interest Expense Deduction
  • For tax years 2019 and 2020, the TCJA limited the amount of deductible interest to the sum of (1) the taxpayer’s business interest expense income, (2) 30% of the taxpayer’s Adjusted Taxable Income , and (3) the taxpayer’s floor plan financing interest expense for the year. Business interest in excess of the limitation was allowed as an indefinite carryforward.
  • The CARE Act increased the 30% limitation to 50% for tax years 2019 and 2020 (2020 only of Partnerships). This increase results in a greater interest expense deduction than what was previously permitted under the TCJA.
• Maryland Automatic Decoupling
  • For the 2020 tax year, Maryland has automatically decoupled from the 30% to 50% limitation. This will require an additional modification on 2020 Maryland income returns.
  • For the 2019 tax year, Maryland currently conforms to the increase to the 30% limitation to 50%.
• Net Operating Loss Provisions (NOL)
  • The TCJA repealed the provision allowing losses to be carried back and the provision limiting the loss carryforward period to twenty years.
  • The TCJA required losses arising in tax years beginning after December 31, 2017 to be carried forward, and in each year used, the NOL could offset no more than 80% of taxable income.
  • The CARES Act altered the NOL provisions enacted under the TCJA to allow a five-year carry back for NOLs, and suspended the 80% carryforward limitation for tax years beginning after December 31, 2017 and before January 1, 2021 (i.e., 2018, 2019, and 2020).
  • As a result, businesses may amend their tax year 2018 and 2019 federal income tax returns to carryback current year losses and offset taxable income for tax years as far back as 2013.
  • Maryland Automatic Decoupling
    • Currently, Maryland has only decoupled from the CARES Act NOL provisions to the extent that such changes impact federal adjusted gross income or federal taxable income for tax year 2020. Thus, for tax year 2020, Maryland will continue to limit a NOL carry forward to 80% of taxable income.  In other words, the NOL rules from the TCJA apply.
    • The CARES act NOL provisions impacting 2018 and 2019 currently apply for Maryland. For example, a NOL carry forward claimed on 2019 return is not limited to 80% of taxable income, and a 2018 return can be amended to remove the 80% limitation and/or carryback a 2019 loss.
• Loss Limitations on Taxpayers Other Than Corporations
  • For tax years 2018 – 2025, the TCJA restricted the business loss deduction available to noncorporate taxpayers (individuals, trusts, and estates) from offsetting more than $250,000 ($500,000 for joint filers) of nonbusiness income with business losses in the year the loss was incurred.
  • The CARES Act retroactively delayed the effective date of the loss limitation rules enacted under the TCJA to tax years beginning after December 31, 2020 (i.e. loss limitation rules do not apply for tax years 2018, 2019, and 2020).
  • Maryland Automatic Decoupling
    • For the 2020 tax year, Maryland has automatically decoupled from the suspension of the loss limitation rules. Thus, the limitation enacted as part of the TCJA will apply for 2020.
    • For 2018 and 2019, Maryland currently conforms to the CARES Act suspension of the loss limitation rules.

Given that there is some uncertainty as to whether the General Assembly will take action to decouple from the CARES Act for 2018 and 2019, taxpayers impacted by the CARES Act amendments discussed above may want to consider position taken on these returns.  Taxpayers that have already filed their 2019 returns likely prepared such returns to reflect Maryland conforming to the CARES Act, which under the current landscape would be correct.  For the 2018 tax year, it may make sense to delay the filing of any amended returns until there is certainty as to whether the General Assembly will enact legislation to have Maryland decouple from the CARES Act for 2018 and/or 2019.  Given the complexity of the rules at issue, taxpayers should seek advise from a tax advisor so they can fully understand the exact impact to their circumstances.

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