The coronavirus pandemic has affected us all in all aspects of our lives. Today we are evaluating how the coronavirus has impacted portfolios from a tax efficiency perspective. To look at this situation properly, we must first revisit the market’s most impactful dates. The first real signs of the US market distress began on February 24 when the Dow Jones fell by almost a thousand points, the S&P fell by over one hundred points and the NYSX closed down more than four hundred points. Over the next 27 days, the drop continued until March 23 —the bottom of the declines in the first quarter of 2020.
Wash Sales/Tax Optimizer
Since the beginning of the market downturn on February 24, any positions sold for a loss on or after February 24 and repurchased on or before March 25 would have generated a wash sale loss deferral under the IRC §1091 wash sales rules.
The IRC §1091 rule states that if a security is sold for a loss and within the statutory 61-day window (made up of 30 days before the date of sale, the date of sale and thirty days after the date of sale), and a substantially similar position was purchased; then a wash sale would be created. Any loss on the original transaction would be deferred in part or whole.
Tax Optimizer, our secure web-based tax preparation and hypothetical trading tool, is equipped with analytic tools that will identify the market volatility impact on your portfolio. Tax Optimizer has value-added functionality that can pinpoint your wash sale loss deferrals and help you create a tax efficiency plan. Our hypothetical trading module will allow you to test “What-if trades” to understand the effectiveness of your tax-efficient trading strategy.
Other Tax Provisions from the CARES Act impacting the Asset Management Industry
Payroll Tax Deferral:
Employers are allowed a deferral of the employee portion of Social Security tax (6.2%) from the end of March through Dec 31, 2020. The payments would be due in two installments—by the end of years 2021 and 2022.
Employer Retention Credit:
Employers are eligible to receive a 50% credit on the social security tax (up to $10,000 in wages). This credit would apply to employers that have suspended operations or have had a 50% reduction in gross receipts due to COVID-19.
In conversations with fund managers, this credit is something to analyze, but not likely to impact larger Funds that are still receiving management fees.
Temporary suspension of Sec 461(l) excess business losses:
As part of tax reform in 2017, Sec 461(l) put in place a limitation on the deduction of business losses through partnerships (non-corporate taxpayers) over $500,000 (for married people filing jointly). The CARES Act turns off the excess business loss limitation rules for tax years beginning before 2021, including with retroactive effect for all years to which Section 461(l) applied.
“Trader” funds or management companies that had business losses that may have been limited could benefit and now may be able to be used to offset income from “investor” funds.
Sec 163(j) interest expense limitation:
Sec 163(j) limits the deduction of net business interest expenses to 30% of adjusted taxable income. The CARES Act raised the limit to 50% for 2019 and 2020. Note for partnerships—the deduction only applies for 2020 (with some other usage provision at the individual level if excess interest expense has been passed through.)
Net Operating Losses (NOLs):
The CARES Act provides some relief from these limitations (NOL limited to 80%) for tax years beginning before 2021. First, business losses arising in tax years beginning in 2018, 2019 and 2020 generally can now be carried back to the five taxable years preceding the year of the loss. For tax years beginning before 2021, NOLs can be used to offset 100% of income. For tax years beginning after 2020, NOLs being carried forward from tax years before 2018 can be used to offset up to 100% of modified taxable income. However, NOLs being carried forward from tax years beginning after 2017 can only be used to offset up to 80% of modified taxable income.
Join us as we explore the implications of the COVID-19 tax stimulus CARES Act. To learn more about the recent tax changes, download our webinar.