The CARES Act Sunset: 2026 Tax Implications for Small Businesses in the United States

The Coronavirus Aid, Relief, and Economic Security (CARES) Act, enacted in March 2020, was a monumental piece of legislation designed to provide immediate economic relief to individuals and businesses grappling with the unprecedented challenges of the COVID-19 pandemic. For small businesses across the United States, the CARES Act offered a lifeline through various provisions, including the Paycheck Protection Program (PPP), Economic Injury Disaster Loans (EIDL), and significant tax adjustments. These measures helped countless enterprises stay afloat, retain employees, and navigate the turbulent economic waters of the past few years.

However, like many emergency legislative responses, the CARES Act was not intended to be permanent. Many of its key provisions are set to expire, or ‘sunset,’ at the end of 2025, with their full impact becoming evident in the 2026 tax year and beyond. This impending CARES Act Sunset presents a critical juncture for small businesses. Understanding these changes, anticipating their effects, and proactively planning are not just advisable but essential for continued financial health and operational stability.

This comprehensive guide will delve into the specific provisions of the CARES Act that are slated to expire, analyze the potential tax implications for small businesses, and offer actionable strategies to prepare for this significant shift. Our goal is to equip you with the knowledge needed to navigate the post-CARES Act landscape successfully, ensuring your business remains resilient and compliant.

Understanding the CARES Act and Its Primary Provisions for Small Businesses

Before we explore the sunset, it’s crucial to recap the core components of the CARES Act that directly benefited small businesses. This foundational understanding will highlight what’s at stake as these provisions roll back.

Paycheck Protection Program (PPP)

Perhaps the most widely recognized component, the PPP offered forgivable loans to small businesses to help them keep their workforce employed during the pandemic. The defining feature was that if certain conditions were met (primarily maintaining payroll levels and using funds for approved expenses), the loans could be completely forgiven, effectively becoming tax-free grants. This was a significant boost, as the forgiven amounts were explicitly excluded from gross income, and expenses paid with PPP funds were still deductible.

Economic Injury Disaster Loan (EIDL) Program

While distinct from PPP, EIDL provided direct economic relief to businesses that suffered substantial economic injury due to COVID-19. Unlike PPP, EIDLs were loans that needed to be repaid, though they came with favorable terms, including low interest rates and long repayment periods. The CARES Act also introduced EIDL Advances (grants) which did not need to be repaid and were also tax-free.

Employee Retention Credit (ERC)

The ERC was a refundable tax credit designed to encourage businesses to keep employees on their payroll. It allowed eligible employers to claim a credit against certain employment taxes. Initially, businesses could not claim both PPP and ERC, but later legislation allowed businesses to claim both, although not for the same wages. The ERC has undergone several modifications and extensions, but its availability has largely concluded for most periods.

Net Operating Loss (NOL) Rules Relaxation

The CARES Act temporarily modified the rules surrounding Net Operating Losses (NOLs). It allowed businesses to carry back NOLs arising in 2018, 2019, and 2020 for up to five years, providing an immediate cash infusion through tax refunds. It also temporarily suspended the 80% taxable income limitation for NOL deductions.

Business Interest Expense Deduction (Section 163(j))

For the 2019 and 2020 tax years, the CARES Act temporarily increased the limitation on the deduction for business interest expense from 30% to 50% of adjusted taxable income (ATI). This allowed businesses to deduct a larger portion of their interest expenses, reducing their taxable income.

Qualified Improvement Property (QIP) Technical Correction

The CARES Act fixed a drafting error from the Tax Cuts and Jobs Act (TCJA) of 2017, allowing Qualified Improvement Property (QIP) to be eligible for 100% bonus depreciation. This was a significant benefit for businesses making improvements to their nonresidential real property, enabling immediate expensing rather than depreciation over 39 years.

The Impending CARES Act Sunset: What Expires in 2026?

The term ‘CARES Act Sunset’ primarily refers to the expiration or rollback of various temporary tax provisions that were either introduced or modified by the CARES Act and subsequent legislation. While many of the direct aid programs like PPP and EIDL advances have already concluded, the tax implications of their original design, combined with other expiring tax benefits, will significantly impact the 2026 tax landscape for small businesses.

Key Provisions Facing Sunset or Changes:

1. Net Operating Loss (NOL) Rules Reversion

The temporary relaxation of NOL rules was a major benefit. Post-2025, the ability to carry back NOLs will largely disappear, with NOLs generally only being carried forward indefinitely. Furthermore, the 80% taxable income limitation for NOL deductions will return, meaning businesses can only use NOLs to offset up to 80% of their taxable income in a given year. This change could significantly impact businesses experiencing losses, limiting their ability to reduce current or past tax liabilities.

2. Business Interest Expense Deduction (Section 163(j)) Tightening

The temporary increase to the 50% limitation on business interest expense deduction expired after 2020. More critically, starting in 2022, the calculation of Adjusted Taxable Income (ATI) for Section 163(j) purposes changed. Depreciation, amortization, and depletion are no longer added back to calculate ATI, making the limitation much stricter. This means many businesses will find it harder to deduct their full business interest expenses, potentially leading to higher taxable income. This tightening is already in effect but its full cumulative impact will be keenly felt as other deductions diminish.

3. Research & Development (R&D) Expensing Change (Section 174)

While not strictly a CARES Act provision, the change to Section 174, effective for tax years beginning after December 31, 2021, is often discussed alongside the CARES Act sunset due to its significant negative impact on businesses. Previously, businesses could immediately deduct R&D expenses. Now, these expenses must be capitalized and amortized over five years for domestic research or fifteen years for foreign research. This change dramatically increases the current taxable income for R&D-intensive businesses, reducing their cash flow and discouraging domestic innovation.

4. Bonus Depreciation Phasedown

The 100% bonus depreciation, which allowed businesses to immediately deduct the full cost of eligible new and used property (including Qualified Improvement Property), began phasing down in 2023. For property placed in service in 2023, it was 80%, dropping to 60% in 2024, 40% in 2025, and 20% in 2026. After 2026, bonus depreciation is set to expire entirely. This phase-out will significantly increase the taxable income for businesses that regularly invest in new equipment or make substantial property improvements.

5. Increased Section 179 Expensing Limits

While Section 179 expensing (allowing businesses to deduct the full purchase price of qualifying equipment and software up to a certain limit) is generally permanent, its limits are indexed for inflation. However, the temporary boosts or expansions that were sometimes coupled with other relief measures will likely not be sustained, and the overall tax environment will be less favorable without bonus depreciation. The interaction between Section 179 and bonus depreciation will become more critical as bonus depreciation dwindles.

Direct Tax Implications for Small Businesses in 2026

The expiration and modification of these provisions will collectively lead to a less favorable tax environment for many small businesses. Here’s a breakdown of the key implications:

Increased Taxable Income and Higher Tax Liabilities

• NOL Limitations: Businesses experiencing losses will have fewer options to offset past or future profits, leading to higher current-year tax burdens.
• R&D Amortization: Companies engaged in research and development will see their current taxable income increase significantly as they can no longer immediately expense these costs.
• Reduced Depreciation Benefits: The phase-out of bonus depreciation means businesses will have to spread the deduction for capital expenditures over many years, rather than taking it all upfront. This reduces immediate tax savings and increases cash outflow for taxes.
• Stricter Interest Expense Limits: Businesses with significant debt financing may find a larger portion of their interest expense non-deductible, further inflating taxable income.

Decreased Cash Flow

Higher tax liabilities directly translate to reduced cash flow. Small businesses rely heavily on available cash for operations, investment, and growth. A reduction in tax benefits means more money goes to taxes and less is available for reinvestment, expansion, or managing unexpected challenges.

Complex Tax Planning

The shifting landscape requires more sophisticated tax planning. Businesses will need to carefully model the impact of these changes on their financial statements and projections. The interplay between Section 179 and the declining bonus depreciation, for instance, will require careful consideration to maximize allowable deductions.

Impact on Investment Decisions

The ability to immediately deduct capital expenditures through bonus depreciation has been a powerful incentive for businesses to invest in new equipment, technology, and facility improvements. As this benefit diminishes, businesses may reconsider or delay investments, potentially slowing economic growth and innovation.

Sector-Specific Impacts

• Manufacturing and R&D-heavy industries: Will be particularly hit by the R&D expensing changes and the decline in bonus depreciation for equipment.
• Real Estate and Construction: Will feel the effects of declining bonus depreciation for qualified improvement property.
• Businesses with high debt: Will face challenges with the stricter Section 163(j) interest expense limitations.

Proactive Strategies for Small Businesses to Prepare

The good news is that 2026 is still some time away, providing a window for small businesses to strategize and adapt. Proactive planning is paramount to mitigate the adverse effects of the CARES Act Sunset.

1. Reassess Your Tax Strategy and Financial Projections

• Update Financial Forecasts: Work with your accountant or financial advisor to re-evaluate your long-term financial forecasts, incorporating the anticipated tax changes. Understand how these changes will impact your net income, cash flow, and overall tax burden from 2026 onwards.
• Tax Liability Projections: Develop detailed tax liability projections for the upcoming years, considering the phasedown of bonus depreciation, R&D amortization, and other expiring provisions. This will help you anticipate future cash needs for tax payments.
• Scenario Planning: Create different financial scenarios to understand the best and worst-case impacts, allowing for more robust decision-making.

2. Optimize Capital Expenditure Planning

• Accelerate Investments: If your business plans significant capital expenditures (e.g., purchasing new equipment, upgrading facilities), consider accelerating these investments to take advantage of the remaining bonus depreciation rates (20% in 2026) or 100% Section 179 expensing before they disappear or become less advantageous. Strategically timing these purchases can yield substantial tax savings.
• Evaluate Lease vs. Buy: Re-evaluate your equipment acquisition strategies. Leasing might become more attractive in certain situations compared to outright purchasing, especially if the tax benefits of ownership diminish.

3. Review and Adjust R&D Activities

• Understand the Impact: For businesses with substantial R&D expenses, it’s crucial to understand the cash flow implications of the Section 174 amortization requirement.
• Explore R&D Tax Credits: While R&D expensing is changing, the R&D tax credit remains a valuable incentive. Ensure you are maximizing your claim for this credit, which can offset current and future tax liabilities. This credit can be particularly beneficial for startups and small businesses.
• Cost Segregation Studies: For businesses with real estate, consider a cost segregation study to reclassify certain building components as personal property, allowing for accelerated depreciation.

4. Manage Net Operating Losses (NOLs)

• Utilize Current NOLs: If your business has existing NOLs from 2018-2020 that can still be carried back, explore options to utilize them before the rules revert.
• Future NOL Planning: For future losses, understand that carryforwards will be the primary option, subject to the 80% taxable income limitation. Plan accordingly to manage cash flow during loss years.

5. Debt Management and Interest Expense

• Review Debt Structure: Businesses with significant debt should review their current debt structure and interest expenses. With stricter Section 163(j) limitations, it might be beneficial to explore ways to reduce interest expenses or optimize financing.
• Understand ATI Calculation: Ensure you understand how your Adjusted Taxable Income (ATI) is calculated for interest expense limitation purposes, especially with the exclusion of depreciation and amortization.

6. Seek Professional Guidance

The complexity of these tax changes makes professional advice indispensable. Engage proactively with a qualified tax advisor, accountant, or financial planner who specializes in small business taxation. They can provide:

• Personalized Analysis: A detailed analysis of how the CARES Act sunset specifically impacts your business.
• Strategic Planning: Assistance in developing a tailored tax strategy that aligns with your business goals and minimizes future tax liabilities.
• Compliance Assurance: Guidance to ensure your business remains compliant with evolving tax laws.

7. Advocate for Policy Changes

Small business owners can also collectively advocate for extensions or permanent changes to beneficial tax provisions. Staying informed about legislative discussions and participating in industry groups can help amplify the voice of small businesses in potential future tax policy debates.

Beyond 2026: The Broader Economic Context

The CARES Act Sunset isn’t occurring in a vacuum. It’s part of a broader economic and political landscape. Factors such as inflation, interest rate fluctuations, potential future legislative changes, and the overall health of the economy will all play a role in how small businesses experience these tax shifts. Remaining agile and informed about these macroeconomic trends will be crucial for long-term success.

Furthermore, the long-term implications of government spending during the pandemic, including the CARES Act, could lead to future efforts to increase tax revenues. Small businesses should be prepared for a potentially less generous tax environment overall, making efficient tax planning even more critical.

The Importance of Ongoing Education and Adaptation

Tax laws are rarely static. The period leading up to and following the CARES Act Sunset will likely see continued adjustments and new proposals. Small business owners must commit to ongoing education and be prepared to adapt their strategies as new information or legislation emerges.

• Stay Informed: Regularly consult reputable tax news sources, IRS publications, and your tax advisor for updates.
• Review Annually: Conduct annual tax reviews to ensure your business is taking advantage of all available deductions and credits and is prepared for upcoming changes.
• Build a Strong Financial Foundation: Focus on maintaining healthy cash reserves, managing debt prudently, and diversifying revenue streams to better withstand financial shocks and adapt to changing tax landscapes.

Conclusion

The CARES Act provided unprecedented support to small businesses during a time of extreme crisis. As the CARES Act Sunset approaches in 2026, its expiration will usher in a new era of tax considerations that demand immediate attention and proactive planning. From the reintroduction of stricter Net Operating Loss rules and the amortization of R&D expenses to the phase-out of bonus depreciation and tighter interest expense limitations, the cumulative impact on small business profitability and cash flow will be significant.

However, by understanding these changes, engaging with expert tax professionals, and strategically adjusting investment, R&D, and financial management practices, small businesses can navigate this transition successfully. The key is not to view the sunset as an insurmountable challenge, but as an opportunity to refine financial strategies, optimize operations, and build a more resilient business model for the future. Start your planning today to ensure your business is well-prepared for the tax landscape of 2026 and beyond.