A few key provisions of the recently enacted Coronavirus Aid, Relief, and Economic Security Act (the “CARES” Act) should prove fruitful for businesses that have new or recent net operating losses.
In December 2017, the President signed into law the Tax Cuts and Jobs Act of 2017 (the “TCJA”). The TCJA dramatically reduced the corporate income tax rate from 35 percent to 21 percent and made other significant changes to the Internal Revenue Code. One area the TCJA restricted was the treatment of net operating losses. Before the TCJA, taxpayers generally were allowed to carry net operating losses (“NOLs”) back to the two years before the tax year during which the losses were generated (“NOL carrybacks”) and/or forward for up to 20 years after the tax year during which the losses were generated (“NOL carryforwards”).
With the enactment of the TCJA, NOLs generated after December 31, 2018 could no longer be carried back to prior years. The TCJA also limited NOL carryforwards generated after 2017 to 80 percent of the taxpayer’s taxable income in the relevant carryforward year, although NOLs could be carried forward indefinitely. NOLs existing before the TCJA were still fully deductible.
The CARES Act
The CARES Act allows taxpayers to carry back losses generated after December 31, 2017 and on or before December 31, 2020. Taxpayers generating NOLs during these 3 years (2018 and 2019 retroactively and 2020), may carry back such NOLs for up to 5 taxable years. NOLs can be carried forward indefinitely, but the 80-percent limit will go back into effect for losses generated after 2020.
This provision has a dual benefit of carrying losses back to prior years and offsetting a greater amount of tax liability in those prior years. In other words, losses generated during 2018 through 2020 that are carried back to years ending before 2018 can offset more income tax liability in those pre-2018 years than they would in post-2017 years because of the tax rate reduction effected by the TCJA. For example, a $1 million loss generated and utilized in 2019 would offset $1 million of taxable income at 21 percent (or $210,000 of income tax). That same $1 million loss would offset up to $1 million of taxable income at 35 percent (or $350,000 of income tax) if it were carried back to 2014.
The 5-year carryback rule applies to owners of pass-through entities (e.g., partnerships, limited liability companies and S corporations) and sole proprietors. Although the dramatic tax rate advantage for corporate NOLs is not present, the ability to carry such losses back to prior years is significant.
In addition to the NOL rules, the CARES Act retroactively postpones the effective date for the excess business loss limitation until January 1, 2021. As a result of the TCJA, the excess business loss limitation allows an individual to use only up to $250,000 ($500,000 for joint filers) of losses each year from an active business to offset an individual’s other income. The deferral of the excess business loss limitation and the new NOL carryback rules could allow individuals to offset significant amounts of business and other income from prior years.
There are generally 2 options to monetize NOL carrybacks. Taxpayers can either file an amended return for the prior year(s), or request a “quick refund” with Form 1139 (for corporations) or Form 1045 (for individuals), which is technically referred to as a tentative refund. The deadline for filing for tentative refunds is 12 months after the end of the tax year during which the loss is generated. The IRS generally reviews the application and applies the credit or refund within 90 days. Pursuant to IRS Notice 2020-26, the IRS has granted a six-month extension for quick refund claims for NOLs generated during 2018. As a result, such taxpayers may file for “quick refunds” on or before June 30, 2020. Additionally, in a set of FAQs, the IRS has indicated that taxpayers are temporarily permitted to submit Forms 1139 and 1045 via fax instead of physical copies ((844) 249-6236 for corporations and (844) 249-6237 for individuals).
Corporations with net income tax liability for the current year that are expecting NOLs in the next tax year generally have been allowed to offset the current year liability with the anticipated NOL for the following year by filing IRS Form 1138. Additional requirements and limitations apply. For example, interest generally accrues on the current-year tax liability, even when the offset is permitted. Taxpayers must file Form 1138 before their income tax payment is due. The IRS recently extended several deadlines to July 15, but because Form 1138 is filed separately from the income tax return (Form 1120), it is not clear whether the extended due date also applies to the Form 1138 in the case of a corporation with income tax liability for 2019 and expecting an NOL for 2020. Additional guidance may be forthcoming.
The new NOL rules, particularly in conjunction with the deferral of the excess business loss limitation rules for individuals, should provide opportunities for taxpayers generating business losses between 2018 and 2020. RMG will continue to monitor updates from the Treasury and the IRS. Contact us anytime for additional information.