Due to the COVID-19 pandemic, many small and mid-sized businesses expect to have significant net operating losses (NOLs) in 2020. What makes this prospect more discouraging is that some companies are still recovering from NOLs suffered in recent years.
The Coronavirus Aid, Relief and Economic Security (CARES) Act provides some relief. It has revamped the NOL rules, undoing some of the effects of the Tax Cuts and Jobs Act (TCJA) passed in 2017. This means your company may be in line for a refund if you amend previous tax returns. However, the CARES Act rules are complex. It’s essential to consult recently released IRS guidance that covers some of the mechanics of requesting a refund — and talk with your tax advisor — before filing an amended return.
Before passage of the TCJA, businesses could carry back NOLs to offset taxable income in two prior years before they carried forward losses to offset income in a maximum of 15 future years. Typically, carrybacks were beneficial because they provided an immediate tax benefit. Alternatively, companies could also elect to forego a carryback and use a carryforward if it was more advantageous.
How these rules applied depended on the structure of the business. For example, an NOL claimed by a C corporation might only be used to offset its business income. But sole proprietors and owners of pass-through entities (such as partnerships and S corporations) could use an NOL to reap tax rewards on their personal returns.
The TCJA changed the rules. It imposed the following restrictions on NOLs arising in tax years after 2017:
Two-year carryback period
This period was repealed (except for certain farms and insurance companies). Therefore, businesses could only carry NOLs forward — not back for any period. However, the allowable carryforward period was indefinite, rather than being limited to 15 years.
Percentage of taxable income
The TCJA limited NOLs to 80% of a company’s taxable income (as determined without claiming the NOL). Carryforwards had to be adjusted to take the 80% limit into account.
Losses of noncorporate taxpayers (such as individuals, estates and trusts) that might have been used to offset nonbusiness income were limited to $250,000 for single filers and $500,000 for joint filers. For S corporation owners and partners in partnerships, these limits were accounted for at the individual level. The amount of the excess business loss was treated as an NOL carryover in the subsequent year, subject to the 80% limit.
The TCJA changes were effective in 2018 and intended to be permanent. Thus, they restricted the tax benefits of NOLs claimed by businesses in 2018 and 2019.
CARES Act to the Rescue
Enacted in response to the COVID-19 crisis, the CARES Act grants companies more flexibility for NOLs, starting with carryback periods. Companies now can carry back NOLs arising in 2018, 2019 or 2020 for five years to offset losses incurred in prior years. So, if it makes tax sense, your company can carry back NOLs all the way to 2013.
Other CARES Act changes:
Suspend the 80%-of-taxable income limit until 2021,
Suspend the threshold for noncorporate taxpayers for 2018, 2019 and 2020 (limits won’t kick in until 2021), and
Coordinate these new provisions with other related parts of the tax code.
The IRS guidance for CARES Act provisions for NOLs can help taxpayers navigate the intricacies of claiming losses. In conjunction with a publicly released notice, the IRS website provides answers to frequently asked questions.
For example, the guidance clarifies how to apply for a tentative refund based on the NOL carryback. Taxpayers generally must file Form 1139 or Form 1045 within 12 months after the end of the tax year in which an NOL arises. The deadline to apply for a tentative refund with NOLs arising in tax years beginning after 2017 and before March 27, 2019, had expired before the CARES Act was passed. But the IRS has granted a six-month extension for taxpayers to file the forms.
Due to the complex rules, carrying back NOLs and amending previous tax returns generally aren’t do-it-yourself propositions. Contact us for help maximizing the tax advantages of NOLs under the current rules.