The Coronavirus Aid, Relief, and Economic Security Act (“CARES ACT”) was signed into law by President Donald Trump on March 27, 2020. The legislation was enacted primarily to provide needed funds to individuals who would lose their jobs during the lockdown and for businesses that expected to be impacted by the pandemic.
An important change under the CARES Act temporarily reduces the restrictions on the net operating loss (“NOL”) deduction under IRC 172, which allows some businesses to obtain refunds or credits by filing an application for a tentative carryback adjustment under IRC 6411. As a result of COVID shutdowns, many businesses will sustain losses this year, thus creating an NOL. Therefore, it is important for businesses in an NOL position to determine how to best take advantage of these losses under the CARES ACT provisions.
NOLs - Prior to the CARES ACT
Prior to the Tax Cuts and Jobs Act (TCJA) an NOL deduction generally could be carried back two (2) years and forward 20 years. In addition, generally the only dollar limitations that existed on the amount of the NOL was the amount of taxable income.
NOLs - After the TCJA
Under the TCJA, the carryback rule was eliminated for most NOLs arising in tax years beginning after December 31, 2017. However, NOLs arising in a tax year beginning after December 31, 2017 could be carried forward indefinitely.
The TCJA also limited the amount of an NOL deduction that can be used in a given year. For tax years beginning after December 31, 2017, the NOL deduction was limited to the lesser of:
1. the aggregate of the net operating loss carryovers to such year, plus the net operating loss carrybacks to such year, or
2. 80% of taxable income computed without regard to the deduction allowable under pre-CARES Act IRC §172(a).
CARES ACT – NOL Carryback losses reinstated
The CARES Act temporarily reinstates a carryback period for all NOLs generated in years beginning after December 31, 2017 and before January 1, 2021. The carryback period for those tax years is five (5) years. Therefore, an NOL generated in the 2018 tax year can be carried back to the 2013 tax year, assuming there was taxable income in 2013. Since the top corporate tax rate was 35% prior to its reduction by the TCJA to 21% for tax years after 2017, carrying back an NOL from 2018, 2019, or 2020 may potentially result in a greater benefit than carrying the NOL forward.
For Example: Corporation ABC incurs a $1,000,000 tax loss in 2018. In addition, Corporation ABC had taxable income over $1,000,000 in 2013. The present value of tax savings from the NOL carryback to 2013 would be approximately $350,000, while if Corporation ABC carried the loss forward, the present value of the NOL would most likely be less than $210,000 based on the top corporate tax rate of 21%.
The CARES ACT IRC 6411 allows a taxpayer to file an application for a tentative carryback adjustment of tax liability for a prior year into which the NOL can be used. To apply for this carryback adjustment corporate taxpayers are required file Form 1139, Corporation Application for Tentative Refund. Individual taxpayers are required to file Form 1045, Application for Tentative Refund. The taxpayer has 12 months from the end of the NOL tax year to file the application. IRC 6411(b) states that within 90 days of filing the application, the IRS will credit, apply, or refund any overpayment.
Under the post CARES ACT rules, NOL taxpayers should consider how they treated NOLs in those years and whether and how to revise that treatment.
CARES ACT Temporarily suspends the 80% limitation rule
The TCJA's limitation of 80% of taxable income applied to all NOLs incurred in tax years beginning after December 31, 2017. The CARES Act temporarily suspends this 80% taxable income limitation. This in-turn allows an NOL carryforward to fully offset taxable income in tax years beginning before January 1, 2021.
However, in the case of a tax year beginning after December 31, 2020, the amount of an NOL deduction is equal to the aggregate amount of the NOLs from tax years beginning before January 1, 2018, that is carried to the tax year, plus the lesser of:
- The aggregate amount of NOLs arising in tax years beginning after December 31, 2017, carried to the tax year; or
- 80% of the excess of taxable income computed without regard to the NOL deduction and the qualified business income and foreign-derived intangible income and global intangible low-taxed income deductions.
For Example: Corporation XYZ's 2021 tax year begins after December 31, 2020, the 80% rule applies. The 2017 NOL can be fully applied to reduce the 2021 taxable income of $180,000 ($200,000 taxable income, less the $20,000 2017 NOL). In addition, Corporation XYZ can deduct the lesser of:
- The aggregate amount of the NOLs incurred after December 31, 2017, or $300,000 ($100,000 + $50,000 + $150,000); or
- 80% of taxable income before an IRC 172 deduction, which is $160,000 ($200,000 × 80%). Since $160,000 is less not more than the $300,000 aggregate carryovers from the tax years 2018, 2019, and 2020, the maximum NOL deduction is $180,000 ($20,000 from the 2017 NOL, plus $160,000, or 80% of taxable income).
Taking Advantage of NOLs
The CARES Act temporarily restores the NOL deduction by reinstating the carryback and removing the limitations on the amount of the NOL deduction. However, the NOL rule changes under the CARES Act only apply to tax years 2018, 2019, and 2020. Taxpayers that incurred an NOL during these three years should be aware of these rule changes so that they can maximize the value of their NOLs. Please contact us with any questions.