The Coronavirus Aid, Relief, and Economic Security (CARES) Act became law on March 27, 2020, providing financial assistance to businesses and individuals impacted by the COVID-19 pandemic. The CARES Act brings in changes to the Net Operating Loss (NOL) rules for businesses, and the impact these changes may have on completed and future corporate transactions. Businesses should evaluate the potential benefits of carrying back the NOLs
What are the changes relating to Net Operating Losses (NOL)?
Under the current rule, the Tax Cuts and Jobs Act (TCJA) had imposed that net operating losses (NOLs) are subject to a taxable-income limitation and cannot be carried back to reduce income in a prior tax year.
The CARES Act gives businesses a five-year carryback period for NOLs arising in 2018, 2019, and 2020 tax years. Under the timing rules of the Internal Revenue Code (“IRC”) Section 172 and the promulgated Treasury Regulations, the carried back NOLs are carried to the earliest of the tax years to which the loss may be carried.
What are the changes relating to Taxable Income Offset?
Under the current rule, the Tax Cuts and Jobs Act (TCJA) had imposed that a taxpayer could only offset 80% of its taxable income with its net operating losses. For example, a business with a $500 operating loss in 2018 can carry forward only 80% of those losses to offset the 2019 taxable income.
The CARES Act suspends the 80% limit of taxable income on the use of Net Operating Losses (NOLs) for tax years beginning before January 1, 2021. As a result of the CARES Act, corporate taxpayers may use NOLs to fully offset taxable income for 2018, 2019, and 2020 tax years.
How will businesses benefit from these Net Operating Loss rule changes?
Corporate taxpayers may be able to amend prior year returns to offset pre-2018 income that was taxed at higher tax rates of up to 35% than the current tax rate of 21%. This will generate a current year refund for companies and provide them with additional cash flow and liquidity. Corporations with NOLs generated pre-2021 tax year will be able to completely offset their taxable income for 2018, 2019, and 2020 tax years.
When can businesses apply for refunds resulting from NOL carrybacks?
Corporations with NOLs arising in prior taxable years beginning in 2018 or 2019 can apply for tentative refunds resulting from NOL carrybacks provided for under the CARES Act. NOL carrybacks could be especially valuable to corporate taxpayers that are able to offset income in 2017 or prior taxable years, during which corporations generally were subject to a 35% federal tax rate, rather than the current 21% rate.
However, corporations that were profitable in 2018 and 2019 and are in a loss position for only the current taxable year generally will be required to wait until after the end of the year to claim refunds attributable to NOL carrybacks.
Does this impact the limitation we have on the excess business loss that can be offset?
Yes, Section 2304 of the CARES Act temporarily eliminates the excess business loss limitation. The Tax Cuts and Jobs Act (TCJA) had imposed this limitation for all taxable years beginning after December 31, 2017, and before January 1, 2026, to prevent non-corporate taxpayers from using net business losses for a taxable year to offset other income.
What’s not impacted by the NOL rule changes in the CARES Act?
The following transactions will not be affected by the Net Operating Loss (NOL) rule changes:
- Purchase and sale of partnerships and limited liability companies taxed as partnerships, S corporations, or, in most cases, subsidiaries of a larger consolidated group.
- Transactions structured for federal income tax purposes as asset purchases.
Where can I find more information on the changes to Net Operating Loss and other COVID-19 economic relief efforts?
More information on the Net Operating Loss/Taxable Income Offset changes can be found on the IRS’s website at https://www.irs.gov/coronavirus.