Net Operating Losses Take Advantage of New Rules to Supplement Cash Flow
Nobody likes to hear the term “net operating losses” (NOL). It may indicate a business has not performed according to expectations, sometimes due to no fault of the business or its owners. Often an NOL is intentional with the advent of 100% bonus depreciation. However, if a business generates a net operating loss, the ability of the business to achieve an income tax benefit from such NOL becomes paramount. This article discusses important recent changes made to the use of NOLs by the Coronavirus Aid, Relief, and Economic Security (CARES) Act passed into law by the federal government on March 27, 2020.
OLD LAW: The 2017 Tax Cuts and Jobs Act (TCJA) limited the deduction for net operating losses (NOLs) of individual taxpayers arising after 2017 to 80% of taxable income. The TCJA also eliminated the ability to carry NOLs back to prior tax years. The TCJA also limited the amount of an annual net business loss to $500,000 for married taxpayers and $250,000 for all other taxpayers. This is known as the “excess business loss” limitation rule.
NEW LAW: For NOLs arising in tax years between 2018 and 2020 the CARES Act allows taxpayers to carryback 100% of NOLs to the prior 5 tax years. Note the NOL must be carried back first to the fifth preceding tax year and then, to the extent not used or not fully used in that tax year, must be carried to the next succeeding tax year. Also note the default rule is that an NOL generated in 2018-2020 years MUST be carried back. If a taxpayer desires to forgo the carryback years, a formal election must be included in the tax return for the year the NOL was generated to waive carryback of the NOL.
How can a taxpayer who has already filed their 2018 or 2019 return formally waive the carryback period? IRS Revenue Procedure 2020-24 makes it very easy. In order to make this waiver, the Revenue Procedure requires taxpayers to formally include an election in their 2020 tax return indicating they are waiving the right to carryback their 2018 and/or 2019 NOLs.
For a personal NOL, IRS Form 1045 is used to report the carryback of an NOL to a prior year and to compute the amount of tax refund available. Currently the IRS is allowing and recommending taxpayers fax their completed Form 1045 to the IRS (rather than mail) to expedite the processing of the tax return and tax refund check.
The CARES Act also temporarily liberalizes the treatment of NOL carryforwards. For tax years beginning before 2021, taxpayers can utilize an NOL deduction equal to 100% of taxable income (rather than the 80% limit under TCJA). For tax years beginning after 2020, taxpayers will be eligible for (1) a 100% deduction of NOLs arising in tax years before 2018 and (2) a deduction limited to 80% of taxable income for NOLs arising in tax years after 2017.
The CARES Act also effectively deferred, for three years, the application of the excess business loss limitation rule. As such, taxpayers have no limitation on net business losses for 2018, 2019 or 2020. For tax years beginning in 2021, the excess business loss rule goes back into effect.
Generally no one wants to generate a NOL, unless you can use bonus depreciation to harvest taxes that were paid in a year with much higher tax rates, such as existed prior to 2017. However, these new CARES Act tax laws provide for those who do generate a NOL during the 2018-2020 tax years the ability to obtain maximum use of such NOLs to receive income tax refunds. If you find yourself in a NOL situation, please contact your trusted KTLLP tax professional to discuss methods of getting needed tax refund dollars in your hands as quickly as possible.