Net Operating Loss Considerations under the CARES Act
In a time of uncertainty, the CARES Act (“the Act”) was passed in late March 2020, in an effort to provide relief to the many businesses and individuals affected by the COVID -19 pandemic. Many of the new provisions include tax benefits for taxpayers, most of which have the effect of placing much-needed cash back into the hands of businesses and families in the form of deductions, refunds or tax credits.
Under the Act, businesses and individuals with federal Net Operating Losses (“NOLs”) originating in years ending in 2018, 2019 or 2020 are permitted to carry back those losses for five years. This temporarily eliminates the tax law provision created under the Tax Cuts and Jobs Act (“TCJA”) of 2017, which eliminated carryback and limited the use of carryforward NOLs to 80% of taxable income.
Corporate taxpayers who are able to take advantage of the NOL carryback provision create additional liquidity for their companies, as the current corporate tax rate, which was lowered under the TCJA, is 21%. Prior to January 1, 2018, was 35%. Given this significant change, corporate taxpayers should carefully analyze the timing of NOL tax attribute utilization to maximize their potential benefit under the Act. This provision allows taxpayers in a loss situation to monetize their loss position and take advantage of a rate arbitrage.
Most C Corporation filers will be able to apply for refunds by filing Form 1139 Corporation Application for Tentative Refund. Individual filers should use Form 1045, Application for Tentative Refund. (The IRS recently released specific filing instructions related to filing forms by fax as well).
In order to take advantage of these provisions, taxpayers should review their 2018 tax return filings to determine if they reflect a loss. If so, and the business or individual filer will likely be eligible to consider a carryback claim. Further, in many cases, we also suggest reviewing 2019 projections or financials. If the projections anticipate a loss, 2019 tax return preparation should be accelerated so that the refund from a carryback might be claimed more timely.
While the NOL carryback rule is a taxpayer-friendly provision in the CARES Act (one of several), taxpayers must be careful when considering this opportunity. Some situations where NOL carrybacks may need special consideration include the following:
- A carryback year in which a corporation was not classified as a corporation.
- A carryback year where the corporation was a member of a consolidated group.
- A carryback year in which a corporation acquired or was acquired by another corporation.
- A carryback to years subject to the Transition tax pursuant to Section 965.
Additionally, carrying back an NOL may also create changes in financial statement disclosures. Some examples are:
- Companies reclassifying a portion of the existing NOL carryforward as an income tax receivable or, conversely, a reduction in income taxes payable, if the company expects a refund as a result of the limitation being eliminated for those tax years.
- Companies with federal NOLs generated in 2018 and 2019 that will be carried back to earlier years will need to re-measure the deferred tax assets related to their NOLs because, as mentioned earlier, the corporate tax rate was different prior to January 1, 2018.
- Companies may need to schedule their temporary differences to determine if any of their deferred tax assets or deferred tax liabilities, upon reversal in tax year 2020, will give rise to an NOL that will be recovered by a carryback to a prior year.
- Companies that have deferred tax assets for disallowed interest expense deductions generated in 2019 may need to think about whether the temporary increase in the interest deduction limitation changes the amount of NOLs generated or used in 2019 that can now be carried back. This consideration also applies to other tax attributes that were used in a prior year as a result of the tax credit such as Section 199, GILTI, etc.
Business and individual taxpayers with Net Operating Losses have an expanded opportunity under the CARES act to file for tax refund claims. For assistance with how the NOL carryback rules may impact you or your business, please contact your Marcum tax advisor.
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