LGT ProfitSense Insights

CARES Act and Net Operating Losses

Written by David Hill, CPA | Jun 17, 2020

On March 27th, 2020 the Coronavirus Aid, Relief, and Economic Security Act (CARES Act or the Act) was signed into law.  The purpose of the CARES Act is to provide economic relief to people and businesses who have been impacted by the COVID-19 pandemic.  One of the provisions of the CARES Act is the expansion of options for how taxpayers can utilize their Net Operating Losses (NOL’s).

Before the CARES Act was signed, the tax law from the 2017 Tax Cuts and Jobs Act (TCJA) required NOL’s arising in tax years ending after December 31st, 2017 to be carried forward to future tax years. The TCJA eliminated the carryback of most tax losses.  In addition, NOL’s arising in years after December 31st, 2017 were also limited to offsetting only 80 percent of taxable income.  The CARES Act has temporarily modified those restrictions substantially.

New Carryback Provisions

The CARES Act allows for the carryback of NOL’s arising in years beginning after December 31st, 2017 and before January 1st 2021.   For calendar year taxpayers this means that NOL’s generated in the tax years ending December 31st 2018, 2019, and 2020 are eligible to be carried back five years.  An added benefit of the five year carryback period is tax rates were higher in years prior to 2018.  This allows for a loss in the current year with a corporate tax rate of 21% or individual and tax rate of up to 37%, to be carried back to a more beneficial prior year with a corporate tax rate of up to 35% or individual and trust tax rate of up to 39.6%.  The Act has also temporarily removed the 80% of taxable income limitation of NOL’s for tax years ending before January 1st, 2021.  This will allow the full offset of taxable income if the taxpayer wishes to elect out of carryback treatment.  Also, included in the Act is a technical correction that applies to fiscal year taxpayers with years beginning in 2017 and ending in 2018.  The correction allows for pre-TCJA rules to apply so those losses can be carried back to each of the two preceding tax years or carried forward and not subject to the 80% income limitation.

Additionally, the Act included provisions that have allowed an extension of time to file an application for tentative refund for losses arising from the 2018 tax year to June 30, 2020.  This is done by filing Form 1139 for Corporations or Form 1045 for individuals.  These forms are normally required to be filed within 12 months of the end of the tax year for which the loss resulted.

Section 461 – Excess Business Losses

Individual taxpayers may benefit from filing an amended tax return before the Form 1045 carryback claim if they had a Section 461 Loss limitation on their 2018 tax return.  Section 461 loss limitations of $250,000 for single or $500,000 for married taxpayers have been suspended for the tax years of 2018, 2019, and 2020.  Amending the return would allow for the full loss incurred in 2018 to be carried back to the previous five years if there was a Section 461 limitation that eliminated or reduced an NOL on the return as filed.

International Taxpayers

There are some special considerations for certain corporations that have international affiliates and paid a Section 965 transition tax (toll-charge) in a previous carryback year.  If there was a Section 965 transition tax, the taxpayer can elect to exclude that year from their carryback.  If a year with a Section 965 transition tax is included in the carryback, the taxpayer is treated as having elected to exclude applying the NOL carryback against the Section 965 transition tax.  The net result is that the Cares Act provision does not allow NOL carrybacks to offset the Section 965 transition tax.

Other Considerations

When a carryback claim is filed it will alter several credits and deductions that are calculated based on taxable income of the previously filed tax returns.  The Section 199A domestic production activities deduction (DPAD) may potentially be reduced and will not carryforward to the next taxable year.  The Section 179 election for depreciation and charitable contributions deduction may be reduced but will carryforward to the next taxable year or increase the NOL carryforward.  The carryback of a NOL may also reduce credits claimed in a previous year.  These will typically reduce the claimed amount in a previous year but increase the amount carried forward to future taxable years.  It is important to consider these changes before finalizing a carryback claim. 

The TCJA repealed the alternative minimum tax (AMT) for Corporations starting in 2018.  Recent guidance regarding NOL carrybacks provided that 2018 through 2020 AMT NOLs would be zero.  This will likely create a big AMT tax liability in any NOL carryback year.  The CARES Act provided that any Corporate AMT credits are fully refundable in 2018 and can be claimed as part of the same application for tentative refund.  The net result is zero but you need to be careful to comply with these rules.

Another consideration is for taxpayers that file multiple states tax returns.  If the federal deductions and credits are reduced it could actually increase the taxable income in the states for the prior years which may requiring amended returns.  The potential increase in state taxes due should be considered in relation to the expected federal tax refund before the finalizing of a carryback claim.

Conclusion

The CARES Act has greatly increased the opportunity for taxpayers to use their NOL’s and Lane Gorman Trubitt can help your benefits be maximized.

The deadline to apply for this is June 30th, 2020. Please reach out to us now if you need help!