CARES Act Modifies Net Operating Loss Deductions for Businesses

Many — perhaps most — businesses in the U.S. may anticipate substantially lower revenues during 2020 than in previous years because of the COVID-19 pandemic, and many may have losses this year. Congress passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act in March in order to provide stimuli to the economy, including loans, grants, tax credits, and other benefits. One section of the CARES Act makes changes to the provisions of the Internal Revenue Code (IRC) that deal with deductions of net operating losses (NOLs). The 2017 tax reform bill eliminated most NOL carrybacks, meaning that businesses could no longer deduct current losses from taxes paid in prior years. The CARES Act temporarily reinstates carryback loss deductions, potentially allowing businesses to claim refunds against taxes paid during the past several years.

What Is a Net Operating Loss?

A business has a NOL when its total allowable deductions is greater than its taxable income during a year. Obviously, if a business’ deductions are equal to their income during a tax year, their tax liability would be zero. The IRC allows businesses to use excess NOL amounts from prior years to lower their tax bills in other years. Without those provisions, any deductions that exceed total income would be lost at the end of the year.

How Are Net Operating Losses Deductible?

Prior to 2018, businesses could carry NOLs both forward and back, subject to limitations. A loss carryforward allows a business to reduce its tax bill in the future. Suppose a company has taxable income of $2 million during a particular year, and allowable deductions of $2.5 million during the same year. It would owe nothing in federal income tax, and would have a NOL of $500,000. The following year, suppose it has taxable income of $2.7 million, and $2.5 million in deductible expenses. The business can carry $200,000 of its NOL forward, reducing its net income for the year to zero. It can apply the remaining $300,000 in subsequent years.

A loss carryback allows a business to apply a NOL to an earlier tax return. Suppose that, the year before it had a NOL of $500,000, the business described paid taxes on $500,0000 of net income. With a loss carryback, it could deduct $500,000 from the previous year’s taxes and claim a refund.

The Tax Cuts and Jobs Act (TCJA) of 2017 made significant changes to the deductibility of NOLs. Businesses had been able to carry NOLs back two years and forward twenty years. After two decades, any remaining NOLs would expire. The TCJA eliminated carrybacks almost entirely, except for some farming losses. It removed time limits on carryforwards, but reduced the amount that can be applied to any particular year, starting with 2018.

What Changes Does the CARES Act Make?

Section 2303 of the CARES Act amends § 172 of the IRC to add new provisions related to NOL carrybacks. Businesses with NOLs during the tax years 2018, 2019, and 2020, meaning the time period between December 31, 2017 and January 1, 2021, can carry those losses back up to five years. The IRS published Rev. Proc. 2020-24 in April, which outlines the procedures for filing and claiming refunds.

If you have questions about taxes or related issues, please contact the tax advisors at the Enterprise Consultants Group today online or at (800) 575-9284 to see how we can assist you.

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