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On March 27, President Trump signed the CARES Act, the $2 trillion stimulus package to help those affected by the COVID-19 pandemic. The package authorizes aid to several parts of the economy.
Most of the news about the act centered around the $349 billion Paycheck Protection Program (PPP), which was later replenished with another $310 billion of funding on April 24, and the $1,200 stimulus checks to eligible taxpayers.
In addition, the CARES Act included a number of noteworthy provisions relating to retirement accounts, such as penalty-free retirement account distributions up to $100,000 with tax payable in three years, no required minimum distributions for 2020, and increasing the maximum 401(k) plan loan amount from $50,000 to $100,000. However, there is one pro-business provision that has not received the attention it deserves:
Carry-Back Of Net Operating Losses
A net operating loss (NOL) results when a business or individual has a greater amount of tax deductions than taxable income during the taxable year. The silver lining to having business losses is you can potentially use some of those losses to offset taxable income from other taxable years. Prior to the 2017 Tax Cuts and Jobs Act (TCJA), a taxpayer was able to carry back an NOL two years to offset against taxable income, or forward 20 years.
However, the TCJA section 13302 abolished the opportunity for taxpayers in most circumstances to carry back NOLs. Now, in most circumstances, NOLs can only be carried from tax years ending after 2017 to a later year. However, the TCJA allowed taxpayers to carry forward NOLs indefinitely, but limited the deduction of NOLs to 80% of taxable income.
Most net operating losses are associated with business losses. To gain the benefit of the NOL, the loss must be included in one’s personal income tax return. Hence, for individuals to use an NOL, the loss must be attributable to a pass-through entity, such as an LLC. Any C corporation NOLs can only be used by the corporation.
In general, to generate an NOL, one must have losses relating to either a business (with some limits) or rental income. For example, if you have an NOL in 2018, you could use those losses to offset gains in 2019 and, thereby, recoup some or all of the taxes paid during that year. In addition, if any portion of the NOL still remains, it can be used to offset income in future years. For instance, if one had a $20,000 net operating loss in 2018 and only $8,000 was used to offset income in 2019, one could carry the remaining $12,000 NOL to 2020 and beyond. Then, one could recalculate one’s tax liability by taking into account the NOL deductions, possibly generating a decent tax refund.
What Changed?
The CARES Act now allows a taxpayer who incurred NOLs during the 2018-2020 taxable years to carry them back to reduce taxable income earned during the five-year period prior to the taxable year in which the NOL was sustained. It also provisionally eliminates the taxable income restriction under the TCJA, thus, permitting taxpayers to use NOLs to reduce 100% of taxable income for the 2018-2020 taxable years.
It is quite surprising that the NOL provision did not get more positive attention from the business community. Businesses that generated net profits in the past but as a result of the COVID-19 crisis will experience NOLs in 2020 can now carry back the 2020 NOL up to five years and recoup income taxes paid in those years.
In addition, losses suffered in tax years 2018, 2019 and 2020 may be carried forward to tax years starting January 1, 2021. The 80% income limitation will not apply. For example, if a taxpayer with a pass-through business generates NOLs in 2020, which is quite likely as a result of the financial impact of the COVID-19 pandemic, the taxpayer can go back up to five years and use those losses to offset income from these years and seek a tax refund.
Even better, a taxpayer can now use NOLs in 2018 and 2019 and immediately go back five years to offset taxable income to generate a tax refund by amending prior tax returns. This could potentially create a huge financial windfall for the small-business owner and help with much-needed cash flow.
Many small-business owners are focused on securing PPP funding for their businesses. While this makes sense in the short term, the NOL provisions may end up proving more valuable for many small businesses in the long run. However, it’s important to work with a qualified professional to see how net operating losses can be used to offset your business’s tax liabilities.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.