CARES Act Impacts On Net Operating Losses: Frequently Asked Questions

APRIL 30, 2020

On March 27, President Trump signed the Coronavirus Aid, Relief, and Economic Security Act (also known as the CARES Act), a $2 trillion stimulus package intended to help mitigate the economic devastation caused by the coronavirus.

The CARES Act includes changes to the tax treatment of business net operating losses (NOLs) for corporations and other taxpayers. Given the significant role NOLs can play in increasing cashflow and helping to mitigate financial distress, we’ve compiled Frequently Asked Questions around NOLs to help break down the latest changes in the CARES Act and what they mean for your business.

What is an NOL?

An NOL occurs when a company’s tax deductions exceed its taxable income within a given tax period. An NOL can be carried forward over future tax periods and used to offset taxable income to reduce a company’s total tax liability. The 2017 tax reform legislation known as the Tax Cuts and Jobs Act of 2017 (TCJA) lifted the previous 20-year limit on NOL carryforwards, but limited NOLs to 80% of taxable income in any one tax period. Among other changes, the CARES Act temporarily removes this 80% limit for taxable years beginning before 2021 to allow an NOL carryforward to fully offset an organization’s income.

What years can I carry back an NOL under the CARES Act?

The CARES Act allows a five-year carryback of any NOL generated in a taxable year beginning after December 31, 2017, and before January 1, 2021. In addition, fiscal year 2017 returns (i.e., returns that began before January 1, 2018, and ended after December 31, 2017) can now be carried back two years as a result of the technical correction to the effective date language in the TCJA (which originally applied the prohibition on carrybacks to taxable years ending after December 31, 2017).

Are carryforwards of NOLs still indefinite?

Yes, the CARES Act still allows for an indefinite carryforward period. Indefinite-lived NOLs are NOLs generated in a taxable year beginning after December 31, 2017. This indefinite carryforward period includes the 2018-2020 NOLs that remain after the five-year carryback period.

Do the NOL carryback provisions apply only to C corporations?

No. The NOL carryback rules also apply to individuals, estates and trusts and tax-exempt organizations filing Form 990-T, Exempt Organization Business Income Tax Return, to report unrelated business taxable income.

Are there any limitations on which corporate taxpayers can specifically use the five-year carryback?

Under the CARES Act, real estate investment trusts (REITs) are not allowed a carryback to any preceding taxable year. In addition, an NOL generated in a non-REIT year cannot be carried back to a year in which the taxpayer was a REIT. Additionally, there are other provisions of the tax code that could prevent a carryback that were not impacted by the CARES Act.

Is it better to carryback the NOL or to elect to use it to offset future income?

While a company’s specific assessment may vary, often the extended carryback provides a favorable rate differential for C corporations because they are able to carry back post-TCJA NOLs to offset pre- 2018 ordinary income or capital gains, which were taxed at higher rates. In addition, a carryback is typically more valuable because of present value discounting, which eliminates the need to generate future taxable income and reduces the risk potential of limitations on future loss utilization.

However, carrybacks can create added tax compliance, including updating calculations for carryback years, expose the organization to tax risks of prior years, or have limited refundability if the organization has experienced certain merger and acquisition activity.

Does the forgiveness of a Small Business Association (SBA) loan have any impact on an NOL carryforward?

The CARES Act treats the SBA loan debt forgiveness as not taxable. While there is some uncertainty, it does not appear that an NOL could be reduced for any small business loan forgiveness.

Does the 80% limitation on taxable income apply to NOLs generated in 2018 through 2020?

The 80% limitation on taxable income only applies to the use of NOLs in taxable years beginning after December 31, 2020. However, only NOL carryovers generated in taxable years beginning after December 31, 2017, are subject to the limitation once they are carried over to a period in which the limitation applies. NOL carryforwards from earlier pre-TCJA taxable years will not be subject to this limitation.

Can a taxpayer carry back an NOL to specific years, for example, the preceding taxable year but not any further? Or must the NOL be carried back for the full period to the extent the corporation has taxable income in those years?

Generally, the entire amount of the NOL for any taxable year (a loss year) must be carried back to the earliest taxable year to which such loss may be carried. Such carryback must be applied until the maximum NOL is absorbed with respect to that year. Any remaining NOL is then carried forward to the next carryback year, and so on. However, an exception under the CARES Act exists where taxpayers can elect to exclude taxable years with Section 965 income (untaxed foreign earnings from certain specified corporations) from the carryback period.

What are the options available to taxpayers in accessing a refund as a result of these new carryback provisions?

The specific form an organization must complete to request a refund varies by entity type; however, all organizations must file the return first before generating the NOL.

How should a taxpayer proceed if it has filed a calendar year 2018 return and would now like to carry back the 2018 NOL?

The Treasury Department and the IRS have granted a six-month extension to file for a tentative refund on Form 1045 for individual taxpayers, trusts and estates and Form 1139 for corporations for the carryback of an NOL that arose in a taxable year that began during calendar year 2018 and that ended on or before June 30, 2019.

This extension is limited to requesting a tentative refund to carry back an NOL and does not extend the time to carry back any other item.

For example, in the case of an NOL that arose in a taxable year ending on December 31, 2018, a taxpayer normally would have until December 31, 2019, to file the applicable forms but due to this extension will now have until June 30, 2020.

For quicker tax refund, where Forms 4466, 1045, or 1139 are used, the IRS recommends including the following direct deposit request forms: (1) Form 8050 for direct deposit amounts of less than $1 million, and (2) Form 8302 for direct deposit amounts of $1 million or more.

If this taxpayer is a corporation that is also seeking to claim an alternative minimum tax (AMT) credit refund, they can file one application for both the AMT refund and the NOL carryback. However, if they file for both simultaneously, they will need to do so by the earlier of the two deadlines.

Additionally, it appears the carryback may result in a new or increased credit in the carryback year, therefore requiring additional amended returns and potentially a larger AMT credit refund.

Understanding and applying these rules to maximize tax savings and increase cashflow is a complex task. Get in touch with our team to understand what these changes and other provisions of the CARES Act mean for your business’ tax planning.