June 19, 2020

Net Operating Losses

The Coronavirus Aid Relief and Economic Security Act (the “CARES Act”) was enacted on March 25, 2020, with the purpose of helping individuals and businesses deal with COVID19 and related lockdowns. Some of its provisions, such as the payments to individuals, and the Paycheck Protection Program have garnered massive media attention. However, there are many provisions of equal or greater importance, especially to the business community. This article explores the new rules in relation to Net Operating Losses (NOL) for taxpayers engaging in business activity.

Generally speaking, taxpayers may take NOL deductions if their business deductions exceed their gross income for a taxable year.¹ Over the years, the taxation of NOLs has changed many times. Often, NOL deductions become more taxpayer friendly during times of economic crisis.² The current COVID19 pandemic and accompanying economic downturn have followed that trajectory.  Under prior law, otherwise qualifying taxpayers were not allowed to carry back NOLs.³ Taxpayers were, however, generally permitted to carry forward NOLs indefinitely into future tax years. Furthermore, under prior law, businesses were limited to deducting only up to 80% of their taxable income when taking an NOL deduction in any given year.⁴

Under the new rule, qualifying taxpayers may elect to carryback NOLs to the five taxable years preceding the taxable year in which the NOL arises.⁵ This new carryback rule is optional. Taxpayers may decide instead to carry forward NOLs.⁶ Taxpayers choosing to carry back NOLs will be entitled to refunds currently on certain taxes paid in those five prior years. When carrying back losses, taxpayers must first carry back to the earliest tax year, then, to each subsequent tax year.⁷ This means, for example, if a business has qualifying NOLs in 2018, these losses will first be allocated to 2013, and then to 2014, and so on. The new rule applies only to tax years 2018, 2019, and 2020.⁸ Furthermore, the CARES Act repealed the 80% taxable income limitation on the use of NOLs for 2018, 2019, and 2020. Taken together, taxpayers with NOLs in 2018, 2019, and 2020 now have increased flexibility and planning opportunities.

            Corporate taxpayers seeking NOL refunds must apply using Form 1139.⁹ For tax year 2018, the deadline for filing a tentative carryback adjustment is now June 30, 2020.¹⁰ Any claims made after June 30, 2020, for tax year 2018 must be made with an amended return. Interested taxpayers should consult their tax advisors with urgency to be eligible to receive their NOL carryback refund as soon as possible. From a tax rate perspective, the five year carrybacks are favorable due to rate changes in the 2017 Tax Cuts and Jobs Act. The current carryback rules allow businesses to carry back losses, incurred under a lower rate, back to tax years when rates were higher. Tax rate comparisons should always be considered in making these decisions. Each organization is different, so careful consultation with tax advisors is needed in making these decisions.

            Distressed companies contemplating NOL taxation should pay special attention to any existing or future creditor claims against the company. In the case of a distressed company facing creditor claims, the company may choose to carry forward losses rather than take a current refund subject to creditor claims.  Overall, the decision to carry back or carry forward NOLs should be made after consideration with tax advisors.

            This Insight is intended only to provide an overview of the matters addressed herein and does not constitute legal advice.  If you have any questions regarding a specific issue, please seek appropriate legal counsel.

¹ I.R.C. § 172(c).

² See e.g., The Worker Homeownership, and Business Assistance Act of 2009 (extending NOL carryback period from two to five years after the financial crisis of 2008-2009); The Job Creation and Worker Assistance Act of 2002 (extending NOL carryback period from two to five years following economic recession of 2001).

³ For a detailed discussion of NOL taxation prior to the CARES Act see The Loss of Loss: The Unheralded Changes of the 2017 TCJA by John George Archer (August 21, 2019) https://gilpingivhan.com/insights/articles/the-loss-of-loss-the-unheralded-changes-of-the-2017-tcja.

⁴ Archer, supra fn. 5.

⁵ § 172(b)(1)(D)(i)      

⁶ § 172(b)(1)(A)(ii)(II).

⁷ § 172(b)(2)(“The entire amount of the net operating loss for any taxable year . . . shall be carried to the earliest of the taxable years to which . . . such loss may be carried. The portion of such loss which shall be carried to the other taxable years shall be the excess, if any, of the amount of such loss over the sum of the taxable income for each of the prior taxable years to which the loss may be carried.”).

⁸ § 172(b)(1)(D)

⁹ IRS Notice 2020-26; see § 6411.

¹⁰ IRS Notice 2020-26 (extending the initial deadline an addition six months ending on June 30, 2020).