How Does the CARES Act Impact Net Operating Losses for Small Businesses?by
The CARES Act revamps the rules for net operating losses (NOLs) claimed by your small business clients, once again permitting carrybacks.
The new Coronavirus Aid, Relief, and Economic Security (CARES) Act includes a bushel of tax breaks designed to help business clients cope with the economic downturn due to the COVID-19 crisis. Ken Berry’s previous columns discussed how the CARES Act impacted retirement fund investments as well as charitable giving.
This week, we delve into how the Act affects small businesses’ net operating losses. Significantly, although the CARES Act essentially repeals tough rules that were imposed by the Tax Cuts and Jobs Act (TCJA), the changes go even deeper than that.
These rules are extremely complex and difficult to follow, even for tax practitioners. The IRS recently issued new guidance on carrying back NOLs under the revised setup (IR-2020-67, 4/9/20). First, let’s recap recent history.
Prior to the TCJA, which was signed late in 2017, a business was able to carry back an NOL for two years and then forward for up to 20 years. In other words, the NOL could first offset tax liability for a prior year. Alternatively, if it suited its purposes, the business could elect to forego the carryback.
The exact methodology for applying these rules depends on the form of business ownership. For instance, an NOL claimed by a C corporation can only be used to offset its business income. However, owners of pass-through entities—such as partnerships and S corporations—and self-employed individuals may use NOLs to offset non-business income on their personal tax returns.
The TCJA imposed three key restrictions for NOLs arising in tax years beginning after 2017:
1. No carrybacks: The TCJA repealed the two-year carryback period (except for certain farms and insurance companies). On the other hand, NOLs could now be carried forward indefinitely.
2. A new 80 percent limit: For the first time, the TCJA created a limit for NOLs based on 80% of the company’s taxable income (determined without respect to the NOL). Carryforwards are adjusted to take the 80% limit into account.
3. A threshold for non-corporate taxpayers: For 2018 through 2025, the TCJA limited losses of non-corporate taxpayers—such as individuals, restates and trusts—that may be used to offset non-business income to $250,000 for single filers and $500,000 for joint filers. For S corporation owners and partners in partnerships, these limits are taken into account at the individual level. Any excess is carried forward as an NOL (subject to the 80 percent limit).
Now the CARES Act provides taxpayers with significantly more flexibility when claiming NOLs. Accordingly, it created the following tax breaks:
- Taxpayers can carry back for five years NOLs from 2018, 2019 or 2020 to offset losses in prior years. In effect, this enables a taxpayer to go as far back as the 2013 tax year.
- The CARES Act suspends the 80 percent-of-taxable income limit until 2021. This allows taxpayers to use NOLs in a year that’s more beneficial for tax purposes.
- Similarly, the CARES Act eliminates the thresholds for non-corporate taxpayers for the 2018, 2019 and 2020 tax years. These limits won’t kick in until 2021.
The CARES Act also coordinates the new tax breaks with various other provisions of the tax code. The new Notice issued by the IRS provides more insights into the methodology for carrying back losses and application of the rules for pass-through entities.
There’s a lot more to this than first meets the eye. To assist professionals and taxpayers, the IRS has posted the answers to a list of frequently questions about the new rules for NOLs.
Next week, we will address employer credits.
Ken Berry, Esq., is a nationally known writer and editor specializing in tax, financial, and legal matters. During his long career, he has served as managing editor of a publisher of content-based marketing tools and vice president of an online continuing education company. As a freelance writer, Ken has authored thousands of articles for a...