As companies close out their books for 2020 and see just how large of an impact the COVID-19 global pandemic had on their businesses, it is important to keep in mind that there can be significant tax benefits associated with net operating losses (“NOLs”). While the Tax Cuts and Jobs Act of 2017 (“TCJA”) made noteworthy changes to the tax treatment of NOLs that were not taxpayer favorable, the CARES Act of 2020 came to the rescue and not only reversed these changes temporarily, but also expanded on the time period taxpayers can utilize for an NOL carryback. These changes impacted losses incurred in 2018 and 2019, but the scope of this article focuses on losses incurred in 2020.
Under the CARES Act, an NOL generated in 2020 can either be carried back five years (with any excess utilized in subsequent years of the carryback period and any remaining excess used in future tax years) or the taxpayer can elect out of this carryback period and instead carry forward the loss to offset future taxable income. Taxpayers should analyze whether it is more beneficial to carryback an NOL or carry it forward taking into consideration the following:
The effective tax rate on income that will be offset by the loss. Carrying back the loss 5 years allows many taxpayers the ability to offset income at pre-TCJA rates that were higher than current rates.
The value of a near term cash infusion from an NOL carryback refund weighed against the future value of tax savings if the loss were carried forward.
Current tax laws will only allow a 2020 loss that is carried forward to 2021 and future years to offset 80% of taxable income whereas a 2020 loss that is carried back can offset 100% of income.
If a taxpayer carries back their NOL, they can either file a tentative refund claim or file amended returns for all carryback years. Typically filing a tentative refund claim results in a faster refund because the IRS is required to process the application and either allow or deny it within 90 days. Whereas, amended returns do not have a 90-day requirement and the IRS is currently experiencing a large backlog of amended returns to process. To file a tentative refund claim, a corporate taxpayer uses Form 1139 Corporation Application for Tentative Refund and noncorporate taxpayers file Form 1045 Application for Tentative Refund. These tentative refund claims must be filed after the taxpayer files its return for the tax year that generated the NOL and within 12 months of the end of the tax year that generated the NOL. For calendar year taxpayers with NOLs incurred in 2020, these refund claims must be filed by December 31, 2021. The IRS released a temporary procedure that allows taxpayers to fax in Forms 1139 and 1045 that will help to expedite processing.
Taxpayers may also be able to receive state tax refunds from carrying back an NOL. It is important to understand the specific rules relative to NOL carrybacks for each applicable state including the state’s conformity with the CARES Act, the impact of state adjustments such as bonus depreciation and state specific deadlines for claiming refunds. Our team of Tax Advisors at Schneider Downs has extensive experience with NOL, so please do not hesitate to contact us with any questions.
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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.