The 2020 Coronavirus Aid, Relief and Economic Security Act (CARES) offered several different relief avenues for small businesses that are suffering in the wake of the COVID-19 pandemic.
Relaxing the net operating loss (NOL) deduction rules gives small business clients the option of changing their NOL deduction elections to provide liquidity, in the form of a refundable tax credit based on loss deductions taken against prior years’ income. Taking advantage of the expanded NOL relief can help many small business clients weather the current economic climate—but before making any concrete decisions, clients should fully understand how the new NOL options might impact their business as a whole.
CARES Act Relief
Prior to the 2017 tax reform legislation, net operating losses were fully deductible. They could be carried back for two tax years and carried forward 20 tax years. The 2017 tax reform legislation changed these rules so that NOLs deductions are limited to 80% of the business’ taxable income. For non-corporate taxpayers, the 2017 tax reform legislation changed the rules so that certain excess business losses must be carried forward and treated as a part of the taxpayer’s NOL in subsequent years.
The CARES Act lifted the 80% income limitation so that NOLs can offset 100% of income for 2018, 2019 and 2020. CARES also allows businesses to carry back losses for 2018, 2019 and 2020 for five years. Generally, the NOL will be carried back to the earliest possible tax year—and if it is not used up during that tax year, it is carried to the next earliest year until it is used up (or carried forward). Business owners have the option of excluding years where they had untaxed foreign earnings under IRC Section 965.
For tax years beginning prior to January 1, 2021, businesses can offset 100% of taxable income with NOL carryovers and carrybacks (rather than capping offsets at 80% of taxable income). The CARES Act also effectively delayed application of the excess business loss rule for non-corporate taxpayers until January 1, 2021.
Taxpayers can also elect to forgo the carryback provision and carry 2018 or 2019 losses forward to future years. Losses incurred in tax years beginning before 2018 may be carried forward to tax years beginning after 2020 without being subject to the 80% income limitation. However, amounts carried forward to tax years beginning on or after January 1, 2021 are once again subject to the 80% limit.