The Coronavirus Aid, Relief and Economic Security Act (CARES Act) has provided many opportunities for taxpayers to evaluate their 2018 and 2019 tax returns to determine potential refund opportunities. One such area is the utilization of net operating losses (NOLs) that could provide taxpayers with much-needed liquidity in these cash-strapped and critical times. Prior to the CARES Act, the Tax Cuts and Jobs Act (TCJA) limited the taxpayers’ ability to utilize NOLs by 1) eliminating the ability to carryback NOLs to recapture taxes paid in prior years, and 2) limiting the amount of income that an NOL carryforward could offset.
Carryback of NOL
The Act now allows a 5-year carryback of NOLs generated for taxable years beginning after December 31, 2017 and before January 1, 2021. This provides a potential rate arbitrage as it will allow taxpayers to carryback losses generated in lower taxed years (21% corporate) to higher taxed years (35% corporate).
The Act provided a technical correction to allow fiscal year taxpayers that incurred a NOL for a taxable year that began before and ended after December 31, 2017, to utilize the pre-TCJA carryback rules, thus allowing them to carryback the NOL to the previous 2 taxable years.
Waiver of 80% limitation
Generally, TCJA allowed a NOL carryover to offset 80% of the income for the year. For taxable years beginning after December 31, 2020, the Act limits the amount of NOL deduction to the sum of the NOLs carried over from years beginning prior to January 1, 2018, plus the lesser of:
(1) The NOLs carried over from years beginning after December 31, 2017, or
(2) 80% of the taxable income.
Repatriation Income – Section 965
CARES Act provides that a taxpayer that has a carryback to a repatriation – or Section 965 - year is deemed to have made a Section 965(n) election that limits the amount of the loss that can be carried back to each such year. Therefore, a NOL can be carried back only to reduce income in excess of the amount of the net Section 965(a) inclusion.
The Act allows another election to exclude all repatriation years from the NOL carryback computation for NOLs incurred in 2018, 2019, and 2020. Therefore, taxpayers that had repatriation income will need to perform further analysis and planning around various scenario outcomes.
IRS issued guidance
The IRS has issued guidance relating to the elections and filing of the claims for refunds.
Waiver of carryback
A taxpayer must carryback a NOL unless an election is made to only carryforward the NOL. The election not to carryback a NOL from 2018 or 2019 must be made on a statement attached to the taxpayer’s tax return filed for the first taxable year ending after March 27, 2020. The election, once made, is irrevocable.
Making the claim for refund
Generally, a claim for refund due to a NOL must be made on Form 1139 for corporations and Form 1045 for all other taxpayers. However, there is a requirement that the claim must be filed within one year after the end of the taxpayer’s year end when the NOL was generated. The IRS has extended those periods as follows:
• For NOLs incurred in years that began prior to and end after December 31, 2017, the claim must be filed by July 27, 2020.
• For NOLs incurred in years that began during 2018 and ended on or before June 30, 2019, the taxpayer has until June 30, 2020 to file the Form 1139 or Form 1045.
IRS implemented new procedures beginning April 17, 2020 directing taxpayers to file via fax – rather than mail - Form 1139 and Form 1045. The acceptance of faxed versions of these forms is only meant as a short-term measure to assist taxpayers in receiving refunds as quickly as possible.
Other items to consider
Even though a taxpayer was not originally in a taxable loss situation in 2018 or 2019, changes stemming from the CARES Act provisions - such as expensing of qualified improvement properties (QIPs), changes in the Section 163(j) interest deductibility or loss limitations for individuals - may create opportunities to create a loss for those years and amend prior year returns to maximize cash refunds.
As mentioned before, the ability to carryback NOLs may provide a tax rate arbitrage versus having to carry the losses forward to future years. This gives planning opportunities, such as method changes or timing of deductions, to maximize the amount of losses and, ultimately, the amount taxes to be recaptured. Therefore, modeling of the potential loss carryback and refund opportunities becomes essential and highly recommended.