Article

Will refunds from losses become a lifeline for struggling businesses?

Oct. 26, 2020 · Authored by Patrick Balthazor

It should come as no surprise that the year 2020 will be a tough one for many taxpayers. A large number of businesses are struggling, particularly in certain sectors. The restaurant and hospitality industries have been particularly hard hit, and they are not alone. Many will show tax losses for 2020. While the losses are not favorable, they may provide somewhat of a lifeline to struggling entities. The ability to use these losses against taxable income from prior years or to offset income in future years may provide businesses with much-needed cash.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act, which was enacted in March 2020, provided stimulus measures to aid businesses that generate net operating losses. These losses may then be utilized to produce tax refunds via carrybacks of the losses to earlier tax years or to offset income in later tax years. Some of the more significant provisions in the CARES Act that can assist in creating refunds include:

• The temporary increase under section 163(j) in the percentage limitation on business interest deductions to 50% of adjusted taxable income (ATI) from 30% of ATI. This provision is discussed in more detail in this letter.
• The effective date for the provision that caps business losses for noncorporate taxpayers to $250,000 annually ($500,000 for joint filers) has been pushed back to taxable years beginning in 2021. This allows taxpayers to utilize the loss in the current year without the cap or to increase a net operating loss that may be carried back to prior tax years.
• For taxable years beginning before Jan. 1, 2021, the provision under the Tax Cuts and Jobs Act that limited the use of net operating losses to 80% of taxable income is not applicable. Thus, losses incurred and used in tax years before 2021 can offset 100% of taxable income. In addition, net operating losses for taxable years beginning after Dec. 31, 2017, and before Jan. 1, 2021, are allowed to be carried back to each of the five preceding taxable years. An election may be made to carry the losses forward.

The prospect of carrying back the loss may seem attractive for taxpayers that have net operating losses in tax years 2018 through 2020. The taxpayer will likely receive the refund quicker if the loss is carried back as opposed to carrying it forward to future tax years. Some taxpayers (especially corporations) may have been in a higher tax bracket in prior years. However, the decision to carry the loss back versus electing to carry it forward should be based on a careful modeling of the consequences. Many factors, including the alternative minimum tax for individuals, repatriation income under section 965 and foreign tax credits must be considered. The application of these factors may result in a carryback refund at a much lower effective tax rate than if an election were made to carry the loss forward. As many practitioners have said: model, model, model. A lack of modeling may result in an inefficient use of the net operating loss.