In response to the economic shutdown caused by coronavirus, Congress unanimously passed the CARES Act and President Trump signed it into law on March 27, 2020. The CARES Act is a two trillion-dollar plus aid and stimulus package including a provision that is a game-changer for taxpayers that have or will experience losses in the years 2018 through 2020.
What The CARES Act Means for Net Operating Losses (NOL)
The CARES Act revived the NOL carryback so that Net Operating Losses can be carried back for up to five years if they occurred in the following years:
Thanks to the CARES Act, many taxpayers that lost money in 2018 and 2019 will immediately be eligible for refunds. Taxpayers that had profits in the years 2015 through 2019 will be looking to maximize their losses and take full advantage of the resurrected NOL carryback.
Specifically in regards to the year 2020, because of the disruption caused by coronavirus and the ensuing economic shut down, it stands to reason that a significant number of taxpayers will likely have large NOLs.
The COVID-19 Effect
Due to the coronavirus economic crisis in the tax year 2020, many businesses will likely sustain significant operating losses. It is a natural consequence of an unplanned shut down of the United States economy.
The first businesses that come to mind when thinking about these 2020 losses are primarily restaurants and oil companies. That said, the overall effect the pandemic has had on the economy will result in businesses in almost every industry experiencing losses for that same year.
However, there is some light at the end of the tunnel. For businesses and individuals that have a history of taxable income for the last five years, these 2020 losses could turn into cash refunds thanks to the resurrection of NOL carrybacks.
Planning For Refunds Associated With A Loss Carryback
In addition to the natural losses that come in a year with an economic downturn, some tax planning can enhance the amount of applicable tax losses and the refund associated with a loss carryback. It will be important to maximize losses in 2020 because the NOL carryback provision in the CARES Act expires so that a loss after that year can only be carried forward.
The list of legitimate tax planning techniques that a taxpayer can utilize to recognize a loss in a given tax year is lengthy and specific, but some examples are:
Sale of Excess Inventory
A retailer has an excess inventory that will ultimately sell for a loss. However, engaging in a sale liquidating that inventory prior to year-end will allow the loss to be taken in 2020.
All Accounts Paid
A cash-basis taxpayer pays all accounts payable prior to year-end.
An accrual-basis business sues a customer that has not paid a significant account. If the business accepts a settlement offer from the customer for half of the amount due, the business will have a recognizable loss. Yet, if the settlement can be completed by year-end, the loss will be deductible in 2020 and could result in a tax refund.
An accrual-basis taxpayer is being sued. So long as the taxpayer denies liability, the taxpayer cannot take a deduction. If the taxpayer settles the suit and agrees to make payments, the taxpayer likely would be entitled to a deduction. This deduction may be taken in the year of settlement if certain conditions are met.
Casualty losses were limited by the 2017 Act. After 2017, only casualties in areas declared natural disasters are eligible for this special tax deduction status. Casualty losses resulting from hurricanes, tornadoes, and earthquakes are well established. President Trump issued an unprecedented nationwide COVID-19 disaster declaration applicable to all 50 states, four territories, and the District of Colombia. Exactly how casualty losses for a virus pandemic will be calculated still need to be developed. The IRS and Treasury will likely provide some guidance and taxpayers and tax professionals will undoubtedly try to aggressively push what they can into the loss calculation.
Plan Your 2020 Tax Strategy
Taxpayers have the remaining months left in 2020 to engage in tax planning that will optimize their losses in a manner that could result in a refund of prior years’ taxes paid. Likewise, this may be an opportunity for taxpayers that still owe unpaid income taxes from prior years to reduce or eliminate that liability.
If you have questions about how the CARES Act could affect your net operating losses, please reach out to the May Firm today.