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Who Qualifies for NOL Carryback?

With the coronavirus related economic shut down of 2020, many businesses are likely to experience a net operating loss. However, with the passing of the CARES Act into law on March 27, 2020, some business owners are unsure if they are eligible to apply. The rules for applying for an NOL carryback depend heavily on if the applicant is a corporation, estate, individual, or trust.

What Kind of Taxpayer Are You?

The Internal Revenue Service (IRS) breaks down who can use an NOL into two separate groups of taxpayers.

  1. One group includes individuals, trusts, and estates.
  2. The other group is limited to corporations.

The treatment and calculations of an NOL is based on the type of taxpayer, but both types of NOLs typically start at the same point with a net negative taxable income. From this point forward, different things come into play when calculating a taxpayer’s NOL.

Corporation studying Carryback Laws
Corporation working on NOL Carryback for their company

Corporations

A corporation has some distinguishing characteristics from individuals. A corporation at its root is a separate and distinct legal entity from the shareholders. It possesses rights and responsibilities similar to an individual. Corporations are also limited liability entities where the shareholder does not have personal liability but is entitled to receive profits.

Not all corporations are subject to taxes at the corporate level. When looking at corporations another distinction must be made by the taxpayer, and this distinction is whether the corporation is either:

  • a C corporation (also referred to as a C Corp.)
  • an S corporation (also known as an S Corp.)

This difference has drastic implications for tax purposes.

C Corps

The United States taxes C Corps. through the corporate entity itself instead of taxing the individual shareholders. The shareholders, however, do not escape tax liability altogether on the profit from the corporation because when shareholders receive profit in the form of dividends, they are subject to tax on it. Essentially the United States taxes a corporation’s earnings twice, but at different levels.

S Corps

Conversely, an S Corp. is generally not subject to income tax at the corporate level. Instead, the income, losses, deductions, and credits are passed through to the shareholders. This pass-through entity operates similarly to a partnership for tax purposes. The NOL from an S Corp. would be subject to certain limitations and pass through to be analyzed as part of an individual taxpayer’s overall income.Not every corporation can elect to be an S Corp. since it requires the satisfaction of certain requirements outlined by the IRS and the election by the S Corp. All shareholders must sign the Form 2553 to elect, otherwise, an election by the S Corp cannot be made.

Partnerships

One more important distinction worth noting regarding S. Corps is a partnership or S Corp. cannot recognize an NOL because they act as pass-through entities. However, according to the IRS Passive Activity and At-Risk Rules, individuals who hold an ownership interest in the partnership or shares in an S Corp. can recognize (with certain limitations) their share of the NOL.

Business owners working on net operating losses

Individuals, Trusts and Estates

Just as in the case of corporations, the specific definition of individuals, trusts, and estates impacts how these entities applying for NOL carrybacks proceed.

  • Individuals: For tax purposes, individuals also include both single people and married couples.
  • Trusts: According to Black’s Law Dictionary, a trust is a legal arrangement involving a fiduciary relationship between a person (“beneficiary”) and the person in charge of the trust, (“trustee”).  The trustee is obligated to hold or use the property in a manner that benefits the recipient beneficiary.
  • Estates: An estate is the possessions a person leaves behind upon their death to be distributed to beneficiaries and heirs.

Trusts and estates deal with NOLs in a similar manner as individuals, except for the different forms that must be filed.

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.

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