When utilizing a NOL, a taxpayer historically had the option to carryback or carryforward a net operating loss. Various tax reforms have impacted NOL over the years so the laws on using a NOL change over time. With the passage of the CARES Act into law on March 27, 2020, the rules changed again which added to business owners’ confusion and could potentially provide them with some much needed financial relief.
History Of Carrybacks and Carryforwards
To say that the rules for carrybacks and carryforwards have changed throughout the years is a bit of an understatement. A breakdown of the more recent changes is as follows:
- Pre 2017. Before the 2017 Act, taxpayers enjoyed a two-year carryback period and a twenty-year carryforward period.
- The 2017 Act. This change did away with carrybacks and made carryforwards periods indefinite. The 2017 Act also imposed a cap on carryforwards NOL at 80% of the taxpayer’s taxable income for any year the carryover is being applied.
- The CARES Act. This act was signed into law on March 27, 2020, and allowed net operating losses to be carried back if the losses occurred during the years of 2018, 2019, and 2020.
The CARES Act and NOL Carrybacks
When the CARES Act was signed into law, it reversed course on these two major points with NOLs:
- It brought back the NOL carryback.
- It allows for NOLs to be carried back for five years. (This means NOLs from 2018, which before the CARES Act could not be carried back, now can be carried back as far as 2013.)
Additionally, the CARES Act removed the 80% taxable income cap on carryforwards until 2021.
For most taxpayers, the CARES Act is welcome news especially given the crisis that has unfolded due to COVID-19 and the likely loss of income many businesses will experience. The carryback option is subject to an irrevocable election by the taxpayer, which waives the ability to use the NOL during the whole carryback period.
The taxpayer cannot pick and choose what years to apply a NOL. If a taxpayer opts to use a NOL carryback, it goes back and is credited against the first year allowed in the period (e.g. 2013 for a 2018 NOL). Any excess NOL not used in that year goes toward the next year in the period and this keeps going until the NOL is eventually used up or the period runs out.
What NOL Carryback Temporary Changes Mean For Business
The resurrection of the carryback provides significant relief for many individuals and corporations. While a carryforward can offset future tax liability, the carryback offers a chance at a refund on taxes already paid.
The NOL carryback reduces taxable income for the carryback year allowed under the provision and calculates a new tax liability incorporating the NOL. The refund comes from the difference originally paid in that carryback year and the new calculated liability.
This refund provides taxpayers access to liquidity in this season of economic distress. For many taxpayers, the bills did not stop when the business revenues stopped. As many individuals and corporations struggle to meet their existing financial obligations, the need for cash has never been greater. The increased liquidity from a carryback may give businesses and individuals a fighting chance.
Although carrybacks result in an immediate loss of revenue for the government due to the refunds that will be paid out, this revenue loss will be offset over time. The decrease in NOL carryforwards as a result the use of NOL carrybacks will offset in some regards with fewer carryforwards from 2018, 2019, and 2020 NOLs.
Ultimately, carryforwards could take years for taxpayers to recognize along with prompting the question as to whether the business will survive long enough to utilize the carryforward. Fortunately, the government recognized this issue and sought to address it by bringing back the NOL carryback in the CARES Act. As a result, the carryback may offer many distressed taxpayers an immediate lifeline that a carryforward cannot offer.
If you have questions about NOLs, carryforwards, or carrybacks in regards to your business, please contact the May Firm for assistance.