Nick Zoyhofski, CPA
Liquidity, Relief and an Action Plan for Carryback Claims
By now we have all heard about the various stimulus and relief packages deployed by the government aimed at providing economic and fiscal relief to businesses of all sizes as well as individuals facing hardships during this challenging time.
Most notably of all the packages is the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which included many of the provisions that have been top of mind for many of us such as the Recovery Rebates checks, the Payroll Protection Program, and the enhancement of Federal unemployment insurance assistance.
Included in the CARES Act were several income tax provisions aimed at providing liquidity and relief, specifically the provisions regarding net operating losses (NOLs).
Temporary Re-enactment of Carryback and Increase in Limitation
Prior to enactment of the Tax Cuts and Jobs Act (TCJA) in 2017, a business that showed a net operating loss on its tax return in the current year could carry that loss backward for several years. This carryback could reduce or eliminate prior-year profits and generate a refund of taxes paid on those profits. The TCJA provided that:
- NOLs arising in tax years ending after December 31, 2017 were ineligible to be carried back to any prior tax periods, and
- The NOL deduction to be utilized would be limited to 80% of taxable income (determined without regard to the NOL deduction) for losses incurred in tax years beginning after December 31, 2017.
The CARES Act amended the Internal Revenue Code (§172) to:
- Allow for the carryback of NOLs arising in tax years beginning after December 31, 2017 and before January 1, 2021 to each of the 5 tax years preceding the year the loss is incurred, and
- Postpone the 80% taxable income limitation to start in tax years beginning after December 31, 2020.
As a result, these provisions allow taxpayers access to much needed liquidity during this time by providing a mechanism to claim refunds of prior income taxes paid utilizing current losses.
Additionally, there is also the potential to effectively generate tax-free earnings as the losses incurred during a period subject to an overall lower tax rate may be eligible to offset income taxed at a higher rate (i.e. NOLs are available to offset Pre-TCJA income which generally were subject to higher income tax rates for both corporate and individual taxpayers).
Technical Amendment Relief for Fiscal Year Filers
As previously mentioned, the TCJA made significant changes to the treatment in NOLs, specifically that NOLs in years ending after December 31, 2017 were ineligible to be carried back. This left fiscal year taxpayers that incurred an NOL in a tax year that began in 2017 ending after December 31, 2017 in a unique (some would argue unfair) position when compared to calendar year filers.
The CARES Act updated the language to read that the provision is applicable to tax years beginning after December 31, 2017, freeing up an additional year eligible to be carried back for fiscal year taxpayers.
Next Steps/Action Items1.) Review past filed returns and positions – It may seem like an obvious decision to elect to carryback an NOL (especially if it involves a carry back to a pre-TCJA year), however this simple task could quickly evolve into a complex modeling exercise. Taxpayers that have already generated NOLs that are now eligible to be carried back and/or projecting one to be carried back should be sure to weigh the pros and cons of doing so. The following are just a few of the items that should be considered before filing a carryback claim:
- a.) Closed or closing tax years: Generally, the IRS statute of limitations is three years from the date a return is filed. As the carryback period is five years this means that one and potentially a second carryback year may be close to running its statute. While carrying back a NOL does extend the assessment period to be the same as the period in which the NOL occurred, generally the IRS cannot examine items unrelated to the carryback.
- b.) Carryback to tax years with §965 inclusions: For multi-national taxpayers that incurred a §965 inclusion as part of the TCJA a decision may be required regarding whether or not to carryback an eligible NOL to such year. Under the provision included in the CARES act a taxpayer carrying back a NOL to a §965 year is deemed to make an election under §965(n) which prevents a taxpayer from utilizing NOLs to offset the tax associated with the §965 inclusion. However, taxpayers may elect to not carryback NOLs to a §965 year in its entirety. Taxpayers will need to determine the effect of carrying back an NOL to a §965 year (including the impact on any unpaid §965 installments) versus electing to exclude the year entirely from the carryback calculation.
- c.) Interaction with other provisions: As NOL carryback claims could potentially span years that include pre-TCJA, TCJA, and now even CARES Act provisions taxpayers will need to determine the impact an NOL carryback may have on certain deductions, credits and limitations in each year the NOL is carried back as well as the impact of any created carryovers.
While this may be uncommon territory for some companies, the idea of reducing current taxes payable through proper planning should be nothing new. Given the benefits available under the new NOL carryback claims, companies should continue to evaluate opportunities to defer income and accelerate expenses where possible.
This could include utilizing the installment sales rules, and reviewing accounting method changes, especially changes that many may have put off in the past given the view that they were simply temporary in nature due to the added benefit of the rate differential. Incorporating tried and true planning techniques with the other added benefits provided in the CARES Act such as the technical amendments made to Qualified Improvement Property and favorable modifications to the business interest limitations, provides taxpayers with the ability to access much needed liquidity as well as obtain a permanent tax savings.
3.) Financial Reporting Considerations – Under the guidance provided for Accounting for Income Taxes (ASC 740), entities need to account for the impact of the tax law changes effective in the period that includes the date the bill is signed into law. In the context of the NOL provisions included in the CARES Act this means companies will need to assess the effects of any carryback claim expected to be filed on both its current taxes payable as well as on its inventory of deferred tax assets and liabilities and record the associated impacts (benefit) in the proper period.
4.) Stay Informed – Like so many of the other relief measures provided related to Covid-19 the guidance related to the NOL provisions seems to be ever flowing. Recently the IRS released Revenue Procedure 2020-24 and Notice 2020-26.
- a.) Revenue Procedure 2020-24 provides procedures for making various elections associated with NOL carryback claims. Additionally, the revenue procedure provides guidance for fiscal year 2017 straddle year (tax years beginning in 2017 and ending in 2018) filers for obtaining quick refund claims related to those years. Generally quick refund claims must be filed within one year of the end of the tax year in which the NOL arose. As a result of the technical correction the IRS included in the CARES act an extension of time for taxpayers in this situation to file a quick refund within 120 days of the Acts effective date, or July 27, 2020.
- b.) Notice 2020-26 provides similar relief to taxpayers who incurred an NOL during the calendar year 2018 and fiscal taxpayers with years ending before March 27, 2020 by allowing a six-month extension to claim a quick refund. Taxpayers who are unable to meet these deadlines may still file to claim refunds, however they will have to do so via amended return procedures.
The potential federal income tax savings and liquidity resulting from the NOL provisions of the CARES act can be significant and hastily needed. However, these provisions interact with other provisions of the CARES Act, as well as, both current and prior tax law. Advance planning should be undertaken to fully understand such interaction before filing a carryback claim.
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