While stimulus checks and forgivable loans have received a lot of attention during the COVID-19 shutdown, businesses and individuals should not overlook other available relief provisions that could help them reduce taxes and improve cash flow. Several of these measures could enable a taxpayer to file amended federal tax returns to recover taxes paid in previous years and request a refund.
Revised Rules for Net Operating Loss Carrybacks
One of the less-talked-about provisions of the CARES Act is the reversal of the net operating loss (NOL) provisions that were introduced in the 2017 Tax Cut and Jobs Act (TCJA). Under the TCJA, a business or individual with an NOL could no longer carry back that loss to earlier years; the loss could only be carried forward to offset income in a future year. In addition, the carryforward could be used to offset no more than 80 percent of the taxable income in the year to which it was carried forward.
The CARES Act significantly liberalizes those rules, allowing net operating losses from 2018 to 2020 to be carried back as far as five years, and removing the 80 percent carryforward limitation. NOLs used in 2021 and onward will remain subject to the 80 percent limitation.
Many companies and individuals with sole proprietorships or pass through losses from partnerships or S-Corps are incurring significant losses in 2020. Under the new rules, they now may be able to fully offset those losses against previous profitable years. Because the rule changes also cover 2018 and 2019 returns, a business or individual that had losses in either of those years could file an amended return to claim additional refunds. This means that corporate taxpayers could use losses generated in years with a 21 percent tax rate to offset taxable income from previous years that had a 35 percent tax rate.
A related benefit in the CARES Act is the elimination of the excess business loss rules for individual taxpayers, which stated that owners of pass-through businesses were limited in their deduction of losses to $250,000 ($500,000 for couples filing joint returns). Losses exceeding this amount were treated as net operating losses, which prior to the CARES Act could only be carried forward.
The CARES Act has postponed the effective date of these rules until Jan. 1, 2021, which means pass-through owners could offset 2020 losses against other income without limitation. In addition, refund opportunities may be available by amending 2018 or 2019 returns as the loss limitations no longer apply in these years as well.
Deducting COVID-19 Casualty Losses
A separate IRS rule—not related to the CARES Act—could also help businesses improve cash flows during the shutdown. Section 165(i) of the Internal Revenue Code allows taxpayers that sustain financial hardship due to an identifiable natural disaster to accelerate certain casualty losses to the tax year immediately preceding the year in which the loss occurred. In other words, they can apply disaster-related casualty losses retroactively to the preceding tax year and file an amended return to request a refund.
This provision traditionally applies only to taxpayers in specific areas affected by natural disasters such as hurricanes or fires, but the nationwide emergency declaration signed on March 13, 2020, made such relief available to all U.S. taxpayers. This means businesses might be able to claim certain losses related to COVID-19 on their 2019 tax returns, possibly earning a refund as well as reducing their 2020 estimated tax payments.
Note, however, that not all losses qualify for acceleration. Temporary or subjective losses such as decreased revenues or a decline in the fair market value of property do not qualify. To be eligible, the loss must be substantiated by completed transactions—not just a loss of revenue. The following are examples of potentially eligible losses:
- Costs incurred in closing stores or work locations
- Inventory loss due to spoilage during the shutdown
- Costs of prepaid raw materials, supplies, or other inventory intended to fulfill a contract that was canceled
- Abandonment of fixed assets or of leasehold and tenant improvements
- Prepaid costs for travel, hotel, or conference space that was not refunded or credited
Of course, any loss covered by insurance cannot be claimed. In addition, taxpayers should carefully document that the casualty loss is caused specifically by the pandemic. The procedures for accelerating such a claim can be complex, but for many companies, the opportunity to improve cash flow by accelerating losses to last year could be well worth the effort.
For more information about emergency-related tax relief, please contact us or call us at 408-377-8700 and we’d be happy to help.