Modifying Revised Net Operating Loss Tax Rules to Ease Financial and Economic Effects of COVID-19

COVID-19 Update

The COVID-19 pandemic’s effects on our nation include significant financial and economic hardships. In response, the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act) relaxes the rules added as part of the 2017 Tax Cuts and Jobs Act related to the timing and amount of net operating losses (NOLs) that may be deducted. Generally, the 2017 act restricts the NOL deduction to 80% of taxable income, which limits the value of NOLs because they can no longer completely eliminate taxable income in years to which the NOLs are carried. However, any remaining NOLs may be carried forward to future years indefinitely. Additionally, the 2017 act eliminated the ability to carry NOLs back to prior years except with respect to certain farming losses and insurance companies.

For example, under the current rules, a calendar-year taxpayer that has $100,000 of taxable income in 2019 would be required to report and pay tax on such income according to the applicable 2019 tax rules. If such taxpayer has a $100,000 NOL in 2020 as a result of business disruptions created by COVID-19, the current tax rules will not permit the taxpayer to carry back any portion of its 2020 NOL to 2019 to offset its 2019 income and obtain a refund. Rather, such taxpayer will be required to carry forward its 2020 $100,000 NOL to future years. As a second example, under the current rules, suppose a calendar-year taxpayer has a $95,000 NOL in 2018 (i.e., $95,000 of deductions in excess of its 2018 income), which is carried forward to 2019, when the taxpayer has $100,000 of taxable income. In 2019, the taxpayer may use only $80,000 of the NOLs (i.e., 80% of $100,000) to offset the 2019 income, and the remaining $15,000 carries forward for use in a future year. If in 2020, the taxpayer has $20,000 of taxable income, the remaining $15,000 of NOLs may be used against the income, because that amount is less than 80% of $20,000. However, if instead the taxpayer had only $16,000 of taxable income in 2020, it would only be able to use $12,800 of the remaining NOLs to offset the 2020 income, and would carry forward $2,200 of NOLs to a future year.

Under the CARES Act, these recently adopted restrictions will be eased to (1) allow NOLs in tax years 2018 through 2020 to be carried back five years and (2) remove the income limitation allowing NOLs to fully offset income. These modifications reduce prior- and current-year income and tax liabilities, freeing up cash in the near term to be utilized by a business.

How Manatt Can Help: Our experienced and sophisticated tax team can provide guidance on understanding these rules, how to take advantage of them and how they may ease your business’s economic hardships in the face of the COVID-19 crisis. Manatt will be closely monitoring the development of this proposed relief.

For More Information: Contact Jeffrey Mannisto, partner and leader, Manatt Tax, at jmannisto@manatt.com or 310.312.4212; David Herbst, partner, Manatt Tax, at dherbst@manatt.com or 650.812.1320; Robert Duran, partner, Manatt Tax, at rduran@manatt.com or 310.312.4274; or Megan Christensen, partner, Manatt Tax, at mchristensen@manatt.com or 202.585.6594.

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