April 2020
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Benefitting From Net Operating Loss Carrybacks

The recently-passed CARES Act contained many tax-related provisions designed to put cash in the pockets of businesses. An important one is the ability to "carry back" net operating losses ("NOLs") to claim refunds of taxes paid with respect to earlier years' income. This can be a big benefit for businesses, in some cases allowing for refunds even if earlier years' income was earned under prior ownership.

  Benefit Of The NOL Carryback.

The new rule allows taxpayers to carry back NOLs from 2018, 2019 or 2020 (technically, tax years beginning after December 31, 2017 and before January 1, 2021) to the 5 preceding years. Thus, if a taxpayer incurs an NOL for any of 2018, 2019 or 2020 and earned taxable income in any of the 5 preceding years, the NOL can be carried back to reduce the earlier income. The tax paid on the earlier income is then fully refundable.

Historically, NOLs could be carried back 2 years. Effective in 2018, the law was changed to eliminate carrybacks. Carrybacks are now allowed again, but only temporarily.

  • The 2018 law change eliminated corporate alternative minimum tax but contained a provision allowing use of NOLs to offset only 80% of total taxable income. Under a different provision of the CARES act, that 80% limitation is not operative in 2020. It appears that use of carrybacks for years before 2018 may still be limited by alternative minimum tax rules.
  • NOLs are losses from operation of a business. Investment losses or personal losses are not NOLs and do not qualify to be carried back.

The benefit of allowing carrybacks is greater than it first appears, because tax rates before 2018 were higher than they are now (39.6% as opposed to 37% or less for individuals; 35% as opposed to 21% for corporations). Thus, the dollar value of using an NOL to reduce 2017 taxable income is greater than the dollar value of using the same NOL as a carryforward to reduce 2021 income.

  NOL Carrybacks In Mergers And Acquisitions.

The tax law contains several rules preventing an acquiring corporation from benefiting from the acquired corporation's NOLs and other tax assets. However, those rules generally operate only prospectively. That is, they do not apply to prevent an acquiring corporation from using its own NOLs incurred after the acquisition to claim a refund of the acquired corporation's taxes previously paid (unless the losses come from "built-in losses" that were present but unrealized at the time of the acquisition).

One loss limitation rule can be applied retrospectively, but only when a corporation is acquired for the purpose of obtaining a tax benefit. It appears quite unlikely to apply to the NOLs arising currently: we are not aware of any case in which a corporation's purpose in acquiring a profitable corporation has been based on a hope that (a) later losses would be incurred and (b) the law would be changed to allow carrybacks.

It is important to review the terms of acquisition documents that affect tax losses. The tax law may specify what refunds are available, but the documents will determine whether the buyer or seller is entitled to the benefit of those refunds.

  Claiming The NOL Carryback.

The IRS provides procedures for claiming a quick refund of an NOL carryback after a taxpayer incurs an NOL, but no refund is available until the year of the loss has ended. Thus, for most taxpayers, the cash infusion from an NOL carryback will arrive no sooner than early 2021.

Theoretically, it is possible for a taxpayer to change its taxable year, thus ending its taxable year early. That could put a taxpayer in a position to claim a refund immediately based on carryback of a few months' losses without waiting for the end of its normal taxable year. (That is more practicable for taxable corporations than for individuals and partnerships, as only corporations (with certain exceptions) have largely unrestrained choice of taxable year.)

  • There is a 4-year waiting period to make a second change of taxable year, so accelerating losses for a few months means the taxpayer will have to wait until the end of the newly-chosen taxable year to claim any additional losses.
  • It might be possible to use a change of taxable year to squeeze some extra months into the period for which NOL carrybacks are allowed (taxable years beginning before January 1, 2021). If that is seen as abusive, the IRS may issue guidance preventing it (or preventing it absent a separate business purpose for the change).

The fact that NOLs can be carried back does not automatically make all losses deductible. Limitations included in the passive activity, at-risk, excess business interest and other rules, where applicable, continue to limit the use of losses.

If you have questions about these issues or their effect on you or your business, please feel free to contact TaxGroup Partners at (213)873-1200 or e-mail us at info@TaxGroupPartners.com or visit our website at TaxGroupPartners.com.
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TaxGroup Partners is an independent "tax only" advisory firm that focuses solely on providing tax services including tax consulting on business tax matters; tax planning for major events such as mergers and acquisitions, financing transactions, insolvencies and joint ventures; tax services in connection with financial accounting; special tax analysis and tax optimization projects; and tax return preparation. By specializing in taxation, the firm is able to be uniquely responsive, efficient and cost-effective in serving its tax clients.
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