NOL carrybacks have long been a complex tax issue for businesses, and the coronavirus pandemic and CARES Act of 2020 have further complicated the issue, leaving many corporations wondering about the importance of NOL carrybacks and what it means to businesses. The bad news, if there is any, is that the process of NOL carrybacks has now changed again as a result of the CARES Act. The good news is that many can use this new protocol to use their 2020 losses to yield cash refunds.
What Is An NOL?
The key to understanding NOL carrybacks is understanding what an NOL is first. Net operating loss, or NOL, is defined by the Internal Revenue Code as deductions allowed minus gross income. In other words, the NOL formula can look like this: (total deductions – disallowed deductions) – total income. Essentially, NOL is the result of a business’s expenses being higher than their source of income in a taxable year.
A business’s net operating loss is one component of a taxpayer’s potential NOL. When calculating an NOL it is vital to distinguish business deductions and income from other types of deductions and income.
Business deductions may include but are generally not limited to:
- Business or trade-related losses
- Losses related to an individual’s partnership
- S corporation share of losses
- Losses on the sale of accounts receivable via a business’ accrual accounting method
- Rental Losses
- State income tax on business income such as salary, wages, and unemployment compensation
- Losses on the exchange or sale of business real estate or depreciable property
Business income can include:
- Wages and salaries
- Self-employment income
- Regular financial gain from the disposition or sale of business real estate or depreciable business property
- Unemployment compensation
- Rental income
- Business income from an S corporation or partnership
If a taxpayer hopes to maximize their NOL loss year, there is some strategy involved as an NOL usually is a product of losses from a taxpayer’s business or trade. For example:
1. A taxpayer may want to pause the sale of depreciable business property or business real estate if it could potentially result in a gain.
2. Businesses with outstanding lawsuits may want to strive to reach settlements before the end of 2020 as it could allow them to utilize a business deduction only if the lawsuit is sufficiently connected to business.
Each of these examples could have the capacity to grow the NOL in a loss year.
What Are NOL Carrybacks?
According to § 172 of the Code, a taxpayer’s NOL can be used as an NOL deduction which then can be carried back or carried forward and used to offset taxable income in a carryback year. The ability for a taxpayer to carryforward or carryback a net operating loss depends on the specific tax reform in place at the time.
Before 2017, taxpayers benefited from a twenty-year carryforward and a two-year carryback. In 2017, the tax laws changed again eliminating carrybacks and extending carryforwards indefinitely. However, with the arrival of the coronavirus pandemic and the CARES Act of 2020, a new tax law was signed in March of that year which:
- allowed net operating losses to again be carried back for a maximum of five years, but only if they occurred during 2018, 2019, and 2020
- removed the eighty percent taxable income cap on carryforwards until 2021
Under the CARES Act, a taxpayer using an NOL carryback must credit it against the first year of the allowed period. Therefore, if they have a 2018 NOL, it can be credited against the year 2013. Any remaining NOL not used in the first allowed year will then go toward the next year in the period. This process repeats until the NOL is entirely used up or the allowed period runs out.
The Importance of NOL Carrybacks and What It Means to Businesses
The importance of NOL carrybacks and what it means to businesses should not be underestimated. For many, the changes brought about by the CARES Act are beneficial, largely due to the COVID-19 pandemic and the loss of income many businesses are continuing to experience because of it.
The carryback can be a particular source of relief for corporations as it offers a chance to receive a refund on taxes that have already been paid. The carryback essentially reduces the taxable income for the carryback year under the CARES Act and then calculates a new tax liability incorporating the NOL. A refund is typically the difference between the new calculated liability and the amount originally paid in a carryback year.
Particularly in the financially challenging season of 2020, the importance of NOL carrybacks is paramount for businesses because a carryback may result in a refund which gives a taxpayer access to liquidity at a time when cash flow could be restricted.
A business or corporation forced to close their doors, reduce their operation, or limit the number of customers in house during the coronavirus pandemic may be struggling to meet financial obligations. A carryback may provide increased liquidity that can help businesses survive in a time when revenue is unstable.
How A Lawyer Might Be Able to Help
The Internal Revenue Code can be complex and, as shown above, tax laws can change frequently making it imperative to stay up to date on proper NOL filing protocol and deadlines. It is also possible for NOL carrybacks to affect some other tax attributes like AMT liability and foreign tax credits.
It is critical to understand the implications of filing an NOL before doing so. A reputable and experienced attorney with a strong background in complex tax and legal issues can be instrumental in making an NOL work for a taxpayer’s greatest benefit.
Other considerations for choosing the right lawyer or firm to help you navigate NOL carrybacks should include:
- Board certification in tax law
- Which states they are licensed to practice tax law in
- Professional associations such as the State Bar of Texas, Texas Society of Certified Public Accountants, and the American Association of Attorney CPAs
If you have questions or concerns about NOL carrybacks, what it means for businesses, and whether you might be eligible for an NOL carryback, please consider reaching out to Harold “Hap” May, P.C. Attorneys at Law today.