On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act). The CARES Act introduces several forms of taxpayer relief, including the relaxation of certain net operating loss (NOL) limitations imposed by the 2017 Tax Cuts and Jobs Act (the TCJA). While these NOL rule changes are unlikely to produce an immediate cash flow benefit for most taxpayers, they may have a positive future impact by providing federal tax refunds and encouraging future mergers and acquisitions (M&A) of distressed businesses.
Five-Year NOL Carryback
The TCJA generally disallowed taxpayers from utilizing post-2017 NOLs to offset income in prior taxable years. The CARES Act retroactively postpones this restriction and provides a five-year carryback period for NOLs generated from 2018 through 2020. Taxpayers cannot carry back NOLs to offset the TCJA's IRC section 965 transition tax, and any carrybacks must be utilized in the earliest of the taxable years to which such losses may be applied. To the extent a taxpayer utilizes NOLs to offset taxable income in a prior taxable year, they may be entitled to a tax refund for that taxable year.
While expanding the ability to utilize NOLs may be beneficial to many taxpayers, this change is unlikely to ameliorate taxpayers' liquidity shortfalls in the near term. In particular, taxpayers will generally not be able to receive a refund for the successful carryback of any 2020 NOLs until their 2020 federal income tax returns are filed in 2021. However, taxpayers that recognized taxable income prior to 2018 and reported NOLs in 2018 or 2019 may be able to obtain a more immediate refund by filing amended federal returns for the applicable pre-2018 taxable years. Thus, taxpayers that experienced sudden downturns or crises in 2018 or 2019, or those in industries negatively impacted by the 2019 trade war with China, may be better positioned to take advantage of these relaxed NOL rules in the short term.
Moreover, the NOL carryback allowance under the CARES Act may facilitate M&A activity during the COVID-19 economic crisis. In connection with a contemplated transaction, NOL carryforwards are typically considered a valuable tax attribute because of their ability to shield gain and offset future taxable income. However, certain proposed regulations released by the Treasury Department and the Internal Revenue Service on September 9, 2019 proposed significant limitations on the value of such NOLs in the context of acquisitions. The NOL carryback allowance lessens the potential impact of this recent guidance by giving more intrinsic value to a taxpayer's NOLs, which can now be monetized as future tax refunds of historical taxable income.
NOL 80% Taxable Income Limit
The TCJA also capped the amount of NOLs a taxpayer can utilize on an annual basis to 80% of the taxpayer's pre-NOL taxable income. The CARES Act generally postpones the application of this limitation until post-2020 tax years. Taxpayers that have been in a sustained historical loss position may be able to benefit from an immediate federal tax refund to the extent of the 20% of NOLs previously subject to limitation under the TCJA.
Procedures for Claiming a Refund and Making Elections
Since the enactment of the CARES Act, the Internal Revenue Service has released guidance outlining the procedures taxpayers should follow to obtain refunds for NOL carrybacks and make relevant carryback elections. Revenue Procedure 2020-26 provides taxpayers a six month extension to file Form 1045 and Form 1139, which allow taxpayers to receive an expedited refund. Calendar year taxpayers seeking an expedited refund for 2018 NOLs have until June 30, 2020 to file such forms. Revenue Procedure 2020-24 describes how taxpayers can make various elections to waive the carryback of NOLs. Revenue Procedure 2020-23 allows partnerships to amend returns instead of filing an Administrative Adjustment Request.
How Venable Can Help
The economic and legislative repercussions of the COVID-19 economic crisis are expected to significantly impact taxpayers from a commercial and tax planning perspective. Venable's international tax team can help clients understand these developments and provide guidance on how to responsively and constructively implement