IRS Issues Revised NOL Guidance

As state-mandated rolling shutdowns and business interruptions continue in the COVID-19 pandemic, there is still uncertainty approaching the months ahead. Even organizations that are still using the Paycheck Protection Program (PPP) funds are faced with cash flow planning concerns. By now, many Atlanta business owners are aware of the tax opportunities contained in the CARES Act. Changes to business interest expense limitations, Qualified Improvement Property (QIP) depreciation, employee retention credits, and net operating loss (NOL) changes. Given the extended 2019 tax season, many may have elected to wait until 2019 returns were filed. Now that the filing deadline has passed, businesses should carefully review available opportunities especially NOL. In late July 2020, the IRS issued updated draft guidance on NOL carrybacks for individuals, estates, and trusts which should help to clarify questions and provide guidance. To help clients, prospects, and others learn about the changes, Wilson Lewis has provided a summary of the key information below.

Net Operating Loss (NOL) Review

Prior to the CARES Act, NOL elections could only be carried forward. The 2017 Tax Cuts and Jobs Act (TCJA) eliminated the previous two-year lookback period for tax years beginning in 2018 and limited NOL deductions to 80 percent of taxable income. In addition, non-corporate filers were limited to a $250,000 or $500,000 threshold – single or married filing jointly, respectively – when claiming NOL carryforwards.

When the CARES Act was passed on March 27, 2020, it softened those rules quite a bit. NOL lookbacks were restored for tax years 2018, 2019, and 2020 and permitted for up to five years, meaning that a taxpayer could look back to as early as 2013 to claim an NOL deduction. The CARES Act also allowed taxpayers to claim the deduction against 100 percent of taxable income, and thresholds for non-corporate filers were removed until 2021. 

At the time the CARES Act was passed, many questions remained about how to properly take the NOL deduction, the due date for tentative refund claims, and what to do in the case of previous tax years that Section 965 already applied. IRS Publication 536, published in July 2020, addressed these issues.

Clarifications to NOL Treatment for Pass-Through Entities, Estates, and Trusts

The new IRS guidance explains how to account for NOL carrybacks during 965 tax years, what to do if NOL applied in 2019 but the return was already filed and confirmed that the TCJA thresholds are repealed for 2018 – 2020. If a taxpayer filed a 2018 and/or 2019 return(s) with the previous limitation in place, they can now file an amended return.

Section 965 tax years, or tax years in which a taxpayer claimed a foreign tax credit, can be excluded or reduced from an NOL carryback or carryforward year. The IRS stated that “The amount of the reduction is equal to the amount of the section 965(a) inclusion (net of the section 965(c) deduction) plus, in the case of a domestic corporation that claims a credit for deemed paid foreign taxes, the section 78 gross-up with respect to the foreign taxes deemed paid with respect to the section 965(a) inclusion.” Taxpayers that already filed a 2019 return by April 9, 2020 and also want to elect the NOL deduction now have the opportunity to do so.

When Can an NOL Be Used?

The following types of business deductions can be used to determine whether an NOL is applicable for a specific tax year. Since there are other deductions; check with a tax advisor to make sure all available deductions are captured accurately.

• State income tax
• Deductible portions of self-employed health insurance and self-employment tax
• Rental losses
• Losses from the sale or exchange of real estate or depreciable property
• Share of business loss in a partnership or S-corp
• Ordinary loss from the sale or exchange of small business stock
• Casualty and theft losses from a federally declared disaster
• Loss on the sale of accounts receivable

While NOL is usually present in tax years where the deductions exceed the business income, there are several elements to total taxable income that cannot be factored into NOL calculations. In general, nonbusiness deductions are not figured as part of the calculation to determine NOL. These include but are not limited to:

• Alimony
• Retirement plan contributions
• Medical savings accounts, such as an HSA
• Most itemized deductions
• Standard deduction
• Domestic production activities deduction (entered as a positive amount when figuring NOL)
• Section 199 pass-through business deduction
• Excess capital loss deductions

Since NOL for pass-through entities is claimed on individual tax returns, it is possible with the revised tax law that situations will arise where the marital and/or filing status changed throughout the five-year lookback period. IRS guidance states that when spouses were not married to each other in all of the five lookback years that NOL applies, only the spouse with the NOL can take the deduction. When calculating NOL deductions for joint returns in this case, only the income of the affected spouse is used.  

Contact Us

For many taxpayers, the change to federal NOL rules creates an immediate and compelling tax savings opportunity. Since the rules surrounding the recent NOL changes are complex it is important to consult with a qualified advisor to guide efforts. If you have a question about the information outlined above or need assistance with another tax planning issue, Wilson Lewis can help. For additional information call us at 770-476-1004 or click here to contact us. We look forward to speaking with you soon.