The Ins and Outs of Eased Loss Limitation Rules

To provide businesses and their owners some relief from the financial effects of COVID-19, the Coronavirus Aid, Relief, and Economic Security (CARES) Act eases the rules for claiming certain tax losses. Here’s a look at the (mostly temporary) modifications.

Liberalized Rules for NOL Carryforwards

The CARES Act includes favorable changes to the rules for deducting net operating losses (NOLs). First, it eases the taxable income limitation on deducting them.

Under an unfavorable provision in the 2017 Tax Cuts and Jobs Act (TCJA), an NOL arising in the 2018 tax year or beyond and carried forward to a later tax year couldn’t offset more than 80% of the taxable income for the carryforward year (the later tax year), calculated before the NOL deduction.

For tax years beginning before 2021, the CARES Act removes this limitation on deductions for prior-year NOLs carried forward into those years. So NOL carryforwards to tax years beginning before 2021 can be used to fully offset taxable income for those years.

For tax years beginning after 2020, the CARES Act allows NOL deductions equal to the sum of:

  • 100% of NOL carryforwards from pre-2018 tax years, plus
  • The lesser of 1) 100% of NOL carryforwards from post-2017 tax years, or 2) 80% of remaining taxable income (if any) after deducting NOL carryforwards from pre-2018 tax years.

As you can see, this is a complicated rule. But it’s more taxpayer-friendly than what the TCJA allowed. And thankfully, this favorable change is permanent.

Carrybacks Allowed for Certain NOLs

The TCJA also stipulated that NOLs arising in tax years ending after 2017 generally couldn’t be carried back to earlier tax years and used to offset taxable income in those years. Instead, NOLs arising in tax years ending after 2017 could only be carried forward to later years. But they could be carried forward for an unlimited number of years.

Under the CARES Act, NOLs that arise in tax years beginning in 2018 through 2020 can be carried back for five years. For example, a taxpayer could carry back an NOL arising in 2020 to 2015 and recover federal income tax paid for that year. That could be very beneficial, because the federal income tax rates for both individuals and corporations were higher before the TCJA rate cuts took effect in 2018.

When advantageous, taxpayers can elect to waive the carryback privilege for an NOL and instead carry the NOL forward to future tax years. In addition, barring a further tax-law change, the no-carryback rule will come back into play for NOLs that arise in tax years beginning after 2020.

Excess Business Loss Rules Postponed

Yet another undesirable TCJA provision disallowed current deductions for so-called “excess business losses” incurred by individuals and other noncorporate taxpayers in tax years beginning in 2018 through 2025.

The CARES Act removes the excess business loss disallowance rule for losses arising in tax years beginning in 2018 through 2020. An excess business loss is one that exceeds $250,000 ($500,000 for a married joint-filing couple). These limits are adjusted annually for inflation.

Barring a further tax-law change, the excess business loss disallowance rule will come back into play for losses that arise in tax years beginning in 2021 through 2025. Any disallowed excess business loss for one of those years will be carried forward to the following year and can be deducted under the rules for NOL carryforwards.

Amended Return Opportunities

These taxpayer-friendly CARES Act changes can affect prior tax years for which you’ve already filed returns. So in addition to planning for your 2020 return, you might want to amend previous returns to reap further benefits. It’s best to contact your tax professionals to determine how these provisions can best help you and your business.

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