The CARES Act includes a temporary change to how companies make use of net operating losses when they file taxes. A company that earns less taxable income than it can claim in deductions can now carry those losses back on their tax returns for up to five years. This will apply to taxes filed for the tax years 2018, 2019 and 2020. This is a new rule designed to help companies through the recession brought on by the coronavirus quarantines. Companies can claim a refund from their prior years’ taxes if their carryback lowers their taxes enough. Here’s how it works.
What Is Net Operating Loss?
A net operating loss (NOL) occurs when a company or individual has more tax-deductible expenses than taxable income in a given year. That NOL can be carried back to prior tax years or carried forward to future years to lessen a company’s or individual’s taxes through an Internal Revenue Service provision known as a loss carryforward.
When a corporation posts a net operating loss in a given year, it can make a choice based on the nature of its specific tax deductions. If the company has refundable tax credits, it may be able to claim a direct refund for that tax year. If not, the amount by which the deductions exceed its income is called a net operating loss.
On its own in any given tax year a net operating loss means nothing (again, unless a company can also claim refundable credits). However, a company can carry this loss forward or carry it back to reduce its burden for other tax years. A carryforward means that the company applies its net operating loss to reduce its taxes on future years. With a carryback, a company retroactively applies its net operating loss to reduce its taxes from previous years.
For example, say that ABC Corp. had a taxable income (income after expenses) of $50,000 in 2018. It has $75,000 in total deductions that year. This gives ABC Corp. a net operating loss of $25,000, the amount by which its deductions exceed its taxable income.
Since ABC Corp. has no refundable tax credits, that $25,000 NOL would go to waste in 2018. So ABC Corp. chooses to carry its NOL forward.
In 2019, ABC Corp. has a taxable income of $80,000. It has $50,000 in total deductions. This leaves the company with post-deduction taxable income of $30,000. By carrying forward its net operating loss from 2018 ABC Corp. reduces its 2019 taxes by another $25,000, leaving it with only $5,000 in taxable income for 2019. (Note that this is not a precise example.) Under the Tax Cuts and Jobs Act, companies may carry forward a net operating loss indefinitely but may only do so up to 80 percent of any given year’s taxable income.
The CARES Act NOL Changes
As part of the CARES Act stimulus provisions Congress has temporarily expanded net operating loss provisions for companies. While the 2017 Tax Cuts and Jobs Act generally doesn’t allow companies to carry back net operating losses, the CARES Act has made critical changes to this rule and others.
First, the CARES Act has eliminated the 80 percent rule. Companies may now apply a net operating loss to their entire taxable income for a given year.
Second, companies may now carry back net operating losses for up to five years from the year of the loss. For example, a company that posts a net operating loss on its 2019 taxes may carry back those losses on its taxes up to 2014. This means filing an amendment to those past years’ tax filings adjusting the amount that the company owed from those years.
Third, companies that carry back their net operating losses may use this to claim a refund for taxes paid on those prior years. For example, say that a company paid taxes on $50,000 of taxable income in 2017. It has a $75,000 net operating loss in 2020. Under these new rules this company can carry back a portion of its losses to 2017, reducing its taxable income from that year to $0.00. The company can now file for a refund on the taxes it paid for that year.
Companies may offset both income and capital gains that were taxed at rates up to 35 percent.
These rules apply to net operating losses incurred in 2018, 2019 and 2020 only. The new rules expire at the end of 2020. While companies can apply these losses back to previous tax years and forward to coming tax years, and may apply these rules at any point that they file their taxes from 2018, 2019 and 2020, the refundable rules apply only to NOLs from the applicable years. Companies that already filed their taxes from 2018 and 2019 may amend their filings to take advantage of these rules.
The Bottom Line
Under the CARES Act a business can now carry back 100% of its net operating losses, for tax years 2018, 2019 and 2020, for up to five years, and may claim a refund based on that adjustment for any or all taxes paid. That enhances flexibility for tax planning that did not exist before the pandemic. Keep in mind that this is a temporary change – basically a “use-it-or-lose-it” situation. Businesses, especially those struggling from the economic fallout of the pandemic, should use it if they qualify.
Tax Filing Tips
- A financial advisor can help you stay on top of recent and upcoming changes to tax laws and regulations. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
- Businesses have several ways that they measure their revenue stream. Whether they’re discussing net income, taxable income, operating income or EBITDA, it all means something different and it all matters. Learn more about how you can measure your business’ income against its expenses, and why it’s so important to get that process right.
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