CARES Act Tax Provisions Series: Net Operating Losses

What Should You Do If You Can’t Deal with the IRS Because of the Coronavirus Shutdown?
April 24, 2020
CARES Act Tax Provisions Series: Interest Expense Deductibility
April 26, 2020

CARES Act Tax Provisions Series: Net Operating Losses

Does the government regulate tax advisors?

The COVID-19 epidemic has upended life for not only individuals but for businesses, too. From redefining what we considered “essential” to learning to cope with temporary work-from-home arrangements, the first three months of 2020 have been described to feel like years. The Coronavirus outbreak and subsequent change to the economic landscape have prompted Congress to pass legislation that attempts to help businesses get through these trying times by temporarily loosening some of the tax policies that they had worked hard to tighten. This article will dive into a category of taxpayer benefits provided by the CARES act: net operating loss provisions. If you have any questions as to how these (or any) of the CARES act provisions can help your business, contact our COVID-19 Business Survival Consulting team.

What Are Net Operating Losses and How Can They Be Used Post-Tax Reform?

Simply put, net operating losses are an accumulation of losses that a business has accumulated over a period of time but has not been able to utilize. Imagine Company X, a corporation, records a net loss in Year 1 of $100. Company X will not pay any corporate income tax because it has no net taxable income. Because Company X was not able to use its loss to offset any income in Year 1, its $100 loss becomes a “net operating loss” and can be carried forward indefinitely. Note: Prior to the Tax Cuts and Jobs Act signed into law in December of 2017, NOL’s could be carried back one year and only carried forward 20 years.

In our example above, if Company X earns $100 of income in Year 2, it will be able to partially offset such income with its NOL. Current law allows taxpayers to offset up to 80 percent of their income with NOLs. Thus, Company X would be able to use $80 of its NOL’s to partially offset its $100 of income, resulting in the net taxable income of $20. The remaining $20 of NOLs that were not able to be used continue to be carried over until it can be utilized.

How Does the CARES Act Change the Utilization of Net Operating Losses?

The CARES act makes two major modifications to the NOL utilization framework, albeit on a temporary basis. First, limited carrybacks of NOLs have been restored. Net operating losses that were generated after December 31, 2019, and before January 1, 2021, may now be carried back up to five years from the date of such loss.

Returning to our example from above, if Company X had a net taxable income of $100 in 2019 and suffered a net loss of $100 in 2020, its loss from 2020 may be carried back to offset its 2019 net income. If you recall, Congress had done away with carrybacks as a part of the TCJA in late 2017.

The second major NOL benefit as a part of the CARES Act is the temporary suspension of the 80 percent limitation on NOL usage. As we explained earlier, the pre-CARES Act, taxpayers could use NOLs to offset up to 80 percent of their taxable income, but not more. Thus, a taxpayer was not allowed to offset an entire year’s worth of net income with losses from prior years. But under the CARES Act, taxpayers may offset 100 percent of their income in 2018, 2019, and 2020 tax years. It is important to note that any NOLs carried forward to tax years beginning after December 31, 2020 are still subject to the 80 percent limitation described above.

Returning to our example, when Company X carries its loss incurred in 2020 back to 2019, it will not be subject to the 80 percent of net income limitation that it otherwise would have been subject to. The suspension of the 80 percent limitation applies to NOL carryforwards from any year that would be used in 2018, 2019, or 2020. Said differently, the NOL does not need to be generated in 2018, 2019, or 2020.

How Can the CARES Act Work for My Business? 

The discussion above relating to NOLs is only a small subset of the tax and financial provisions included in the CARES Act. Many of the provisions have implications on the utilization of other provisions and will have an impact on the taxation and operations of your business going forward. Business owners considering taking advantage of the CARES Act should consult with our COVID-19 Business Survival Consulting team prior to the implementation of any business or tax strategy changes to ensure that the proposed action will indeed have the desired outcome.

Should I be Cautious in Generating or Utilizing my NOL’s?

Throwing off NOL’s from your business while maintaining a luxurious lifestyle is a huge red flag.  Imaging the IRS learning that a taxpayer lives across the street from the beach, drives a Maserati, eats at expensive restaurants, and has lost 3 million dollars in their business over the last 4 years. The IRS or FTB might launch a criminal tax investigation and utilizes several economic methods to prove tax fraud has occurred.   Additionally, Net operating loss and capital loss carryforwards can be challenged with an unlimited statute of limitations.  My suspicion is that the IRS is going to be under huge pressure by congress to minimizer the tax gap and increase collections considering all the large ticket COVID-19 bailout provisions that the federal government is currently handing out. Additionally, it is very hard to qualify for any type of loan with a history of losses.

Note:  As long as a taxpayer that has willfully committed tax crimes (potentially including non-filed returns coupled with affirmative evasion of payment) self-reports the tax fraud (including a pattern of non-filed returns) through a domestic or offshore voluntary disclosure before the IRS has started an audit or criminal tax investigation/prosecution, the taxpayer can ordinarily be successfully brought back into tax compliance and receive a nearly guaranteed pass on criminal tax prosecution and simultaneously often receive a break on the civil penalties that would otherwise apply.

It is imperative that you hire an experienced and reputable criminal tax defense attorney to take you through the voluntary disclosure process.  Only an Attorney has the Attorney-Client Privilege and Work Product Privileges that will prevent the very professional that you hire from being potentially being forced to become a witness against you, especially where they prepared the returns that need to be amended, in a subsequent criminal tax audit, investigation or prosecution.

Moreover, only an Attorney can enter you into a voluntary disclosure without engaging in the unauthorized practice of law (a crime in itself). Only an Attorney trained in Criminal Tax Defense fully understands the risks and rewards involved in voluntary disclosures and how to protect you if you do not qualify for voluntary disclosure.

As uniquely qualified and extensively experienced Criminal Tax Defense Tax Attorneys, Kovel CPAs and EAs, our firm provides a one stop shop to efficiently achieve the optimal and predictable results that simultaneously protect your liberty and your net worth.   See our Testimonials to see what our clients have to say about us!

See our Non-Filer Q and A Library

See our 2011 OVDI Q and A Library

See our FBAR Compliance and Disclosure Q and A Library 

See our Foreign Audit Q and A Library

We Are Here for You

Regardless of your particular business or estate needs, the professionals at the Tax Law Offices of David W. Klasing are here for you. We are open for business and our team will help ensure that your business is too. Contact the Law Offices of David W. Klasing today to discuss your business with one of our professionals.

In addition to our main office in Irvine,  the Tax Law Offices of David W. Klasing has unstaffed (conference room only) satellite offices in Los Angeles, San Bernardino, Santa Barbara, Panorama City, Oxnard, San Diego, Bakersfield, San Jose, San Francisco, Oakland, Carlsbad and Sacramento. During the COVID-19 pandemic, our staff are working from home, but have full virtual meeting capability.

Our office technology allows clients to meet virtually via GoToMeeting. With end-to-end encryption, strong passwords and top-rated reliability, no one is messing with your meeting. To schedule a reduced-rate initial consultation via GoToMeeting follow this link.   Call our office and request a GoToMeeting if you are an existing client.