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Monetizing Previously Restricted Losses Under the CARES Act

The CARES Act and Net Operating Losses

Section 2303 of the CARES Act modifies the net operating loss (NOL) rules for both corporate and non-corporate taxpayers to permit the carryback of net operating losses generated in years beginning after December 31, 2017, and before January 1, 2021.

Net operating losses generated in this timeframe can now be carried back 5 years. Taxpayers can still elect to waive this carryback and elect to carry forward the net operating loss indefinitely, which may be advantageous in limited circumstances. Further, net operating losses generated in this timeframe are not subject to the previous 80% limitation. Instead, these net operating losses can offset 100% of taxable income in the prior year.

The CARES Act and Excess Business Losses

Section 2304 of the CARES Act modifies the excess business loss rules of Section 461(l) by deferring the application of those rules until years beginning after December 31, 2020.  Section 461(l) limited non-corporate taxpayers from deducting business losses in excess of $500,000 (for married filing jointly taxpayers; $250,000 for single).  This disallowed loss was eligible to be carried forward but not back.  Since Section 2204 of CARES Act deferred application of 461(l) until 2021, excess business losses generated in 2018 or 2019 may instead create or increase a net operating loss for those years.

What does this mean for me?

If you are a corporate taxpayer that generated a Net Operating Loss, or an individual that incurred an Excess Business Loss limitation in years beginning after December 31, 2017, and before January 1, 2021, the modifications created in the CARES Act may benefit you.

How do I know if I generated an Excess Business Loss that was limited or a Net Operating Loss?

For individual taxpayers, Excess Business Loss limitations are reported on Form 461. Corporations do not have Excess Business Loss limitations.

For individual taxpayers, Net Operating Losses are reported on Form Schedule A – NOL. For corporate taxpayers, Net Operating Losses are reported on page 1 of Form 1120.

How do I Carryback a Net Operating Loss?

There are 2 ways to carryback a Net Operating Loss.

  1. Amend previous year tax return to carryback net operating loss
    1. Individual taxpayers would file a Form 1040X
    2. Corporate taxpayers would file a Form 1120X
  2. File an Application for Tentative Refund
    1. Individual taxpayers would file Form 1045
    2. Corporate taxpayers would file Form 1139

What are the Deadlines to Carryback a Net Operating Loss?

Tentative Refund

There are pros and cons to be considered for each process. The main advantage of filing an Application for Tentative Refund is that this will be the quickest way to get a refund back from the IRS since the IRS only does a limited examination of the Application and must issue the refund within 90 days.

For taxpayers wishing to carryback their net operating losses by filing an Application for Tentative Refund, these forms typically must be filed within 12 months of the close of the taxable year in which the net operating loss was generated. The IRS has granted a 6-month extension to file these forms for tax years that the original 12-month deadline has already expired. This means that taxpayers with net operating losses generated in 2018 have until June 30, 2020 to file their Applications for Tentative Refund. Taxpayers with net operating losses generated in 2019 and 2020 have until December 31, 2020, and December 31, 2021, respectively, to file their Applications for Tentative Refund.

Amended Return

For taxpayers wishing to carryback their net operating losses by filing an amended return for a previous year, the amended tax returns generally must be filed within 3 years of the close of the tax year in which the net operating loss was generated. This means that taxpayers potentially have until December 31, 2021, 2022, and 2023, respectively, for net operating losses generated in tax years 2018, 2019 and 2020 to file their amended returns. The tax year in which the net operating loss is generated will dictate all applicable filing deadlines and the statute of limitations.

Fax Filing May Speed Refunds

The IRS is temporarily allowing fax filing of refund claims on Forms 1139 and 1045. This means taxpayers may get their refunds more quickly, making CARES Act relief available before IRS processing centers reopen. Previously, Forms 1139 and 1045 could only be filed via hard copy delivered through the USPS or by a private delivery service. The IRS also will accept applications for tentative refunds for both the NOL carryback and the 100% refundable minimum credit on the same 2018 Form 1139.

The statutory time frame for processing these forms is 90 days from receipt. The IRS has set up these temporary procedures to process these forms while its normal operations are closed due to the pandemic.

Fax filing is not allowed for amended returns on Forms 1120X and 1040X. These returns must be filed by traditional methods–hard copy or authorized electronic filing.

Things to Consider

As with any change or modification to tax legislation, there are several things to look out for. The ability to now carryback net operating losses up to five years and maximize any potential refunds involves understanding how other tax provisions might be impacted. You should consider changes in the effective tax rate in previous years, limitations on other deductions such as DPAD and Section 179 expense, and any Section 965 issues.

Planning Opportunities

The modifications provided in the CARES Act are meant to provide immediate economic relief to taxpayers adversely affected by the COVID-19 pandemic. However, the modifications also present some planning opportunities that taxpayers may wish to pursue. For example, taxpayers who are in a position to make capital investments in their business may choose to accelerate those investments into the 2020 tax year to take advantage of depreciation write-offs that would create a net operating loss which can then be carried back to a previous tax year. Further, taxpayers who have unclaimed federal tax credits or other tax attributes from previous tax years that are currently closed may be able to free up those credits by generating a net operating loss in a current year and carrying it back.

Tax planning can be complex, with “domino effects” creating unintended consequences. Contact your Frazier & Deeter tax professional to discuss your unique situation.

Written by

Sarah Edwards, Tax Senior Manager

Contact: sarah.edwards@frazierdeeter.com

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