By: Jenny Zhang, CPA, MT
Undoubtedly, 2020 was a difficult year for businesses due to the pandemic. Many sustained significant losses because of temporary closings or reduced sales. Today, we will focus on 2020 tax law changes related to business losses and how to best utilize those losses in your tax filings.
New NOL Carryback Rules Enacted by CARES Act
Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, net operating losses (NOL) generated in tax years beginning after December 31, 2017, and before January 1, 2021, may be carried back to each of the five years preceding the tax year of such loss and offset 100% of taxable income in the carryback years. If you forgo the carryback, you can carryforward the loss indefinitely. The carryforward loss can be used to offset 100% of taxable income prior to 2021 or 80% of taxable income after 2020.
Losses generated after January 1, 2021, will fall under the 2017 Tax Cuts and Jobs Act (TCJA) rules. Under 2017 TCJA, there is no carryback of losses allowed. The losses can be carried forward indefinitely and offset 80% of taxable income in future years. Given the need for continued closures or capacity limitations for businesses, there could be future legislation to address 2021 loses. Stay tuned!
Carryback Loss by Filing Form 1045 or 1139
Individuals, estates, and trusts may file Form 1045 to carryback 2020 losses. Form 1045 must be filed within one year of the NOL occurrence. If you are a calendar-year taxpayer, the due date for filing Form 1045 for 2020 losses would be December 31, 2021. If you miss the deadline to file Form 1045, you will need to file amended tax returns for each applicable carryback year.
The significant advantage of using Form 1045 instead of amended returns for a NOL carryback is that the IRS must act on a Form 1045 within 90 days from the later of (1) the date it is filed, or (2) the last day of the month in which the due date falls for filing the returns for the year in which the NOL was generated.
For corporate taxpayers, they may file Form 1139. It has the similar rules as Form 1045 for the non-corporate taxpayers.
Preserve Losses for Higher Tax Atmosphere
Depending on your facts and circumstances, you may consider forgoing NOL carrybacks. Instead, you may want to elect to carry NOLs forward. The most common reason for this approach is when your effective tax rate was considerably lower in the prior years and you expect higher effective tax rates in future tax years.
The pandemic has widened the U.S. budget deficit. As a result, Congress may look to increase revenue. The Biden Administration’s current tax plan includes an increase to the preferred capital gains tax rates from 20% to 39.6% for taxpayers with over $1M in income, an increase to the highest tax bracket for individuals from 37% to $39.6%, and an increase to the corporate income tax rate from 21% to 28%.
With higher tax rates anticipated for higher income taxpayers, NOLs could be more economically valuable if carried forward, however doing so is to forgo the ability to create immediate cash flow from carryback claims. IMPORTANT - If you decide to forgo a NOL carryback, there is an irrevocable election you must make with the timely filed tax return for the loss year.
Each taxpayer’s economic and tax situation is unique. The Tax Warriors® at Drucker & Scaccetti are here to help you analyze which strategy would be best suited for you. Call on us for expert advice.