Changes to net operating loss (NOL) rules have impacted how many small and mid-size businesses approach deduction and carryover rules. Below, I discus the 2017 Tax Cuts and Jobs Act (“TCJA”) and the 2020 Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, their impact on tax planning, and highlight subsequent guidance from the IRS.
- The TCJA and CARES Act have substantially changed the way companies will use and value NOLs. Before the TCJA, NOLs could be carried back two years and carried forward 20 years. In general, after the TCJA, NOLs arising after 2017 can no longer be carried back, but may be carried forward indefinitely. (The CARES Act, discussed below, temporarily allowed some post-2017 NOLs to be carried back.)
- As a result, the TCJA can be viewed as favoring start-up companies, and disfavoring more established companies with fluctuating income, whereas both types of companies benefitted from the pre-TCJA rules. Start-ups rarely have taxable income in early years and only need to carry NOLs forward, which is allowed indefinitely under the TCJA.
- The TCJA provides that post-2017 NOLs can only offset 80% of a company’s taxable income. Before the TCJA, it was necessary to calculate the alternative minimum tax (“AMT”) NOL. The TCJA abolished the corporate AMT, so this is no longer necessary.
- The 2020 CARES Act provides for a five-year carryback for NOLs that arose in years 2018– Companies may recover estimated tax payments via a Form 4466 and get “quickie refunds” with a Form 1139. The CARES Act also eliminated the 80% limitation for 2018 through 2020.
- While the 20-year carryforward still applies to pre-TCJA NOLs, the repeal of the corporate AMT, and the fact that post-2017 NOLs can now offset 100% of corporate taxable income pursuant to the CARES Act (for NOLs arising in 2018-2020), means that the value of these NOLs has increased for some corporations.
- The TCJA also introduced the “BEAT,” “GILTI,” and “FDII”: new tax regimes that use some or all of NOL carryovers to calculate tax. The BEAT haircuts NOLs based on a percentage, and thereby partially disallows NOLs. The GILTI and FDII allow a deduction, which is calculated based on taxable income reduced by NOLs, thereby reducing the benefit created by these NOLs.
- The changes created by the TCJA and CARES Act will also have a substantial effect on the way tax-receivable agreements (“TRAs”) and tax sharing agreements (“TSAs”) are valued, particularly for distressed companies and companies targeted for investment by private equity funds.
- Along with the new rules and regimes, the TCJA brought about a substantial amount of uncertainty. Some of this uncertainty has been addressed in subsequent guidance from the IRS. Many areas remain unclear, however.
- This uncertainty is compounded further by state and local tax laws, particularly where some (or all) of the TCJA has not been adopted. Careful tax planning will be necessary for all parties implementing the new rules until further guidance is available.