Net Operating Losses are Expanded

By Baker Newman Noyes April 1, 2020

Updated as of April 14, 2020

This article was updated on April 14 to explain that beginning April 17, the IRS temporarily will accept carryback claims via fax.

Prior to the Tax Cuts and Jobs Act (TCJA), net operating losses (NOLs) of a C Corporation, individual, or trust could be carried back two years and forward 20 years, and could offset 100% of taxable income (90% for Alternative Minimum Taxable Income (AMTI) purposes). TCJA substantially changed these rules by disallowing all carrybacks related to post-2017 NOLs but providing an indefinite carryforward period which limited the use of post-2017 losses when carried forward to 80% of taxable income.

The CARES Act temporarily reverses the TCJA changes. NOLs carried forward to tax years beginning before January 1, 2021 (2019 and 2020 tax years for calendar year taxpayers) will be permitted to offset 100% of taxable income. NOLs from 2018, 2019, and 2020 will be permitted to be carried back for up to five years. There are also special rules for REITs, life insurance companies, and for the Code Section 965 year that we are not addressing here.

BNN Observation: As a result of the extended carryback provision, taxpayers can carry back 2018, 2019, and 2020 NOLs to offset pre-TCJA ordinary income that could be taxed at higher rates (35% C Corporations and 39.6% individuals and trusts), thereby generating a current refund and a favorable rate differential. However, Alternative Minimum Tax is currently applicable to carryback claims from 2013 through 2017, so a taxpayer may not receive a full refund of taxes paid for those years.

BNN Observation: The CARES Act does not address Alternative Minimum Tax (AMT) NOL Carryforwards to 2019 and 2020 for individuals (AMT was repealed for corporations beginning after December 31, 2017). Additional guidance is needed to clarify whether AMT NOLs can offset 100% or 80% of AMTI.

Barring any further procedural changes from the IRS outside of Revenue Procedure 2020-24 and Notice 2020-26, a taxpayer can request a refund on Form 1045 (individuals and trusts) and Form 1139 (corporations) which generally results in the processing of the refund in 90 days.  (When available, these represent much better options than the alternatives, which involve filing “regular” amended returns to obtain the refunds.)  The Code and regulations require that an application must be filed within 12 months of the close of the taxable year in which the NOL arose.  For example, in the case of an NOL that arose in a taxable year ending on December 31, 2018, a taxpayer normally would have until December 31, 2019, to file the Form 1045 or Form 1139.

BNN Observation:  Form 1045 and Form 1139 may require additional attachments to process the refund application.  Taxpayers should make sure all required attachments are included so processing is not delayed.

Taxpayers that generated an NOL in a taxable year that began during calendar year 2018 and that ended on or before June 30, 2019 got relief from the due date requirements with Notice 2020-26.  Those effected taxpayers are granted a six-month extension of time to file Form 1045 or Form 1139 as long as they file the applicable form no later than 18 months after the close of the taxable year in which the NOL arose (June 30, 2020 for 2018 calendar year tax filers) and include on the top of the applicable form “Notice 2020-26, Extension of Time to File Application for Tentative Carryback Adjustment.”

BNN Observation:  Notice 2020-26 provides a short opportunity to file the refund application.  Meeting this narrow window may be challenging, due to so many other CARES Act changes to incorporate in the returns, complex entity structures, and limited resources.  Alternatively, NOL carryback refund claims may instead be filed on Form 1040-X (individuals), Amended Form 1041 (trusts and estates) and Form 1120X (corporations), thereby providing a wider window to accomplish the same goal, as long as they are timely filed and include all required attachments per those forms’ instructions.

Taxpayers who choose to forgo the five-year carryback for any NOLs arising in tax years beginning in 2018 and 2019 should carefully review Revenue Procedure 2020-24 and make the appropriate timely filed election.  Generally taxpayers must make an irrevocable election with the filing of their 2020 tax returns stating that the taxpayer is electing to apply § 172(b)(3) under Rev. Proc. 2020-24 and the taxable year for which the statement applies.

BNN Observation: Taxpayers forgoing the carryback should not forget to make this timely election or NOLs could be permanently lost.

Revenue Procedure 2020-24 also provides Taxpayers with Section 965 Transition Tax with the ability to make an election to exclude 965 years from the carryback claim and expanded the defined terms for consolidated groups.

Starting on April 17, 2020 and until further notice, the IRS will accept eligible refund claims (Form 1139 and Form 1045) to be submitted via fax. Taxpayers are encouraged to use this procedure rather than mailing their Forms 1139 and 1045, because mail processing is delayed due to the pandemic. More information may be found on the IRS website.

Finally, taxpayers who prepare financial statements in accordance with Generally Accepted Accounting Principles (GAAP) should be aware that these changes may dramatically impact the deferred tax assets and liabilities presented on their financial statements.

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