An Overview of the Net Operating Loss Tax Provisions in the CARES Act

September 04, 2020
An Overview of the Net Operating Loss Tax Provisions in the CARES Act

Besides offering financial relief to individuals & loans to businesses struggling during the Covid-19 disaster, the CARES (Coronavirus Aid, Relief, and Economic Security) Act changes several tax perquisites to improve liquidity for organizations that are enduring a large decline in cash flow.

Among other tax modifications, the Coronavirus Aid, Relief, and Economic Security Act untied rules governing NOLs (net operating loss deductions). These amendments offered much-required relief for businesses, and there’s a chance to build upon them in forthcoming “Phase 4” economic relief legislation.

Why NOLs Matter? 

The objective of business income taxation is to tax an organization’s net earnings, preferably in a consistent way over time. However, some industries and businesses may have more unstable profits than others year over year, which may prompt to unsteady tax treatment gradually without a net operating loss deduction. For example, imagine an organization in an unstable industry that makes a $100,000 profit in their first year and has$50,000 lossin second year. A second organization makes an even $25,000 in first and second years, so both companies have the same combined net earnings over those 2 years.

Without a net operating loss deduction carry back, organization one compensates a higher effective tax rate compared to organization 2: a 21% tax on $100,00 in net income for year 2 regardless of merely a $50,000 net over the last 2 years. This penalizes organization 1 for having more unstable profits compared to the 2nd organization.

The NOLs provisions in the CARES Act:

The CARES Act made 3 changes to the NOLs that enhance cash flow for stressed companies:

• Offered a 5-year carryback for losses acquired in 2018, 2019, or 2020, which lets companies to amend tax returns up to 5 years before counteract taxable earning from those tax years.

• Suspended the NOL limit of 80% of taxable earnings.

• Pass-through business owners may employ NOLs to counteract their non-business earnings above the earlier limit of $250,000 (single) or $500,000 (married filing jointly) for 2018, 2019, and 2020.

Takeaway: 

Opposite to some of the oratory surrounding the changes to NOL deductions in the Coronavirus Aid, Relief, and Economic Security Act, the terms are a step forward for offering companies liquidity in a time of financial disaster and limited cash flow.

The objective is not to offer a windfall to companies nor to reduce long-run taxes, but to make sure companies without past gains can stay alive through an unparalleled financial catastrophe that Covid-19 has created.