2020 Net Operating Losses – Days of Future Past?

2020 Net Operating Losses – Days of Future Past?

For the many thousands of you (ok, you know who you are), who follow my weekly offerings, you likely have noticed my most recent posts have been designed to help as you wrap up 2020 filings, hopefully by the extension due date of October 15.

This week’s topic will continue that trend by reminding you regarding some factoids about tax clients with net operating losses (NOLs).

We’ll begin with a little history lesson. Prior to the NOL rule changes made by the Tax Cuts and Jobs Act (TCJA) in late 2017, when your client experienced an NOL you had opportunities for planning such as accepting NOL default treatment of automatic carryback (and the length of the carryback depending on what type of loss your client had such as business or theft or their type of activity such as traditional business activities versus farming operations), or you could conclude with your client that the best idea was to forego carryback and carry the loss forward for up to 20 future years.

TCJA changed those rules dramatically. Specifically, TCJA took away the carryback election for NOLs incurred after 2017, allowed for an unlimited number of carryforward years, but also limited the use of NOLs incurred after 2017 to offset no more than 80% of the taxable income in the carryforward year. Additionally, TCJA introduced excess business losses (EBLs) which limited business losses to $500K for a married couple or $250K for other filing statuses. Losses in excess of those limits (which are indexed for inflation by the way) would convert into NOLs and then be subject to the previously mentioned TCJA NOL limitation rules (80% of taxable income, unlimited carryforward, etc.). The TCJA limitations I have stated on several occasions act as an alter ego to many other TCJA provisions which encourage large, immediate write offs or immediate asset purchase expense elections.

You might find yourself asking why is he bringing up TCJA NOLs now? Well, I’m doing this because the TCJA NOL rules were basically put on hold for 2018 THROUGH 2020 by action under the Coronavirus Aid, Relief and Economic Security Act (CARES). In particular, §§2303 and 2304 of the CARES Act allow for NOLs created during 2018 THROUGH 2020 to be eligible for up to five-year carryback, or carryback may be waived, and losses carried forward with no 80% limitation in the carryforward years.  The CARES Act also delayed the implementation of the EBL limitations until 2021. In fact, given that the CARES Act didn’t become law until March of 2020, taxpayers who followed TCJA rules for NOLs when filing 2018 and 2019 returns were able to go back and forego the TCJA rules and apply CARES Act rules to those NOLs.

Well, that brings us to the current day, early October 2021. For taxpayers who experience NOLs this year (2021) we have the return of the TCJA rules and, with respect to potential EBLs, the American Rescue Plan Act (ARPA) added another year to the EBL limitations (inflation adjusted at $524K for married couples and $262K for other filing statuses for 2021) which were set to expire at the end of 2025 but will now last through 2026.

But these facts do NOT apply to those 2020 returns you are wrapping up now.  The CARES Act NOL rules still apply.

Because the CARES Act provisions still apply, in my opinion, waiting until now to file 2020 returns provides planning opportunities. Here are some thoughts for you to ponder while making final 2020 decisions:

From The Moody Blues Late Lament

…Cold hearted orb that rules the night,
Removes the colours from our sight.
Red is grey and yellow white.
But we decide which is right.
And which is an illusion?

So, which is right, and which is an illusion?  It might be hard to tell…

1. Should we claim 100% bonus depreciation or max out §179 expense elections on equipment purchases for 2020, potentially create a net operating loss, then determine whether the loss is to be carried back by default?
2. Would a better decision be to forego carryback to have that loss available for days of future not yet passed?
3. We’re already in October of 2021 (these are by definition days of future past). Can we get an idea of how 2021 is shaping up for our client? Nine months of 2021 are finished which might provide insight as to where the NOL might be most useful– by either carrying the loss back to years prior to 2020 or forego carryback and carrying the loss forward.
4. Is your client contemplating making investments into business property yet this year for 2021 which, if elected to be expensed, might offset enough taxable income in 2021 so that the 2020 NOL is best carried back?
5. Are tax rates likely going to be higher in the future so that a 2020 NOL might be more beneficial for future years rather than for those carryback years?
6. And about income tax rates being potentially higher in the future, is it possible you might consider not creating a 2020 NOL at all by opting out of bonus depreciation or not making §179 expense elections thus saving deductions for future years?

All of these ideas are worth pondering as your days of future past become the present.

Breathe deep, my friends. Your clients are not moody with blues but thankful for your careful planning on a Tuesday afternoon (or any other day or night for that matter)…..

Just think….once October 15 is finished it will be (Evening) Time to Get Away…

By Tom O’Saben, EA