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The coronavirus has marginalized thousands of businesses, but there may be a glimmer of hope for businesses struggling with cash.
Businesses affected by the pandemic and lockdowns in the community now need money. One of the best ways to do this is to take advantage of very favorable rule changes in the treatment of net operating losses in the CARES Act.
A company suffers NOL when its tax deductions exceed its income in a given year. In general, taxpayers can lower their taxes by using that loss to offset income in a future year.
The CARES Act goes one step further and allows abused businesses to convert this year’s red ink into a tax refund on previous years’ income.
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A legal provision allows companies to carry back losses from 2018, 2019 and 2020 for five years.
“There are whole areas of US business where companies are making significant losses [the NOL rule changes] Give them access to cash that can help them survive, “said Doug Bekker, CPA and partner at BDO USA’s National Treasury.
“We anticipate many NOL withdrawal claims in 2021 and expect many early filings to get their money back quickly,” he said.
According to the CARES Act, losses from 2018 can be used to offset income as early as 2013. Losses made this year can be deducted from 2015 taxable income.
The IRS has also promised to send refund checks to business owners and businesses within 90 days of application if they follow a quick refund process. Individuals must submit Form 1045 while C companies must submit Form 1139.
“This is the best part of the CARES Act,” said CPA Robert Tobey, tax partner at Grassi & Co. in New York and a member of the tax committee for individuals and the self-employed at the American Institute of CPAs.
“Cash flow is the biggest concern facing businesses right now. How often does the government offer to return taxes you have already paid?” he said.
Cash for C-Corps
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The deal is especially good for C companies – generally larger companies that are taxed as separate entities from their owners.
The Law on Tax Cuts and Jobs, passed in late 2017, lowered the tax rate for C-Corps from 35% to 21%.
Companies that can trace losses back to years prior to 2017 may receive a larger profit.
“For larger companies like airlines, hotels or restaurant franchises that have made money from higher taxes these years, this is one way to get through this period,” said Ryan Losi, CPA and executive vice president at Piascik in Glen Allen, Virginia.
Small businesses, smaller savings
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The tax arbitrage benefit is less dramatic for small business owners, who are generally structured as pass-through businesses such as S-Companies and LLCs. In this case, the income from the business “flows” into the owner’s personal tax return.
The Tax Cut and Employment Act lowered the highest marginal tax rate for individuals from 39.6% to 37%, a cut far less drastic than the C-Corps tax rate cut.
However, the potential cash inflow from loss carryforwards can help keep pass-throughs in business.
“In my experience, most business owners need the money now,” Losi said. “If you lose money this year, you can get up to 40 cents on the dollar for those losses.”
First, talk to a tax advisor
The NOL carryover option isn’t necessarily for everyone. If a taxpayer has been out of business or has had little taxable income in those earlier years, getting a small refund may not be worth it.
It will also reopen your tax file for the years you suffer losses, which can increase the risk of previous returns being scrutinized. “You’re opening a closed year,” said Tobey. “There is a risk associated with the reward.”
Taxpayers can make an irrevocable choice to forego the loss carryforwards and use losses in the 2018-2020 period to offset future revenue. Under the CARES Act, these losses can be carried forward indefinitely.
The more complicated your tax situation, the more difficult the decision becomes, said Bekker.
Another factor to consider is whether states are complying with the new federal regulations and allowing taxpayers to also reimburse previously paid state taxes.
“You may want to help, but you are in difficult situations yourself,” said Losi.
Entrepreneurs need to work with their tax professionals to see if this year’s misery has a silver lining.
“This is the year you put every expense and bad news on your 2020 tax return,” said Tobey. “Cash is king now and this is a great place to find it.”