Allowing businesses to use losses to offset income earned in prior years is a longstanding anti-recession policy with solid bipartisan support. It was adopted after the 9/11 terrorist attacks, after Hurricane Katrina, and again following the financial crisis. It is simply a way to give businesses suffering losses the ability to recognize those losses more quickly.
Yet now some are charging that the bipartisan loss limitation relief included in the CAREs Act is a “massive” tax break for “hedge funds” and real estate moguls that was “snuck” into the bill at the last moment. None of this is true.
In fact, the bipartisan relief was in the first CAREs Act “draft” released back on March 19th, it was in every subsequent draft as negotiations ensued over the weekend, and it was in the final bill that unanimously passed both the Senate and the House a week later. It was included in our business community letter signed by 120 national trade groups. And, it was included in the alternative bill released by Speaker Pelosi on March 23rd.
Anybody claiming not to know it was part of the relief package simply wasn’t paying attention.
How does the policy work? Many companies are selling assets this year to raise capital to keep the businesses running. The Cares Act helps by allowing these businesses to offset any capital gains they realize against their active business losses, reducing the tax hit at the end of the year. Using active business losses taxed at high rates to offset capital gains taxed at low rates is extremely inefficient and not something that would happen in normal times. But these are not normal times and these businesses need the liquidity.
This benefit is limited to “trade or business” losses that have already passed through the passive, at-risk and other tests. Losses from investments in passive assets, like those made by many hedge funds, do not benefit.
Moreover, any losses claimed this year will not be available in the future. The NOL and loss limitation relief are primarily timing benefits. Lower taxes in 2020 will equal higher taxes in 2021 and beyond. As the Obama White House said during the financial crisis:
“The Economic Recovery Act included a provision that allowed small businesses to count their losses this year against the taxes they paid in previous years. Today, the President extended that benefit for an additional year and expanded it to medium and large businesses as well….This provision is a fiscally responsible economic kick-start, putting $33 billion of tax cuts in the hands of businesses this year when they need it most, while enabling Treasury to recoup the majority of that funding in the coming years as these businesses regain their strength and resume paying taxes.”
The same logic that applied when Democrats controlled the White House, the House of Representatives, and the Senate, applies now. The policy makes perfect sense during the COVID-19 response because it helps businesses now and then recaptures the revenue when the economy improves.
Another issue is the revenue estimate issued by the Joint Committee on Taxation. That estimate suggests that the revenue loss of for the corporate Net Operating Loss provision was $26 billion over ten years, while the same policy applied to pass-through businesses under the loss limitation relief was, although recently revised downward, still an eye-popping $135 billion.
How is a revenue loss that high possible? The short answer is we have no idea. Any benefit from recognizing more losses this year should equal the higher taxes the business will pay next year. It should be close to revenue neutral over a ten-year window. One potential explanation: the losses being suffered by Main Street businesses from the government-imposed shutdown are going to be simply massive, like nothing we’ve ever seen before.
So the motivation of the after-the-fact opponents remains a mystery. What’s not a mystery is where the provision came from, why its in the bill, and how much long-term, bipartisan support it has enjoyed. It’s working exactly as promised, providing temporary relief to millions of employers. Congress should leave it be and focus instead on the many other economic challenges in front of us.