Is the loss limitation relief in the CAREs Act an unwarranted giveaway, as claimed by the Washington Post this week? That’s a big “N-O.” As others have noted, this relief prevents the “recession bombs” of the underlying NOL and loss limitation rules from inflicting damage on Main Street during the COVID-19 crisis.
Here’s the reality and why 120 Main Street business groups asked Congress to adopt this provision earlier this year:
- The benefit is timing only: Aside from some limited rate arbitrage, any tax reductions allowed by the loss limitation relief this year would have otherwise been claimed in 2021 or later. Put another way, lower taxes in 2020 equal higher taxes in the future. There’s little net tax benefit here. As the National Taxpayers Union Foundation observes, “Net Operating Losses Aren’t Handouts.”
- Its good tax policy: Good tax policy smooths the realization of income, so that taxes go up when times are good and they go down when times are bad. Times are very bad right now, so the provisions shift deductions that would otherwise be claimed in the future and allows businesses to claim them now.
- The benefit is temporary: The NOL and loss limitation relief sunset at the end of the year. Businesses can use the relief in 2020 to increase their deductions and to file amended returns in 2018 and 2019. As before, any deductions claimed in 2018-20 would mean increased taxes in the future.
- The benefit is not new: Congress has provided NOL relief in just about every US recession going back decades. This is standard tax policy when the economy sinks and business losses are widespread. The only new item is the loss limitation rule, which didn’t exist in previous recessions and would prevent pass-through business owners from claiming NOLs.
- Needed for Pass-Through Fairness: Absent loss limitation relief, pass-through business owners would be blocked from claiming the NOL relief offered to C corporations.
The NOL and loss limitation relief accelerates a business’ ability to deduct losses, so they can claim them now rather than later. Any losses claimed now are effectively used up and not available in future years, so while a business might see lower taxes (or bigger refunds) this year, they will then see higher taxes next year and beyond. This is especially important now that, with the economy shut down, millions of profitable businesses are going to be reporting losses this year.
The need for Congress to relax these rules should not be a surprise. The NOL and new loss limitation rules were controversial when they were adopted three years ago and many tax experts warned that they would threaten businesses when the economy turned. They are, as the Investment News argued, a “recession bomb” that “could prove troublesome for businesses and their owners — as well as the broader economy — in the next recession.”
By allowing businesses to deduct their current losses against past profits, the old rules provided economic help for struggling businesses via an immediate cash infusion, said Steven Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center. “That softens the blow to the direness of that [situation],” he said.
However, in a future recessionary environment when companies are suffering from widespread losses, they must wait for a year of profits to get a cash infusion, Mr. Rosenthal said, and that infusion will be smaller. It’s money you don’t have in your pocket that you can’t put back into your business,” said Robert Keebler, founder of accounting and tax advisory firm Keebler & Associates.
How does it work? Here’s Forbes on the implications of the new rules published last May:
Suppose Cindy is single and has a start-up software business with $510 thousand in losses. She also has $250 thousand in other income (note: there are some questions on what constitutes ‘other income’), $20 thousand in dividends and $150 thousand in capital gains. Under the previous rules, Cindy would have income of -$90 thousand, which she could carry back against the previous two years’ income. Under the current rules, Cindy would have income of $165 thousand ($250 + $20 + $150 – $255). The remaining losses would be carried forward and then offset against 80% of future income.
So Cindy loses $90,000 but has to pay taxes as if she made $165,000? In normal times, this policy would be a challenge to Cindy – where does the money come from to pay the tax? With the entire economy shut down, it’s everybody’s problem. There are thousands of Cindy’s losing money this year and they employ many millions more.
The business relief in the CAREs Act simply restores — for one year – tax rules that used to exist on a permanent basis prior to the TCJA. NOL and loss limitation relief puts money in the pockets of employers now, when they need it most. It will keep more businesses afloat, and it will keep more people employed. Its good tax policy. By opposing it, the Washington Post is embracing “recession bombs,” bankruptcies and joblessness. Nicely done, WP.