House leadership released their HEROES Act yesterday with a plan to vote on it Friday. The bill includes an eye-popping $3 trillion in assistance to families, businesses, non-profits, and governments.
One item that stands alone in this tidal wave of spending is the repeal of the NOL and loss limitation relief enacted as part of the CARES Act. Where almost all the other HEROES Act provisions reduce costs on businesses, this one would hike their taxes.
Let’s be clear — the CARES Act NOL provisions are largely timing benefits – whatever tax benefit businesses receive now will have to be repaid in the form of higher taxes in coming years. The idea is to help them when times are tough and then reclaim the revenues when the economy returns to normal.
This general approach of counter-cycle taxation has a long and strongly bipartisan history. Members of both parties have introduced and voted on similar relief in past decades – it really is a standard tool in the tax writers recession toolbox.
- Disallowing any carryback if the company pays its executives more than $1 million in compensation subject to section 162(m); and
- Disallowing any carryback if the company’s cumulative distributions since 2017 exceed an amount equal to the value of any stock issued after 2017 plus 5 percent of the corporate fair market value (measured as of the last day of the year).
For S corporations and other pass-through businesses, the HEROES Act goes even further. It rolls back the loss limitation rule relief, so that business owners with more than $250,000 (single) in active business losses will be precluded from claiming those excess losses this year or in past years. They would have to be carried forward and claimed in future years.
It also effectively blocks pass-through owners from carrying back any losses by applying the distribution limitations to them as well as C corporations. Note to Taxwriters: Pass-through businesses must make distributions so their owners can pay their taxes. It’s the equivalent of a C corporation writing a check directly to the IRS. Plus, how is a private business supposed to know its “fair market value” on the last day of the year, or any other time?
Finally, the HEROES Act would make permanent the more restrictive NOL and loss limitation rules enacted under the Tax Cuts and Jobs Act (TCJA). They currently expire at the end of 2025. As a result, the tax benefits from the TCJA only last for 7 years, but the “pay-for” for those provisions lasts forever. Permanence results in a tax hike in the hundreds of billions
How did we get here? How did conventional, bipartisan policy suddenly become the tax theft of the century? Two events took place.
First, the TCJA eliminated all loss carrybacks. Under the TCJA, any losses experienced by businesses would need to be carried forward. Numerous tax experts, including Steve Rosenthal, observed at the time that this was a bad idea that would hurt companies in the next recession.
It also limited the ability of pass-through owners to offset active business losses against their wages and investment income. (This latter provision was apparently designed to prevent rate arbitrage where owners would take losses subject to a 29.6 percent rate and apply them against wages taxed at 37 percent, but we’re not sure.)
Second, the Joint Committee on Taxation has consistently estimated that the new TCJA policy and its suspension would result in massive revenues gained and lost. How a simple timing difference can score in the hundreds of billions is still beyond us, but even with a revised score the JCT issued in late March, the size of the revenue estimates on these provisions is clearly attention getting.
The net result is that the standard NOL relief of the past was now scored as a huge tax cut and attributed to business owners directly, rather than to the corporation.
Which brings us back to the beginning of this analysis – these are timing issues. When the business community asked for them as part of the response to COVID-19, the idea was to identify reasonable policies that would help at a time when large percentage of all businesses were going to experience losses.
As an example, many private companies are selling assets this year to help fund their operations. They need money to pay their workers, the rent, suppliers, etc. Their revenues are down and they need cash, so they sell stuff. Under the CARES Act, these owners can offset the gains from these sales with the losses from their businesses. Under the HEROES Act, they would be required to recognize their capital gains, but delay recognizing their business losses until next year or later. They still get the deductions, but only after the crisis has run its course.
So the HEROES Act would have these businesses pay taxes in a year in which overall, they experienced significant losses. That’s just bad tax policy, and its magnified by the prospect that the policies will be extended out beyond 2025. The Main Street Employers coalition that initially asked for the CARES Act NOL rules has responded to this new draft.
At a time when 20 million Americans are out of work and millions of businesses are closing their doors, the HEROES Act would raise their taxes. The Main Street Employers coalition strongly supports the NOL and loss limitation relief provided by the CARES Act and calls on Congress to keep this important relief intact as it considers additional responses to COVID-19.”
NOL carrybacks have been part a response to every economic downturn since we can remember. Now that the economy is sinking into something that resembles a depression, they are needed more than ever.