With the odds of a recession rising, a common tool used to counter past slowdowns may no longer be available. That’s bad news for private businesses and the workers they employ. Congressional tax-writers need to start thinking about this issue now, while there’s still time to address it.
The tool in question is allowing businesses suffering losses to carry those losses back to previous years, reducing their tax liability in those years, and receiving refunds now while the economy is doing poorly. The benefit itself is mostly one of timing. Any refunds received while the economy is slow will be paid back in the form of higher taxes when the economy regains its strength.
This long-standing, bipartisan approach to helping employers has been complicated by two significant events in recent years:
- First, the Tax Cuts and Jobs Act changed the rules, by eliminating the ability of businesses to carry-back Net Operating Losses (NOLs) and imposing a new, $500,000 limit on the ability of pass-through owners to use active business losses to offset other forms of income, such as wages and investment income.
- Second, the Joint Committee scored a one-year suspension of these new loss-limitation rules, as included in the CARES Act, as a huge revenue loser. Eye poppingly huge. The Committee said suspending the rule for just one year would cost the Treasury $135 billion over ten years, or nearly as much as the entire eight-year policy was supposed to raise when it was adopted in 2017.
After more than a century of bipartisan support for allowing carry backs during economic downturns (World War I, World War II, you get the idea), this price tag was simply too much for some members of Congress, and NOL relief immediately became a pollical football. As we wrote at the time:
The CARES Act included a 5-year carryback for losses incurred in 2018, 2019, and 2020. It also suspended the loss limitation rules for those years. Absent the loss limitation relief, pass-through businesses with large losses would have been unable to access the NOL relief. With small business revenue declining by 30 percent in the past year, this provision was necessary to ensure businesses of all sizes benefitted from the policy.
Providing temporary NOL relief has broad support in the business community. One-hundred and twenty national business trade groups called on Congress to include it in the response to the COVID-19 pandemic. It was part of the CARES Act negotiations from the beginning and it was included in every CARES Act draft leading up its adoption. There is simply no truth to the notion that this provision was “snuck” into the legislation.
Nor is it true that this policy is something new. NOL relief enjoys a longstanding history of bipartisan support during economic crises. The “alternative” bill authored by Speaker Nancy Pelosi last spring included five-year carrybacks of net operating losses, as did the Worker, Homeownership, and Business Assistance Act of 2009, the Gulf Opportunity Zone Act of 2005, and the Job Creation and Worker Assistance Act of 2002. All of those bills were supported by bipartisan coalitions and were adopted by the House and Senate with overwhelming majorities.
This situation has been complicated by the House-passed Build Back Better Act. Section 138202 (do they make section numbers that high?) of that bill would amend the loss limitation rules by 1) making the rule permanent (it currently expires in 2026) and 2) reclassifying any losses above the $500,000 cap as excess business losses (EBLs) rather than NOLs.
This second provision would treat pass-through businesses with losses worse than a similar C corporation. The permanent EBL designation would preclude them from using those losses to offset other sources of income in future years.
Again, the policy of allowing businesses to use losses to offset past or future income is a timing benefit only. Losses offset today means higher taxes tomorrow. The policy included in the BBB would turn that approach on its head, so that any losses incurred today may never be offset, resulting in the very real possibility that businesses owners end up paying taxes when they lose money as well as when they are profitable.
Fortunately, the BBB is stuck in the Senate, but this issue of how and when to allow businesses to offset their losses is going to become critical the closer we get to a recession. The Fed, with its historically low rates and record balance sheet doesn’t have many tools left to counter a slowdown. Let’s make sure this unnecessary fight over NOLs and loss limitations doesn’t put Congress in a similar position.
For more on this issue, see:
- Business Community Rallies to Defend NOL Relief – The S Corporation Association (s-corp.org)
- More on NOL and Loss Limitation Relief – The S Corporation Association (s-corp.org)
- NOL-Loss Limitation Relief Support Building – The S Corporation Association (s-corp.org)
- The truth about business tax relief in the CARES Act – The S Corporation Association (s-corp.org)