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Saturday, April 18, 2020

Business Loss Change by CARES Act - Track Changes and Policy


The CARES Act (P.L. 116-136; 3/27/20) or Phase 3 of COVID-19 relief includes several tax law changes for individuals and businesses. Most notable for many (but not all) individuals is the recovery rebate or what the IRS calls the economic impact payment. Generally, this provides many adults with an advance, refundable credit for 2020 - today, of $1,200 +$500 if they have a child under age 17.

A few notable ones for businesses include the ability to carryback net operating losses (NOLs) for 2018, 2019 and 2020 for 5 years even though the TCJA ended this for tax years beginning after 2017 and even though the carryback can go to years when tax rates were higher than today. Employers also have some payroll credits and deferrals that should help with cash flow and some financial relief.

In addition to a temporary NOL change, the CARES Act also temporary changes another TCJA item. The limitation on losses for non-corporate taxpayers (IRC Section 461(l)) is changed to go into effect for tax years beginning after 12/31/20 rather than after 12/31/17. The TCJA's expiration date of tax years beginning before 1/1/26 remains.

There are a few other changes to Section 461(l) including making the technical corrections from the TCJA that are needed. To help see what is changed, please see the track changes version of Section 461(l) I have posted here.

This loss limitation only applies to non-corporate taxpayers with income above $250,000 ($500,000 if married filing jointly). Thus, this is relevant to less than 5% of non-corporate taxpayers. It causes them to not be able to currently use a specified loss above these amounts; the excess is not lost, it carries forward. One of the technical corrections made is that in measuring the income the loss can offset, wages are not included. This means it is more likely for some individuals to have a loss and for others who already have a loss and wages, the amount to carryforward will be higher. But, this loss limitation rule now doesn't go into effect until tax years beginning after 12/31.20.  Those who applied it on 2018 returns will need to amend.

So, what this an appropriate change to provide financial relief for COVID-19 economic problems? I don't think so as the small group that benefits are already high income taxpayers (in the top 5%) and there were other business relief measures provided that benefit employees and self-employed that could have been larger without the Section 461(l) change.

It's a costly change: The Joint Committee on Taxation estimates that the 461(l) change will cost $170 billion over 10 years. In contrast, the NOL change will cost $26 billion. The employer retention credit will cost $55 billion. The recovery payments for individuals will cost $292 billion. Given how few benefit from the 461(l) change and that they are individuals who are well off, seems like an odd use of limited funds and poorly targeted. Senators Whitehouse and Doggett use JCT data to state that 4 our of 5 filers that benefit from the change make $1 million or more per year and for a few, the average benefit is $1.6 million.

The change also creates some complexity due to the need to amend 2018 returns for affected taxpayers. Also, some states might not conform to this CARES Act change.

This change is not a complete giveaway though because most of these taxpayer would most likely eventually be able to use the carried forward loss. This just delays the impact of this TCJA temporary provision and provides a refund opportunity for 2018 and the ability to use more losses for 2019 and 2020. There are other changes that would have benefited far more taxpayers. I have several in prior blog posts (3/13/20 + 4/4/20) although most of them have already been enacted.

When the TCJA was enacted and when California conformed to Section 461(l), I was surprised to see that the revenue raised was so large (such as the $170 billion cited above just for removing the limitation for 2018, 2019 and 2020).  It's a reminder that some taxpayers have large business losses. Many are likely in the real estate industry where depreciation and interest expense can easily create large losses. But, if they have income high enough to be subject to this loss limitation, they are in the top 3 - 5% of individuals and arguably not suffering or wondering how they will pay rent or mortgage payments and utility bills during the pandemic shutdown.

Why did Congress make the change? Did they not have the data on how few would benefit and that they are high income taxpayers? Too rushed? Something else?

What do you think?

1 comment:

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