Can 2020’s Red Ink Convert Into Cash?

Can 2020’s Red Ink Convert Into Cash?

Businesses may be able to convert 2020’s red ink into cash with coronavirus tax breaks.

KEY POINTS
  • Business owners incur net operating losses when their tax deductions exceed income in a given year. Generally, these losses can offset future income.
  • The CARES Act allows taxpayers to carry back losses incurred in 2018, 2019, and 2020 for up to five years.
  • Affected firms and business owners can use those losses to offset income from prior years, leading to a cash refund

The coronavirus has pushed thousands of businesses to the edge, but there may be a ray of hope for cash-strapped firms. Businesses laid low by the pandemic and community lockdowns need money now, and one of the best ways to get it is by taking advantage of very favorable rule changes on the treatment of net operating losses in the CARES Act.

A company incurs NOL (Net Operating Losses) when its tax deductions exceed its income in a given year. Generally, taxpayers can lower their taxes by using this loss to offset income in a future year.

The CARES Act takes this a step further, allowing battered businesses to turn this year’s red ink into a tax refund from prior years’ income. A provision in the legislation allows companies to carry back losses incurred in 2018, 2019, and 2020 for five years.

The IRS has also promised to send out refund checks to business owners and companies within 90 days of a claim if they follow a quick refund process. Individuals will need to file Form 1045, while C-corporations will have to file Form 1139.

The deal is particularly sweet for C-corporations — generally larger companies that are taxed as separate entities from their owners. The Tax Cuts and Jobs Act passed in late 2017 dropped the tax rate on C corps to 21% from 35%. Companies that can carry back losses to pre-2017 years potentially get a bigger bang for the buck.

The tax benefit is less dramatic for small-business owners who are generally structured as pass-through corporations like S-corporations and LLCs. In this case, income from the business “passes through” to the owner’s personal tax return.

The Tax Cuts and Jobs Act lowered the highest marginal individual income tax rate to 37% from 39.6%, a cut that’s far less drastic than the rate reduction for C-corps. However, the potential cash infusion from loss carrybacks may help pass-throughs stay in business.

The NOL carry-back option is not necessarily for everyone. If a taxpayer was not in business in those earlier years or made little taxable income then, it may not be worth the effort to get a small refund. It also reopens your tax file on the years you carry losses back to, which can raise the risk of an audit of prior returns.

Taxpayers can make an irrevocable election to forgo the loss carry-backs and use losses in the 2018-2020 period to offset future income. The CARES Act allows those losses to be carried forward indefinitely. Another factor to consider is whether states will conform to the new federal rules and allow taxpayers to also get refunds of state taxes previously paid.

Business owners should work with their tax professionals to determine whether there’s a silver lining to this year’s misery.

Read the original CNBC article here

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