The hard truth for many businesses is that 2020 may be the year for losses – substantial losses in some cases – but those losses do not have to be a bad thing. The Coronavirus Aid, Relief and Economic Security (CARES) Act, as one example, temporarily allowed Net Operating Losses (NOLs) to be carried back to earlier tax years. The result is a refund of taxes paid in those earlier, more profitable years and an infusion of badly-needed cash.
Just as many security business owners and managers were focused on building and growing their businesses, the world took a nosedive. Now, the focus for many has turned to survival. Whether a result of economic conditions, competition, or factors outside of anyone’s control, every business is at risk of losses. Would a refund on taxes paid by a formerly profitable security business in years past help ease the pain of lingering losses this year? What if last year's losses from the security business could be used to offset next year's profits and reduce the tax bill for years to come?
Taking full advantage of 2020 losses might be the key to survival; however, it is crucial to know what kinds of losses are deductible and how they should be tackled. Obviously, recoveries via tax law are not always smooth, so seek professional assistance as needed.
Operating Losses
When losses are combined with an operation’s other deductions and it exceeds income, the result is a Net Operating Loss (NOL). The 2017 Tax Cuts and Jobs Act (TCJA) limited the amount of NOLs that could be utilized to only 80% of taxable income, and the NOLs could only be carried forward.
The CARES Act changed this. It allows NOLs arising in a taxable year beginning after Dec. 31, 2017 and before Jan. 1, 2021, to be treated as a carryback to each of the five preceding tax years – unless the taxpayer chooses to forego the carryback.
Businesses that incur NOLs in 2018, 2019 or 2020 can carry back those losses as far as 2013, 2014 and 2015, respectively. In light of the maximum corporate tax rate for tax years prior to 2018 being 35% rather than today’s current 21% corporate tax rate, these carrybacks can be quite rewarding. For tax years 2021 and thereafter, the old rules, including the previous 80% of taxable income limitation, will be reinstated.
The reinstated five-year NOL carryback provides a welcome injection of liquidity for many security businesses suffering from the economic impact of the coronavirus pandemic; however, that relief is only temporary.
Obviously, recoveries via tax law are not always smooth, often requiring professional assistance or, at the very least, an understanding of how the tax rules work. Could you or your security or installation business profit from this year’s losses?
To claim a refund of taxes from a NOL carryback, a security business uses either a single tentative refund claim covering all carryback years, or an amended tax return for each carryback year. With the IRS required by law to process the refund request within 90 days.
Form 1045 or Form 1139 are the preferred forms. Incorporated security businesses file a tentative refund claim on Form 1139 (Corporate Application for Tentative Refund), while individuals use Form 1045 (Application for Tentative Refund). These forms eliminate the burden of filing multiple amended returns to account for each carryback year should the NOL not be fully absorbed in the first carryback year.
Taking advantage of the new and temporary NOL carryback rules allow security integration businesses to quickly increase cash flow; however, it also has some drawbacks on several levels – thus, some thought should be given to carrying back NOLs to tax years closed by the Statue of Limitations as well as to years when cancellation of debt income may have been allowed.
State tax implications should also be a consideration when carrying back NOLs. Ensuring that carrybacks are properly claimed at the state level and that the Statue of Limitations does not inadvertently get extended are other considerations. It is also expected that many states will “decouple” from the five-year carryback as they have in the past when NOL disaster relief was enacted.
Casualty Losses
Businesses can continue to take casualty loss deductions for losses that occur as a result of fire, natural disaster and other casualties. There is an exception for both individuals and businesses for losses attributable to a federally-declared disaster when losses can be taken in the year they occur or, if an election is made, in the prior year to produce a refund of previously-paid taxes.
A nationwide emergency in response to the coronavirus pandemic was declared in early March, making the tax law’s Section 165(i), Disaster Losses – rules that most often kick-in in the wake of an actual storm or other natural disaster – potentially invaluable for many security businesses. Quite simply, Section 165(i) allows 2020 coronavirus losses to be claimed on last year’s tax return.
Section 165(i) does not allow a deduction for general losses, but even in the absence of the physical damage of a natural disaster, it does give a security business owner or manager the option of taking a loss deduction for the year before the year in which the loss was actually sustained.
To claim a loss under Section 165(i), the security business must be able to show the property losses were directly caused by the coronavirus pandemic (i.e., an “identifiable event” requirement). Plus, it must be shown that (1) the loss could not be reimbursed through insurance or otherwise, (2) the loss can be evidenced by “closed and completed transactions” and (3) the loss was related to the disaster and sustained in the year when the disaster occurred.
A security business that has permanently closed its facility, abandoned pending business deals (at least for costs already capitalized) and made termination payments based on cancelled contracts or deals can benefit from accelerating Section 165(i) losses back to 2019. General lost revenue, declines in fair market value and a loss of goodwill cannot usually be deducted under Section 165(i) because the provision applies only to “property” losses.
Pushing the 2020 losses into 2019 could actually generate larger NOLs – which, as mentioned, can be carried back to earlier tax years when the security business may have been more profitable. Even better, the earlier cap on the amount of business losses that could be deducted by some taxpayers has been lifted.
Excess Business Losses
Under the TCJA, Excess Business Losses (EBLs) – the excess deductions from all trades or businesses over any gain – an individual’s losses above $250,000 (or $500,000 if spouses file a joint return) could no longer be deducted. Fortunately, the CARES Act removed the limitation on excess business losses for so-called non-corporate taxpayers going all the way back to 2017.
The new, temporary rules allow non-corporate taxpayers to fully offset taxable income with business losses for the 2018, 2019 and 2020 tax years – even if those losses are not related to coronavirus. For tax years beginning in 2021 through 2026, taxpayers may treat excess business losses as NOLs for the purpose of determining a Net Operating Loss carryover in the following year.
For partnerships, S corporations and other pass-through business entities, the loss limitation is applied at the partner or shareholder level – not at the entity level. Regardless of the amount of business losses a non-corporate taxpayer may have, he, she or they very likely could have taxable income subject to tax.
Because the EBL rule is applied by aggregating a taxpayer’s business income and deductions, it does not prevent taxpayers from offsetting losses of one business against the income of another business. Any EBL will carryforward under the NOL rules, subject to the limitations.
Mark E. Battersby is a freelance writer who specializes in tax-related issues. Email him at [email protected].
