This article was originally published on May 27, 2020
Under normal circumstances, many businesses incur substantial losses in some years while realizing profits in other years. This is particularly true in cyclical industries. To alleviate the burdens and inequities of only taxing profits, all states that tax income allow businesses a deduction for net operating losses (NOLs). As many practitioners know, navigating NOL issues is complicated. Determining the eligibility and the amount of NOL deductions is often a complex endeavor requiring significant time and resources.
Part of the complexity arises from the variations of laws and regulations concerning NOLs among the states that tax business income. For example, states vary as to the time limits for NOL carryforwards. Those and other state-specific nuances are often dependent on a state’s conformity to federal tax law. Most states generally conform to federal law, although many states have added specific modifications to their NOL rules. Furthermore, federal tax laws regarding NOLs changed significantly with the passage of the Tax Cuts and Jobs Act (commonly known as ‘TJCA,’ P.L. 115-97). State treatment of NOLs often varies depending on whether the losses were incurred before or after TCJA.
Businesses often overlook the fact that state treatment of NOLs usually depends on whether the losses were incurred organically, i.e., in the normal course of business, or whether they resulted from an acquisition of an entity with existing losses. Moreover, the use of NOLs is dependent on whether a business is operating in a combined reporting state or a separate accounting state.
As if the state NOL landscapes was not complicated enough, the federal Coronavirus Aid, Relief and Economic Security Act (CARES Act) was enacted in response to the COVID-19 pandemic. The CARES Act provides that taxpayers can carry back NOLs five years. This is a significant change from the previous law enacted as part of TCJA which essentially eliminated federal carrybacks. The CARES Act provides that both corporations and non-corporate taxpayers are eligible to carry back losses from 2018, 2019 and 2020 to the prior five taxable years. In addition, the 80% limitation on the utilization of losses was suspended through 2020 allowing the full utilization of NOLs.
The CARES Act NOL changes provide business refund opportunities and the risk of additional assessments in years thought to be closed by statute of limitations. The benefits from the CARES Act will depend on whether the business is filing in a rolling conformity state or whether the state has enacted specific conforming legislation. Filing federal amended returns to claim the carryback may also trigger additional state tax filing requirements.
The RSM State and Local Tax group can assist companies in assessing how best to address NOLs issues at the state level. With the economy distressed by the COVID-19 pandemic, businesses across the country are experiencing unprecedented losses. Those losses will likely continue as large parts of the country remain under government mandated shutdown. Many, if not most, business will have losses in the next two years. Businesses should be aware that many states will likely revise their NOL rules through legislation, rulemaking or administrative guidance. Some states may provide more generous NOL deductions. Other states may further limit NOLs to raise revenue.
Whatever the landscape, businesses should be aware of the state tax risks and opportunities inherent with NOLs. Where a business files, whether a state conforms to federal law, and if NOLs can be shared with related parties are just some of the issues businesses encounter. Importantly, with NOLs, one size does not fit all businesses.