The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) provides taxpayers with the opportunity to utilize net operating losses (NOLs) that can be carried back five years to generate significant refunds of tax previously paid. This is a significant change from the rules set forth in the Tax Cut and Jobs Act (TCJA) enacted in 2017. Under that law, carryback of NOLs became limited to losses incurred in tax years ended Dec. 31, 2017. 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.
While the new rules will result in significant federal income tax savings, the CARES Act NOL changes could have significant ramifications for state taxation. Businesses claiming the federal NOL carryback might have the opportunity to improve cash flow through income tax refunds for years that were thought to be closed by state statutes of limitation. But claiming the federal NOL carryback could also create the risk of additional assessments for years in which the statute of limitations is extended by the federal claims. There are other potential state tax consequences from claiming the federal NOL carryback.
The RSM State and Local Tax group has identified several issues that should be considered before claiming the federal NOL carryback. These include but are not limited to:
State conformity to federal NOL provisions
Businesses contemplating claiming the federal NOL should know whether states in which it files conform to the federal extended NOL carryback provisions. Companies may directly benefit from the extended carryback period in states that have rolling conformity with the Internal Revenue Code and have adopted NOL carryback provisions. Businesses should be aware that states that currently conform may decouple from the NOL carryback extension. It is critical to be aware of both state administrative guidance and possible legislative changes concerning CARES Act tax provisions.
Additional filing requirements
Many business are unaware that filing amended federal tax returns could trigger additional state tax filing requirements. The rules vary widely by state. The rules governing what triggers state filing requirements may depend on the manner in which companies claim the federal NOL carryback. For example, the filing of a federal Form 1120X or other applicable amended return generally triggers a state filing requirement. The states often require amended returns even if the federal amended return does not affect state tax liability. It is unclear in most states whether filing federal Form 1139, Corporation Application for Tentative Refund, to claim the NOL would trigger state filing requirements. Businesses should consult with their tax advisors to ascertain the best way to claim the federal NOL carryback.
Statute of limitations
Whether filing Form 1139, Form 1120X, or other applicable amended returns, businesses should be aware of such filing on state statute of limitations. In many states, the statute of limitations for open years are extended when a taxpayer receives a federal final determination or files a federal amended return. Some states will reopen an otherwise closed year when a federal change occurs and allow refunds and assessments for issues unrelated to the federal change. Few states have issued guidance on the impact of filing federal Form 1139 on the limitation periods. It is unclear whether the limitations period would be reopened as a result of filing Form 1139. There is a possibility that such filing would not be treated as a final determination or an amended return. Again, it is critical to know the state tax benefits and risks of which method is used to claim the federal credit.
Refund opportunities and assessment risks
Claiming the federal NOL carryback can create substantial refund opportunities for many businesses. Assuming that the state limitation periods for the carryback years are open, taxpayers should review and evaluate their income tax liabilities. In many instances, a reverse income tax audit will yield refunds. Those refunds could alleviate cash flow problems during the economic crisis and improve a company’s financial position. A review of past income tax filings may also lead to future income tax savings as companies discover changes that have long term benefits. The review of past income tax returns often identifies incorrectly apportioned income, missed credits and incentives, and income constitutionally or statutorily excluded from taxation.
Claiming the federal carryback, however, creates state tax risks as well. If the NOL claim opens or extends the statute of limitations, state revenue departments could assess additional tax for open years. New assessments usually occur when the state revenue department is aware of sizable tax liabilities that are barred by the statute of limitations. The federal claim could prompt the state to look at any income tax issue in the returns for the years being amended to identify refund offsets and assessments. Businesses should evaluate past tax positions prior to claiming the federal NOL carryback.
The RSM State and Local Tax group can assist companies in assessing the potential state tax benefits and risks of pursuing a federal NOL carryback claim. Companies should know: state filing requirements; the effect on the statute of limitations; the best method of claiming the NOL for state purposes; and the refund opportunities and assessment risks. Most importantly, companies should consult with their state tax advisors before filing the federal NOL claim.