A little noticed provision in the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) may provide distressed corporations with a much needed liquidity boost. The CARES Act restores the ability of corporations to carry back net operating losses (“NOLs”) generated in taxable years beginning in 2018, 2019 or 2020 for up to five years, and (ii) removes the limitation on the amount of NOLs that can be carried forward to taxable years beginning in 2018, 2019 and 2020. Therefore, a corporation with NOLs can carry back and carry forward NOLs to reduce taxable income and, thus, generate a refund of some or all of the previously paid U.S. federal income taxes.
NOL carry backs and carry forwards have generally been part of tax law for most of the last 100 years. The U.S. Supreme Court described the policy reasons for the carry back and carry forward rules as follows:
[These rules] ameliorate the unduly drastic consequences of taxing income strictly on an annual basis. [The rules] were denied to permit a taxpayer to set off its lean years against its lush years, and to strike something like an average taxable income computed over a period longer than one year. Lisbon Shops, Inc. v. Koehler, 353 U.S. 382, 386 (1957).
In 2017, however, as part of the Tax Cuts and Jobs Act of 2017 (the “TCJA”), Congress eliminated NOL carry backs entirely and reduced the amount of NOLs that could be carried forward. The CARES Act, as discussed above, substantially liberalizes the ability of corporations to carry back and carry forward NOLs and, in many cases, restores the favorable provisions that applied before enactment of the TCJA.
The renewed ability to carry back NOLs could be particularly helpful for a corporation currently experiencing liquidity issues that paid U.S. federal income taxes in prior years. Corporations should immediately analyze their tax situations to determine whether they can carry back any NOLs to earlier years to receive a tax refund. Furthermore, it is reasonable to expect that many formerly profitable corporations will incur NOLs in 2020. These corporations should analyze whether to take advantage of the ability to carry back the 2020 NOLs to previous years.
Chapter 7 bankruptcy trustees also should consider whether the new rules can create value for any of their bankruptcy estates that have been pending for multiple years. Chapter 7 estates frequently receive income in one year but do not incur corresponding expenses (such as distributions to creditors) until later years, after all claims have been administered. The estate must then pay tax on the income received. Before 2017, Chapter 7 trustees could amend the return(s) for the years in which the estate paid tax and utilize the losses incurred in later years to obtain a refund. The 2017 Act eliminated that option for Chapter 7 trustees. Now, after the passage of CARES, a Chapter 7 trustee’s ability to carry back NOLs has been restored.
All of this is welcome news for distressed corporations and their creditors. Corporations now may have a source of liquidity that literally did not exist before enactment of the CARES Act.