Carrying on our tradition of providing you with Solutions Beyond the Obvious, we are pleased to bring you our “Ask the Experts” series of articles. In these articles, our Tronconi Segarra & Associates tax experts identify and explain the significant tax changes that were passed as part of the Coronavirus Aid, Relief and Economic Security (CARES) Act which can provide additional relief for businesses and individuals facing economic hardship as the result of the coronavirus pandemic. Contact your Tronconi Segarra & Associates tax advisor for more information about any of the topics discussed in these articles.
James K. Frank, CPA
As part of its effort to provide businesses the ability to generate cash as they struggle through the coronavirus crisis, Congress has brought back in the CARES Act, the ability to carry-back tax losses. Previously eliminated in the 2017 Tax Cuts & Jobs Act (“TCJA”), tax net operating losses (“NOLs”) generated in tax years beginning after December 31, 2017 and before January 1, 2021 can now, under the CARES Act, be carried back five tax years. To the extent they are not used in this carry-back period, the losses can be carried forward indefinitely to offset future taxable income.
The CARES Act also temporarily suspends the 80-percent-of-taxable income limitation on the use of NOLs that was also an element of the TCJA. The losses generated in the tax years 2018 to 2020 can offset taxable income in the five-year carry-back period without limitation. However, if those losses are carried forward, the 80% limit is reinstated.
Example – XYZ Corporation uses the calendar year as its tax year and has generated taxable income and losses as follows:
Discussion – Under the CARES Act, the tax loss generated in 2018 could be carried back to offset the income in 2013, while the NOL in 2019 could be carried back to reduce the taxable income in 2014, 2015, and 2016 to zero. The 2020 tax loss could be carried back to eliminate the 2017 taxable income, leaving $900 of the 2020 NOL to be carried forward. However, only $400 ($500 x 80%) of this loss carry-forward could be used to reduce the 2021 income due to the reinstatement of the 80-percent-of-taxable income limitation for tax years beginning after December 31, 2020.
To obtain a refund of taxes previously paid via a loss carry-back in the quickest manner possible, corporate taxpayers will file a Form 1139, Corporation Application for Tentative Refund while taxpayers other than corporations will file a Form 1045, Application for Tentative Refund. Generally, the resulting refund will be issued within 90 days of the filing of the application. The Internal Revenue Code and regulations thereunder, however require that Form 1139 and Form 1045 must be filed within 12 months of the close of the taxable year in which the tax loss arose. Thus, it would be too late to file a refund claim using Forms 1139 of 1045 for calendar year taxpayers who suffered a tax loss in 2018. Thankfully, in Notice 2020-26, the IRS granted a six-month extension of time to file Form 1045 or Form 1139, as applicable, to taxpayers that have a tax loss that arose in a taxable year that began during calendar year 2018 and that ended on or before June 30, 2019. As a result, calendar year taxpayers that have a loss in 2018 have until June 30, 2020 to file Form 1139 or 1045 to carry-back that loss and claim a refund.
If the timeline for filing claiming refunds for loss carry-backs using Forms 1139 or 1045 is missed, a refund can still be requested by filing an amended income tax return for the year the loss is carried back to and claiming a deduction for such loss. However, the IRS is not bound to issue a requested refund within 90 days when it is claimed via an amended return. The Service could, and normally often does, hold any refunds claimed on an amended return until it has completed a protracted review or audit of the amended return.
If, for whatever reason, a taxpayer does not wish to carry-back losses generated in 2018, 2019, and 2020, they do have the ability to elect to relinquish the carry-back period for each of those years. Such elections for tax years 2018 and 2019 must be made by the due date, including extensions, for filing the taxpayer’s return for the first taxable year ending after the March 27, 2020 date of enactment of the CARES Act. For calendar year taxpayers, this means the relinquishment election for 2018 and/or 2019 must be filed by the due date of the 2020 return, which would normally be April 15, 2021, extendable to October 15, 2021. Any election to relinquish the carry-back period for losses generated in the 2020 year would have to be made by the due date of that return, including extensions.
Correction of an Unforced Error
The CARES Act also corrects a technical glitch in the 2017 Act that impacted corporations that use a fiscal year other than the calendar year. The TCJA had eliminated the ability to carry-back losses effective for tax years ending after December 31, 2017 while the Congressional intent was to apply this provision to tax years beginning after that date. The CARES Act retroactively adjusts the TCJA to the intended language. So, fiscal year taxpayers which generated a tax loss in their tax year that began in calendar 2017 can now carry back this loss to the prior two fiscal years to claim a refund for corporate income taxes paid in those earlier years. However, they are going to have to hurry; affected taxpayers are only given 120 days after enactment of the CARES Act (March 27, 2020) to file such carry-back claims, or to otherwise waive this additional carry-back period.
Corporate Tax Rate Arbitrage
Effective January 1, 2018, the Tax Cuts & Jobs Act reduced the maximum corporate income tax rate from 35% to 21%. With its five-year carry-back period, the CARES Act provides the opportunity to recover taxes paid in the high-rate tax years of 2013 – 2017. To maximize this benefit, tax planning strategies could be considered to maximize the tax losses, particularly in years for which a tax return has not been filed as yet, i.e. 2019 and 2020. Such strategies could include maximizing the tangible property placed in service in order to take advantage of the 100% bonus depreciation still available for federal income tax, and utilizing the installment sale method when available to defer income past 2020. Taxpayers should also consider evaluating the accounting methods utilized to determine taxable income to identify opportunities to defer income or accelerate deductions into loss years. If taxable income is expected for 2019, consideration could be given to “bunching” as much income in that year so as to maximize a tax loss generated in 2020 that could be carried back to the high tax-rate years of 2015 – 2017.
The Alternative Minimum Tax (AMT) Lives Again . . . but not for long
It should be kept in mind that the carry-back of losses will require the recalculation of certain items in the years to which the losses are carried. For example, the so-called “domestic production deduction” of §199 available to U.S. manufacturers before its repeal after 2017, would have to be redetermined after considering the amount of tax NOLs carried back to years 2013 – 2017.
The corporation AMT was a tax regime that paralleled the “regular” tax before its repeal effective for tax years beginning after December 31, 2017. With an objective of assuring that corporations ‘paid their fair share of tax,’ NOLs could not fully eliminate alternative minimum taxable income. Therefore, if losses are carried back to the years 2013 – 2017, corporate taxpayers will have to recalculate the AMT and may find themselves subject to it in those years, which would reduce the amount of the tax refund for that year. That’s the bad news.
The good news is that the AMT is creditable against future regular taxable income. Further, the CARES Act accelerates a prior transition rule such that any unused AMT credit carry-forward can be claimed as a refund as early as the 2018 tax year. Those taxpayers electing to claim the refund of any AMT credits for 2018 need to file such claim by December 31, 2020. Otherwise the refund of the AMT credit can be claimed on the 2019 tax return.
For businesses whose operation and market are primarily domestic, the evaluation of the opportunities afforded by the NOL provisions of the CARES Act will be fairly straight-forward. However for those corporations that extensively sell to foreign markets or have operations outside the U.S. conducted through foreign subsidiaries, the analysis likely will be much more complex.
As part of its shift to a “semi-territorial” system of international taxation with the Tax Cuts & Jobs Act, the U.S. enacted the ‘transition tax’ under §965 whereby accumulated earnings of foreign subsidiaries were deemed distributed to the U.S. parent in 2017 and effectively taxed at a reduced U.S. tax rate. Because of this, the CARES Act specifies that if a loss is carried to a tax year in which an amount is includable in gross income by reason of §965 (which generally would be 2017), the taxpayer is automatically deemed to make an election under §965(n) to not use such tax losses against the §965 income. In other words, taxpayers would only be able to use an NOL carryback to offset non-§965 income. However, because of the residual complexity associated with determining the §965 tax vis-à-vis the regular tax, the CARES Act contains a potentially helpful provision that allows taxpayers to elect to exclude from the carryback period tax years in which §965 income was recognized. Simply put, taxpayers will be allowed to carry back their NOLs for a five-year period while electively skipping over the §965 inclusion year.
As part of the international tax reform included in the Tax Cuts & Jobs Act, Congress enacted the “Global Intangible Low Taxed Income” (GILTI) regime whereby a portion of the earnings of foreign subsidiaries is immediately pulled into the U.S. for taxation; corporations are allowed a deduction of 50% of this income to theoretically reduce the rate of tax on this income from 21% to 10.5%. In addition, a deduction was provided to U.S. corporate taxpayers of 37.5% of “Foreign Derived Intangible Income” (FDII) on sales of product and services to foreign customers. Both the 50% GILTI deduction and the 37.5% FDII deduction are referred to as the §250 deduction.
Current law places limitations on the use of the §250 deduction when GILTI and/or FDII income exceed taxable income. Any unused §250 deduction cannot be carried forward or back; i.e. it is lost if not used. Therefore any tax losses carried to 2018 and 2019 could have the effect of substantially reducing the §250 deduction and reducing the benefit of the loss, a portion of which would be used to replace the §250 deduction.
Example – ABC Corporation utilizes a calendar tax year and has foreign subsidiaries. In 2018, it has taxable income of $1,000 before GILTI income, and $500 of GILTI income. Assuming no FDII or interest, the 2018 tax results for ABC Corporation are:
In 2020, ABC generates a tax loss of $1,200, which is carried back to 2018.
Discussion – Because of the operation of the limitations on the §250 deduction, the $1,200 of loss carried back from 2020 would reduce the total taxable income before the §250 deduction from $1,500 to $300. The §250 deduction is limited to the lower of GILTI or taxable income, and it would therefore be reduced to $150 ($300 taxable income after NOL x 50%). The net taxable income of $150 after the §250 deduction would result in a remaining tax of $32 ($150 x 21%) and a refund claim of $231 ($263 original tax less $32 remaining tax).
The refund claim of $231 is less than if the full $1,200 loss carryback could reduce taxable income ($1,200 x 21% or $252). This is because $100 of the NOL carryback had to be utilized to replace the permanent reduction of the §250 deduction ($250 – $150).
While the loss carryback provisions can still provide meaningful cash refunds to U.S. taxpayers with international operations, as demonstrated above, the actual refund may be lower than anticipated.
The erosion of the §250 deduction may not be the only consequence that multinational corporations could face if they chose to carryback tax losses. Reducing taxable income through a loss carryback to a given year could also reduce the ability of the corporation to claim foreign tax credits that year. While foreign tax credits can be carried forward, the carryforward period is limited to ten years. Thus to the extent the foreign tax credits used in the year the loss is carried to were themselves carried forward into that year, or if the taxpayer finds they cannot fully utilize the foreign tax credits in future years, such credits may be lost, effectively resulting in double taxation on the foreign source income.
Coronavirus financial issues may drive the need to carryback losses to obtain the cash needed to continue the business operations. However, in situations where the need for liquidity is not so acute, a multinational corporation may be well served to analyze the situation to determine if the carryback of losses is worth the potential loss of other deductions and credits.
Please contact your Tronconi Segarra & Associates tax advisor for more information on this or any tax matter. If you do not have a Tronconi Segarra & Associates tax advisor, please call 716.633.1373 or Contact Us through our website with your question.
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