The Lockdown

We are in a Coronavirus-induced lockdown. Most places of business are either closed or are open on a very limited basis. Social distancing is the order of the day. Those who can work remotely are doing so.[i] Many don’t have that option.

Certain businesses are experiencing an uptick in revenue as a result of the lockdown.[ii] Other businesses are floundering as demand for their goods or services has plummeted.[iii]

Then there is the great majority of businesses – closely held businesses – which basically live “from paycheck to paycheck.” It is a truism that they need to collect on their receivables in order to satisfy their payables.

In bad times, they may be able to rely on a line of credit for some finite period of time (assuming the line is adequate) – the question, of course, is for how long – or they may have to dip into their reserves or even request an infusion of capital from their owners.

The Economy

Many of these businesses are struggling to stay afloat.

They are trying to generate a steady flow of work from those other businesses with which they ordinarily transact, as well as from the general public – this can be a challenge in normal times, let alone under the circumstances in which they now find themselves, where even these potential or existing “client businesses” are experiencing the same challenges.

Even when this work can be found, one has to wonder whether the client will ultimately be able to pay the usual price charged by the business, or whether they will negotiate a discounted charge from the get-go. It is not at all unusual for a business to settle for a near-to-below market rate just to keep its doors open and its workers employed – we’re talking damage control until one can round the proverbial corner.

And while it may be difficult to generate the necessary business and the resulting receivables, which hopefully will be collected sooner rather than later, many business expenses are fairly fixed – unless the business is able to negotiate concessions from its landlord, bank, vendors, etc.;[iv] for example, rent, debt service, salaries, pension, insurance, and others.[v]

Congress Acts

In response to this stressful – but hopefully short-lived – business environment, the Federal government has taken some extraordinary measures over the last couple of weeks to help American businesses, and the public generally, to cope with what is expected to be the significant economic toll attributable to the Coronavirus.

Thus, income tax return filing dues dates have been pushed back 90 days, and a similar “holiday” has been granted for income tax payments, regardless of the amount owed.[vi]

Businesses that are required to provide paid leave for employees are being granted a refundable tax credit to defray the associated cost.[vii]

The “CARES” Bill

More recently, the Republican leadership in the Senate introduced an economic stimulus plan, dubbed the Coronavirus Aid, Relief and Economic Security (“CARES”) Act,[viii] and has started discussions with the Administration and the Democratic Senate leadership[ix] regarding its terms.

Among other things, the proposed legislation provides, among other things, that a business with fewer than 500 employees may qualify for a loan of up to $10 million that would help cover payroll and rent, among other obligations. If the business retains its employees and payroll levels, the loan would be forgiven to the extent it is used to cover payroll and certain preexisting obligations.[x]

Each of these measures should alleviate some of the pain that businesses have begun to feel, and will continue to experience for some time, as a result of the Coronavirus lockdown.

Net Operating Losses

Notwithstanding this promised relief, the fact remains that many businesses will be generating losses – real and immediate and substantial economic losses.[xi] Once upon a time, not that long ago, such a business would have been able to carry its net operating losses (“NOLSs”) – generally, the amount by which its business deductions exceed its gross income[xii] – for a taxable year back to its two immediately preceding taxable years,[xiii] as a result of which the business would have been entitled to a refund of all or a portion of the Federal income taxes paid in such earlier years; in other words, it would have received, in relatively short order, funds that the business needed in order to help it recover, and it would not have had to incur debt to do so.

Under existing rules, however, these businesses will be denied the full economic benefit of such losses – at a time during which this benefit may be sorely needed. That’s because the Tax Cuts and Jobs Act (“TCJA”)[xiv] eliminated the option[xv] for most taxpayers to carry back an NOL. Indeed, most taxpayers can only carry NOLs arising from taxable years ending after December 31, 2017 to a later year.[xvi]

The TCJA did not only eliminate the carryback of a taxpayer’s NOLs, it also limited the use of such NOLs for any taxable year of the taxpayer to which they may be carried forward.

Specifically, the NOL deduction – for losses arising in taxable years beginning after December 31, 2017[xvii] – cannot exceed 80 percent of the taxpayer’s taxable income for a carryforward taxable year (determined without any NOL deduction).

The practical effect of this limitation is that a taxpayer with an NOL carryforward to a taxable year, that could otherwise have been used to offset their entire business income for such year – thereby eliminating their income tax liability for the year – has to defer part of the benefit of the NOL into a later taxable year while paying income tax in the current year.

Excess Business Loss

Prior to the TCJA, an individual taxpayer’s business losses could offset the individual’s nonbusiness income,[xviii] without limitation.

The TCJA limited the amount of losses from the trades or businesses of a noncorporate taxpayer[xix] that the taxpayer can claim each taxable year.[xx] If the noncorporate taxpayer owns an interest in a partnership or in an S corporation that is engaged in a trade or business, the taxpayer’s allocable share of the losses therefrom is also considered.[xxi]

Specifically, the taxpayer cannot deduct overall net business losses in the current taxable year. This is the amount by which the total deductions from the taxpayer’s trades or businesses are more than their total gross income or gains from such trades or businesses, plus a statutorily prescribed threshold amount.[xxii]

The amount of any excess – the excess business loss – is treated as an NOL carryover in the subsequent taxable year.[xxiii]

The practical effect of this limitation is that a taxpayer with excess business losses for a taxable year, that could otherwise have been used to offset their nonbusiness income for such year – perhaps even eliminating their tax liability for the year – have to defer the benefit of the excess loss into the next taxable year while paying an amount in income tax in the current year that they otherwise could have used in their business.

What Should Congress Do?

The next few months will be challenging for almost every business in the country. Many businesses will fail that should not have failed. Others will rack up some significant operating losses that they should not have realized. The culprit in both cases is the Coronavirus, and the closely held business will be one of the inadvertent victims of our response to this very serious public health crisis.

Many “experts” have stated that they expect the crisis will pass before the end of the 2020 calendar year, maybe even as early as late Spring. At this point, we can only hope.[xxiv] Those businesses that survive – whether because they were “lean and mean” before the crisis, had adequate reserves or other financing sources, or for some other reason, including plain luck – are likely to have realized significant losses. They are also likely to be in need of new capital.

Why limit the ability of these businesses to convert their losses as soon as possible into badly needed funds? Why defer this benefit to later years when we can reasonably expect an immediate need for capital in the short-run?

Whatever the underlying policy reasons may have been for the TCJA’s enactment of the above-described loss limitation rules – other than to offset revenue losses resulting from the reduction in the Federal corporate income tax rate – they are overshadowed by the current economic threat.

Congress should act accordingly, and it should act immediately. In fact, the CARES Act proposes to make some of the changes outlined above, as well as others.

In particular, the Act calls for the retroactive elimination of the excess business loss rules for 2018 and 2019; in addition, the rules would not apply for 2020. These rules are scheduled to expire after 2025 in any case, and their retroactive repeal would allow business owners to whom the limitation applied in 2018 or 2019 to immediately file a refund claim. Frankly, their elimination from the Code[xxv] should be accelerated.

The CARES Act also proposes changes to the TCJA’s limitations on the use of NOLs. Taxpayers with NOLs arising in 2018, 2019 and 2020 would be allowed to carry such losses back to each of the five taxable years[xxvi] immediately preceding the taxable year in which the loss was realized. Assuming these taxpayers had tax liabilities for those years, they will be entitled to a refund of what is likely a badly needed infusion of cash.

The Act would also suspend the 80-percent-of-income limitation for taxable years beginning before January 1, 2021 (basically, 2018, 2019 and 2020), thereby freeing up dollars that otherwise would have been paid to the government.

The foregoing provisions of the CARES Act would be especially helpful for those businesses that will realize substantial losses this year, of which there will probably be many.

However, one must not lose sight of the fact that these amendments to the Code have not yet been enacted – indeed, they remain subject to change as Republicans and Democrats try to reach a consensus.

Speaking of which, when last I checked,[xxvii] the Washington Post had reported that Democrats were characterizing the CARES bill as a form of “corporate welfare,” and the loan program as a “slush fund” for businesses and their owners. Insisting that the preservation of workers’ jobs and salaries be the first priority of any economic aid legislation, they have promised to offer a competing legislative proposal.[xxviii]

Stay tuned. Hopefully, we will have some resolution later this week.


[i] Some more effectively than others.

[ii] I read that the consumption of “comfort foods” is on the rise. I must be in a bad way all of the time because I frequently seek out such foods. Indeed, as I revise this post, I have before me a large cup of coffee and a plate of Oreos. It’s a small plate, really. No, they are not the over-stuffed variety. Don’t judge me. Back off.

[iii] Restaurants, hotels, theaters, fast food joints, donut shops, etc. – anyplace in which people congregate.

[iv] It takes two to tango. Yada, yada, yada.

[v] Clearly, the leaner a business was going into this situation – no unnecessary obligations (so-called “fat”), an available line of credit, adequate reserves – the greater its chances of enduring the slowdown and ultimately emerging from it.

Examples of items that may be characterized as fat include the following: above-market workforce salaries and benefits, excess labor (meaning that a function that should reasonably be performed by one person is spread out over two), unnecessary overhead expenses (like an unnecessary location), personal travel and entertainment, non-targeted charitable contributions.

[vi] See IRS Notice 2020-18.

[vii] Families First Coronavirus Response Act. P.L. 116-127.

[viii] S.3548.

[ix] Mostly the Senate because the House appears to be out of session until March 24. https://www.congress.gov/resources/display/content/Calendars+and+Schedules

[x] Moreover, these businesses would not have to include the forgiven debt as COD income under IRC Sec. 61(a)(11). FYI, prior to the TCJA, in the case of a corporate business, the forgiven debt could have been treated as a capital contribution under IRC Sec. 118. As a result of the TCJA, however, the exclusion of a capital contribution from a corporation’s gross income, under Sec. 118(a), does not apply to a contribution by a governmental entity.

[xi] As distinguished from “mere” tax losses.

[xii] IRC Sec. 172(c). With certain modifications.

[xiii] IRC Sec. 172 prior to the TCJA.

[xiv] P.L. 115-97, Sec. 13302.

[xv] Before the TCJA, the taxpayer could elect to waive the carry back of NOLs for a taxable year and, instead, carry all of such losses forward.

[xvi] Under prior law, the carryforward period was limited to twenty years. Today, an NOL may be carried forward for an indefinite period, until it is fully utilized.

[xvii] IRC Sec. 172(a)(2). See the Instructions for IRS Form 1045.

[xviii] For example, investment income such as dividends, capital gains, and interest income.

[xix] Individuals, estates, and trusts.

[xx] TCJA Sec. 11012. IRC Sec. 461(l).

[xxi] The trade or business determination is made at the entity level, but the limitation is applied at the level of the partner or shareholder, as the case may be.

[xxii] For 2019, the threshold amount is $255,000 ($510,000 for married taxpayers filing a joint return). These amounts are indexed for inflation. See IRS Form 461, Limitation on Business Losses.

[xxiii] The provision applies after the application of the passive loss rules of IRC Sec. 469. Thus, the loss must have first satisfied the basis limitation rules in the case of an interest in a partnership (IRC Sec. 704(d)) or S corporation (IRC Sec. 1366(d)), as well as the at risk rules of IRC Sec. 465.

Note that the loss limitation provision does not apply to taxable years beginning on or after January 1, 2026.

[xxiv] From Lord of the Rings, The Two Towers (my favorite of the three movies):

THEODEN: [speaking loudly, that his men may hear] They will break upon this fortress like water on rock. [they walk around the inner ramparts] Saruman’s hordes will pillage and burn.
We’ve seen it before. Crops can be resown……homes rebuilt. Within these walls……we will outlast them.
ARAGORN: [raising his voice in response to what he perceives as Theoden’s foolish plan] They do not come to destroy Rohan’s crops or villages. They come to destroy its people……down to the last child.
THEODEN: [walks back towards Aragorn, takes his arm, and in a lowered voice, through clenched teeth says] What would you have me do? Look at my men. Their courage hangs by a thread.

[xxv] I am referring to the one true Code. Title 26 of the U.S.C.

[xxvi] The previous longest carryback period was three years, though there have been longer exceptions. The regime replaced by the TCJA – two years back, twenty years forward – was enacted by the TRA of 1997, P.L. 105-34.

[xxvii] At 3:00 pm EST, March 22.

[xxviii] Senate Republicans had hoped for a vote on Monday, March 23.