Good to Know

THE TREASURY DEPARTMENT PROVIDES MORE THAN SBA LOANS FOR BUSINESS WORKING CAPITAL

SBA loans and the Paycheck Protection Program dominated the business headlines over the last few months. But several less-heralded provisions of the CARES Act go beyond recent headlines to shore up cash flows of struggling businesses, too. How? Liberalization of formerly restrictive tax regulations may put more desperately-needed cash into the hands of business owners.

Specifically, potential sources of cash for business owners include:

Deferral of employer’s portion of Social Security taxes

Loosened restrictions on net operating loss carrybacks

Suspension of excess business loss deduction limits

Next, we will summarize each of these opportunities.

Deferral of Employer’s Portion of Social Security Taxes

Employees have 6.2% of their compensation1 withheld from their paycheck in Social Security taxes. Employers must match the employee withholding amount as an employer contribution to Social Security. The CARES Act allows an employer to defer payment for most of an employer’s 2020 Social Security contribution for up to two years; 50% must be paid by December 31, 2021, and the remaining 50% must be paid by December 31, 2022.

Loosened Restrictions On Net Operating Loss Carrybacks

A net operating loss (NOL) is a tax loss from operating a business. An NOL carryback is simply an income tax strategy in which an NOL in the current year is “carried back” to a previous year in which the business reported taxable income. NOL carrybacks generate an income tax refund if income taxes were paid for the carryback year. NOL carrybacks were abolished for 2018 and later years but have been temporarily restored by the CARES Act. A pre-CARES Act example follows:

  • Your client had business taxable income of $500,000 in 2016 and an NOL of $500,000 in 2017.
  • In those years, the business could “carry back” the 2017 NOL of $500,000 to 2016, thereby reducing 2016’s business taxable income to zero.
  • Any income taxes paid for 2016 would then be refunded to the business.

Under the CARES Act, a business may now carryback NOLs incurred in 2018, 2019, and 2020 for as many as 5 years. Of equal note, the CARES Act also suspended the annual 80% limit on the use of NOLs; As much as 100% of NOL carrybacks may now be used to reduce prior year business taxable income.

Temporary Suspension of Excess Business Loss Deduction Limits

The Tax Cuts and Jobs Act (TCJA) imposed an “excess business loss” limit effective for 2018 and later years for certain business owners. Under the TCJA, a married-filing-jointly business owner operating a business in “flow-through” form2 could not deduct more than $518,000 (2020, as indexed)3 in NOLs against business income in a carryforward year.4 A TCJA-era example follows:

  • Assume a sole proprietor had a $750,000 business operating loss in 2019 and $750,000 in business taxable income in 2020. Before the CARES Act, the business owner could only deduct $518,000 of the 2019 NOL against 2020’s taxable income.
  • In the wake of the CARES Act, the sole proprietor can deduct the entire 2019 $750,000 NOL against 2020’s $750,000 in business taxable income.

The CARES Act retroactively suspends the excess business loss limits for 2018, 2019 and 2020 tax years. Taxpayers who were limited by the excess business loss limits may file an amended tax return and claim a refund for tax years 2018-2020. In the example just presented, the taxpayer could have reduced income taxes by as much as $85,840 (additional NOL deduction allowed of $232,000 [750,000-518,000] multiplied by the top individual marginal rate of 37%).

The CEO of Volvo was reported to have coined the phrase “Cash is King” after the 1987 crash in global stock markets. That sentiment resonates even stronger today for businesses challenged by the cash-flow wrecking ball named COVID19.

While not as dramatic as the headline-grabbing Paycheck Protection Program, the CARES Act also gives savvy business owners cash flow from an unlikely source – their friendly IRS tax refund “banker.”

1 Compensation above $137,700 in 2020 is not subject to Social Security tax.
2 A “flow-through” business pays no entity-level income taxes. Income and expense flow through to the owner’s personal income tax return. Flow-through businesses include Sole Proprietorships, Partnerships, Sub-S Corporations and certain Limited Liability Companies.
3 The limit falls to $259,000 for other filing statuses.
4 Other limits on losses (“at risk” and “passive loss”) continue to apply for flow-through business owners.

Disclaimer

The information presented herein is provided purely for educational purposes and to raise awareness of these issues; it is not meant to provide and should not be used to provide legal, tax or financial advice to clients. There are variations, alternatives, and exceptions to this material that could not be covered within the scope of this blog.