One Small Change in the Tax Code Could Help Many Businesses in Uncertain Time

COMMENTARY Taxes

One Small Change in the Tax Code Could Help Many Businesses in Uncertain Time

Mar 18th, 2020 3 min read
COMMENTARY BY
Adam Michel

Senior Policy Analyst, Grover M. Hermann Center

Adam N. Michel focuses on tax policy and the federal budget as a Senior Policy Analyst in the Grover M. Hermann Center.
Businesses should be able to make full use of any losses on past years' tax returns, giving them quick cash to bridge the coming months of economic uncertainty. PeopleImages/Getty Images

Key Takeaways

One small change in the tax code could provide a lot of help to businesses big and small.

Companies should be able to make full use of any losses on past years’ tax returns, giving them quick cash to bridge the coming months of economic uncertainty. 

Smoothing tax liability over time is not a bailout; it is sound economic policymaking in good times and in times of economic uncertainty.

In response to coronavirus, people are staying home, canceling flights, postponing vacations, and not eating out. 

All the businesses that were counting on those customers over the next several months will struggle to pay their lenders, keep paying their employees, and eventually to stay open at all. 

One small change in the tax code could provide a lot of help to businesses big and small. Companies should be able to make full use of any losses on past years’ tax returns, giving them quick cash to bridge the coming months of economic uncertainty. 

In years when businesses are not profitable, the tax code allows net operating losses (called NOLs) or negative profits to be carried forward to future years and used to offset subsequent positive taxable profits.

In good times, this allowance is usually thought of as a way to help fledgling businesses that take a year or more to get off the ground. 

Say a new startup spent $100 in its first year but did not earn a single penny because it was developing and perfecting products. The business lost $100 in the first year. The following year, it made $100 in profit after finally opening its doors. 

By allowing the first-year loss to offset the second-year profits, the tax code essentially enables businesses to average their profits and losses over time. In this example, the company can “carry forward” its losses. 

But net operating losses are not just for startups. They can function as an important safety valve for businesses that lose money in an economic downturn. 

Following the 2017 tax cuts, businesses generally are prohibited from carrying net operating losses back to previous tax years (essentially claiming a credit against previous years’ positive gains and taxes paid), and NOL carryforwards are limited to 80% of net income. For many small and medium privately owned businesses, NOLs are limited to as little as $250,000 a year. 

By not letting struggling businesses credit their current losses against past taxes paid, the current NOL system provides benefits that are too little, too late. 

When businesses need cash to make payroll and pay creditors today, the NOL benefit on future-year tax returns is little help. By allowing companies to refile past years taxes with a current year loss deduction, they can receive a direct refund from the IRS of taxes they already have paid. 

Congress should allow net operating losses to be carried back for an immediate refund for two or more years. If companies choose instead to carry their losses forward to future tax years, the 80% limitation and other loss limitation rules should be removed. Congress has made similar adjustments to NOL rules in past economic downturns, most recently in 2009.

For even more immediate relief for the hardest-hit industries, such as airlines and hospitality services, Congress could consider allowing a temporary carryback of estimated future losses and make all losses refundable.

Many businesses don’t have existing losses waiting to be credited; their losses are still in the future. For these companies, Congress could allow them to estimate the coming year’s losses given simplified rules assuming several months’ worth of significant disruptions. These estimated losses also could be carried back for an immediate refund, injecting much-needed cash into struggling industries. 

For example, if a business had $500 in profits last year and paid $100 in taxes on those gains, but anticipates having $500 in losses this year, it could carry back those estimated 2020 losses and receive a $100 credit today against previous taxes paid.

Estimated losses and actual losses or profits would be reconciled at the end of the tax year, once the immediate economic uncertainties have subsided.

Congress also should delay quarterly estimated tax payments and filing requirements for all taxpayers to allow businesses and self-employed workers to keep more of their own money to bridge the temporary decline in commerce. 

The first quarter of 2020 estimated taxes are due April 15, and underpaying estimated taxes can lead to significant penalties. Congress should automatically allow businesses and self-employed workers (without filing) to delay their estimated tax payments until the third-quarter Sept. 15 deadline at the earliest or entirely eliminate estimated tax payments, filing, and associated penalties. 

Businesses still could file tax forms if they expect to benefit from the paid sick and family leave credits Congress is likely to pass. They just would not have to pay any positive taxes due until at least the third quarter.

Treasury Secretary Steven Mnuchin already has announced interest and penalties will be waived for 90 days from the April tax filing deadlines, but has not delayed filing. Filing requirements also should be delayed.  

Expanding access to net operating losses will allow struggling businesses to benefit more quickly from existing safeguards in the tax code that allow income taxes to be smoothed over the business cycle. 

Smoothing tax liability over time is not a bailout; it is sound economic policymaking in good times and in times of economic uncertainty.

This piece originally appeared in The Daily Signal